UNITED        STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

**FORM        10-K**

 

Annual        Report Pursuant to Section 13 or 15(d) of

The        Securities Exchange Act of 1934

 

| For the fiscal year ended                    |  | Commission file number**0-5534** |  |
|----------------------------------------------|--|----------------------------------|--|
| **December 31,                        2007** |  |                                  |  |

**BALDWIN & LYONS, INC.**

(Exact name of registrant as specified in its charter)

         

| **Indiana**                     |  | **35-0160330**      |  |
|---------------------------------|--|---------------------|--|
| (State or other jurisdiction of |  | (I.R.S. Employer    |  |
| incorporation or organization)  |  | Identification No.) |  |

 

| **1099 North Meridian                        Street, Indianapolis, Indiana** |  | **46204**        |  |
|------------------------------------------------------------------------------|--|------------------|--|
| (Address of principal executive offices)                                     |  |  (Zip Code) |  |

| Registrant’s telephone number,                        including area code: (317) 636-9800 |  |
|-------------------------------------------------------------------------------------------------|--|
| Securities registered pursuant to Section                        12(b) of the Act:None          |  |
|  Securities registered pursuant to                        Section 12(g) of the Act:        |  |

(Title of class)

Class A        Common Stock, No Par Value

Class B        Common Stock, No Par Value

 

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

Yes o          No x 

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 periods that the registrant was required to file such reports), and        (2) has been subject to such filing requirements for the past 90 days.

YesxNo        o

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 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.

x

Indicate        by check mark whether the registrant is a large accelerated filer, an accelerated filer, or        a non-accelerated filer. See definition of “accelerated filer and large accelerated        filer” in Rule 12b-2 of the Exchange Act.

Large        accelerated filer o  Accelerated filerxNon-accelerated filer        o

 

The        aggregate market value of Class A and Class B Common Stock held by non-affiliates of the        Registrant as of June 30, 2007, based on the closing trade prices on that date, was        approximately $216,918,000

The number of shares outstanding of each of the issuer’s classes of        common stock as of March 3, 2008:

|   | Common Stock, No Par Value: |
|--------|-----------------------------|

|   | Class A (voting) | 2,650,059 shares |
|--------|------------------|------------------|

|   | Class B (nonvoting) | 12,592,555 shares |
|--------|---------------------|-------------------|

 

The Index        to Exhibits is located on pages 75 through 77.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Portions        of the Proxy Statement for Annual Meeting of Shareholders to be held May 6, 2008 are        incorporated by reference into Part III.

 

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**PART I**

 

**Item        1.****BUSINESS**

 

Baldwin        & Lyons, Inc. was incorporated under the laws of the State of Indiana in 1930. Through        its divisions and subsidiaries, Baldwin & Lyons, Inc. (referred to herein as        “B&L”) specializes in marketing and underwriting property and casualty        insurance. B&L’s subsidiaries are: Protective Insurance Company (referred to        herein as “Protective”), with licenses in all 50 states, the District of        Columbia and all Canadian provinces; Sagamore Insurance Company (referred to herein as        “Sagamore”), which is currently licensed in 47 states; and B&L Insurance,        Ltd. (referred to herein as “BLI”), which is domiciled and licensed in Bermuda.        These subsidiaries are collectively referred to herein as the “Insurance        Subsidiaries.” The “Company”, as used herein, refers to Baldwin &        Lyons, Inc. and all its subsidiaries unless the context indicates otherwise.

Approximately 67% of the gross direct premiums written and assumed by the        Insurance Subsidiaries during 2007 were attributable to business produced directly or        indirectly by B&L. Approximately 13% of gross premium is assumed from several        non-affiliated insurance and reinsurance companies through retrocessions. The remaining 20%        consists primarily of business written by Sagamore which was originated through an        extensive network of independent agents.

The        Insurance Subsidiaries cede portions of their gross premiums written to several        non-affiliated reinsurers under excess of loss and quota-share treaties and by facultative        (individual policy-by-policy) placements. Reinsurance is ceded to spread the risk of loss        among several reinsurers. In addition to the assumption of non-affiliated reinsurance,        described below, the Insurance Subsidiaries participate in numerous mandatory        government-operated reinsurance pools which require insurance companies to provide        coverages on assigned risks. These assigned risk pools allocate participation to all        insurers based upon each insurer’s portion of premium writings on a state or national        level. Assigned risk premium typically comprises less than 1% of gross direct premium        written and assumed.

The        Insurance Subsidiaries serve various specialty markets as follows:

Fleet        Trucking Insurance

 

Protective        provides coverage for larger companies in the motor carrier industry which retain        substantial amounts of self-insurance, for independent contractors utilized by large        trucking companies and for medium-sized trucking companies on a first dollar or small        deductible basis. Large fleet trucking products are marketed by the B&L agency        organization directly to trucking clients and, for one large account, in partnership with a        non-affiliated broker. In addition, broker or agent intermediaries are used on a limited        basis for certain smaller accounts. The principal types of insurance marketed by Protective        are:

 

|   | - | Casualty insurance including motor vehicle liability,                        physical damage and other liability insurance. |
|--------|---|-----------------------------------------------------------------------------------------------------------------------------|

|   | - | Workers’ compensation insurance. |
|--------|---|----------------------------------------|

|   | - | Specialized accident (medical and indemnity) insurance for                        independent contractors. |
|--------|---|------------------------------------------------------------------------------------------------------------|

|   | - | Fidelity and surety bonds. |
|--------|---|----------------------------|

|   | - | Inland Marine consisting principally of cargo                        insurance. |
|--------|---|---------------------------------------------------------------------------------|

|   | - | “Captive” insurance company products, which are                        provided through BLI in Bermuda. |
|--------|---|---------------------------------------------------------------------------------------------------------------------|

B&L        also performs a variety of additional services, primarily for Protective’s insureds,        including risk surveys and analyses, government compliance assistance, loss control and        cost studies and research, development, and consultation in connection with new insurance        programs including development of computerized systems to assist in monitoring accident        data. Extensive claims handling services are also provided, primarily to clients with        self-insurance programs.

 

Non-affiliated Assumption Reinsurance

 

Protective        accepts cessions and retrocessions from selected insurance and reinsurance companies,        principally reinsuring against catastrophes. Prior to 2007, exposures under these        retrocessions were almost exclusively in high upper layers, spread among several geographic        regions and limited so that only a major catastrophic event or seriesof major events would have a material impact on the Company’s        operations or financial position. Beginning in 2007, Protective entered into an exclusive        agreement with a non-affiliated reinsurance broker which concentrated on catastrophe losses        which attach at much lower levels, primarily covering tornado and hail losses in the U.S.        Midwest, windstorm events excluding Florida and U.S. earthquake excluding California. This        new business comprised 42% of non-affiliated premium assumed during 2007.

 

- 2        -

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Private        Passenger Automobile Insurance

 

Sagamore        markets private passenger automobile liability and physical damage coverages to individuals        through a network of independent agents in thirty states.

 

Small        Fleet Trucking Insurance

 

Sagamore        provides commercial automobile liability, physical damage and cargo insurance to truck        owner-operators with six or fewer power units. These products are marketed through        independent agents in thirty-one states.

The most        significant expense category for the Company’s insurance subsidiaries is losses and        loss adjustment expenses incurred. A discussion of this expense category        follows.

 

Property/Casualty Losses and Loss Adjustment Expenses

 

The        consolidated financial statements include the estimated liability for unpaid losses and        loss adjustment expenses (“LAE”) of the Insurance Subsidiaries. The liabilities        for losses and LAE are determined using case basis evaluations and statistical projections        and represent estimates of the Company’s ultimate net exposure for all unpaid losses        and LAE incurred through December 31 of each year. These estimates are subject to the        effects of trends in claim severity and frequency and are continually reviewed and, as        experience develops and new information becomes known, the liability is adjusted as        necessary. Such adjustments, either positive or negative, are reflected in current        operations.

The        Company’s reserves for losses and loss expenses (“reserves”) are        determined based on evaluations of individual reported claims and by complex estimation        processes using historical experience, current economic information and, when necessary,        available industry statistics. Reserves are evaluated in three basic categories (1)        “case basis”, (2) “incurred but not reported” and (3) “loss        adjustment expense” reserves. Case basis reserves, which comprise approximately 64%        of total net reserves at December 31, 2007, are established for specific known loss        occurrences at amounts dependent upon criteria such as type of coverage, severity of injury        or property damage and the underlying policy limits, as examples. Case basis reserves are        estimated by experienced claims adjusters using established Company guidelines and are        subject to review by claims management. Incurred but not reported reserves, which are        established for those losses which have occurred, but have not yet been reported to the        Company, are computed on a “bulk” basis. Common actuarial methods are employed        in the establishment of incurred but not reported loss reserves using company historical        loss data, consideration of changes in the Company’s business and study of current        economic trends affecting ultimate claims costs. Loss adjustment expense reserves, or        reserves for the costs associated with the investigation and settlement of a claim, are        also bulk reserves representing the Company’s estimate of the costs associated with        the claims handling process. Loss adjustment expense reserves include amounts ultimately        allocable to individual claims as well as amounts required for the general overhead of the        claims handling operation which are not specifically allocable to individual claims.        Historical analyses of the ratio of loss adjusting expenses to losses paid on prior closed        claims and study of current economic trends affecting loss settlement costs are used to        estimate the loss adjustment reserve needs related to the established loss reserves. Each        of these reserve categories contain elements of uncertainty which assure variability when        compared to the ultimate costs to settle the underlying claims for which the reserves are        established. For a more detailed discussion of the three categories of reserves, see        “*Loss and Loss Expense Reserves”*under the caption, “Critical Accounting Policies” beginning on        page 27in*Management’s Discussion and        Analysis.*

 

The        reserving process requires management to continuously monitor and evaluate the life cycle        of claims. Our claims range from the very routine private passenger automobile        “fender bender” to the highly complex and costly claims involving large        tractor-trailer rigs. Reserving for each class of claims requires a set of assumptions        based upon historical experience, knowledge of current industry trends and seasoned        judgment. The high limits covered bythe Company’s trucking        liability policies provide for greater volatility in the reserving process for more serious        claims. Court rulings, legislative actions, geographic location of the claim under        consideration and trends in jury awards also play a significant role in the estimation        process of larger claims. The Company continuously reviews and evaluates loss developments        subsequent to each measurement date and adjusts its reserve estimation assumptions, as        necessary, in an effort to achieve the best possible estimate of the ultimate remaining        loss costs at any point in time.

 

- 3        -

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Loss        reserves related to certain permanent total disability (PTD) workers’ compensation        claims have been discounted to present value using tables provided by the National Council        on Compensation Insurance which are based upon a pretax interest rate of 3.5% and adjusted        for those portions of the losses retained by the insured. The loss and LAE reserves at        December 31, 2007 have been reduced by approximately $5.6 million as a result of such        discounting. Had the Company not discounted loss and LAE reserves, pretax income would have        been approximately $.7 million lower for the year ended December 31, 2007.

 

For        policies inforce at December 31, 2007, the maximum amount for which Protective insures a        trucking risk is $10 million, less applicable self-insured retentions, although for the        majority of policies written, the maximum limits provided by Protective are $5 million. Any        limits above $10 million required by customers are either placed directly by Baldwin &        Lyons, Inc. with excess carriers or are written by Protective but 100% reinsured. Certain        coverages, such as workers’ compensation, provide essentially unlimited exposure,        although the Company protects itself to the extent believed prudent through the purchase of        excess reinsurance for these coverages. After giving effect to current treaty and        facultative reinsurance arrangements Protective’s maximum exposure to loss from a        single occurrence is approximately $1.3 million for the vast majority of risks insured        although, for certain losses, Protective’s maximum exposure could be as high as $2.7        million for a single occurrence. Reinsurance agreements effective since June 3, 2004        include provisions for aggregate deductibles that must be exceeded before the Company can        recover under the terms of the treaties. The Company retains a higher percentage of the        direct premium (and, therefore, cedes less premium to reinsurers) in consideration of these        deductible provisions. Net premiums earned and losses incurred by the Company for 2007,        2006 and 2005 each include $28,427, $23,366 and $15,878, respectively, related to such        deductible provisions. Protective has revised its treaty arrangements several times in        prior years in response to changing market conditions. The current treaty arrangements are        effective until June 3, 2008 and cover the entire policy period for all business written        from inception of the treaty on June 3, 2007 through that date. Treaty renewals are        expected to occur annually in the foreseeable future. During the past ten years,        Protective’s maximum exposure to a single occurrence has ranged from less than        $100,000 to as much as $3.7 million for a very limited number of risks. Because Protective        occasionally offers multiple year policies and because losses from trucking business take        years to develop, losses reported in the current year may be covered by a number of older        reinsurance treaties with higher or lower loss retentions by Protective than those provided        by current treaty provisions.

 

With        respect to Sagamore’s private passenger automobile and small fleet trucking business,        the Company’s maximum net exposure for a single occurrence has never exceeded        $250,000.

 

The table        on page 5 sets forth a reconciliation of beginning and ending loss and LAE liability        balances, for 2007, 2006 and 2005. That table is presented net of reinsurance recoverable        to correspond with income statement presentation. However, a reconciliation of these net        reserves to those gross of reinsurance recoverable, as presented in the balance sheet, is        also shown. The table on page 11 shows the development of the estimated liability, net of        reinsurance recoverable, for the ten years prior to 2007. The table on page 12 is a summary        of the re-estimated liability, before consideration of reinsurance, for the ten years prior        to 2007 as well as the related re-estimated reinsurance recoverable for the same        periods.

 

- 4        -

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| RECONCILIATION OF LIABILITY FOR LOSSES AND LOSS                        ADJUSTMENT |
|-----------------------------------------------------------------------------------|
| EXPENSES (GAAP BASIS)                                                             |
|                                                                              |   |   |   |   |   |   |
|                                                                              |   | Year Ended December 31 |
|                                                                              |   | **2007** |   | 2006 |   | 2005 |
| NET OF REINSURANCE RECOVERABLE:                                                   |   | *(In thousands)* |
| Liability for losses and LAE at the                                               |   |   |   |   |   |   |
| beginning of the year                                                             |   | **$   249,495** |   | $  242,130 |   | $  207,137 |
|                                                                              |   |   |   |   |   |   |
| Provision for losses and LAE:                                                     |   |   |   |   |   |   |
| Claims occurring during the current year                                          |   | **129,065** |   | 129,551 |   | 154,314 |
| Claims occurring during prior years                                               |   | **(21,284)** |   | (16,947) |   | (13,692) |
|                                                                              |   | **107,781** |   | 112,604 |   | 140,622 |
| Payments of losses and LAE:                                                       |   |   |   |   |   |   |
| Claims occurring during the current year                                          |   | **53,820** |   | 45,658 |   | 45,286 |
| Claims occurring during prior years                                               |   | **58,956** |   | 59,581 |   | 60,343 |
|                                                                              |   | **  112,776** |   | 105,239 |   | 105,629 |
|                                                                              |   |   |   |   |   |   |
| Liability for losses and LAE at end of year                                       |   | **244,500** |   | 249,495 |   | 242,130 |
|                                                                              |   |   |   |   |   |   |
| Reinsurance recoverable on unpaid losses                                          |   |   |   |   |   |   |
| at end of the year                                                                |   | **134,116** |   | 159,917 |   | 188,143 |
|                                                                              |   |   |   |   |   |   |
| Liability for losses and LAE, gross of                                            |   |   |   |   |   |   |
| reinsurance recoverable, at end of the year                                       |   | ** $ 378,616** |   |  $ 409,412 |   |  $ 430,273 |
|                                                                              |   |   |   |   |   |   |

 

The        reconciliation above shows that a savings of $21.3 million was developed in the liability        for losses and LAE recorded at December 31, 2006, with similar savings developed during the        two prior calendar years. The following table is a summary of the $21.3 million reserve        savings by accident year.

 

| **Years in Which Losses Were Incurred** |   | **Reserve at December 31, 2006**        |   | **(Savings) Deficiency Recorded During 2007** |   | **% (Savings) Deficiency** |
|-----------------------------------------|--------|-----------------------------------------|--------|-----------------------------------------------|--------|----------------------------|
|                                    |   |                                    |   |                                          |
| 2006                                    |   | $     83,893        |   | $     (5,910)             |   | (7.0%)                     |
| 2005                                    |   | 69,412                                  |   | (6,261)                                       |   | (9.0%)                     |
| 2004                                    |   | 32,886                                  |   | (6,299)                                       |   | (19.2%)                    |
| 2003                                    |   | 14,998                                  |   | (2,635)                                       |   | (17.6%)                    |
| 2002                                    |   | 3,427                                   |   | (845)                                         |   | (24.7%)                    |
| 2001 & prior                        |   | 44,879                                  |   | 666                                           |   | 1.5%                       |
|                                    |   | $      249,495 |   | $   (21,284)                        |   | (8.5%)                     |
|                                    |   |                                    |   |                                          |   |                       |

 

 

- 5        -

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The savings        recorded for these loss years was derived from varied sources, as follows.

 

|                                                                                                                     |   | 2001 & Prior                          |   | 2002          |   | 2003                                    |   | 2004           |   | 2005                                                                                             |   | 2006      |
|--------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|---------------|--------|-----------------------------------------|--------|----------------|--------|--------------------------------------------------------------------------------------------------|--------|-----------|
| Losses and allocated loss expenses developed on cases known                        to exist at December 31, 2006         |   | $       722 |   | $  (493) |   | $      (1,989) |   | $ (1,307)      |   | $                                   3,087 |   | $ (4,427) |
| Losses and allocated loss expenses reported on cases unknown                        at December 31, 2006                 |   | 570                                       |   | 22            |   |      280       |   | 656            |   |                                  8,225              |   | 7,989     |
| Unallocated loss expenses paid                                                                                           |   | 166                                       |   | 52            |   |      257            |   | 669            |   |                                  648                |   | 1,570     |
|  

Change in reserves for incurred but not reported losses and                        loss expenses                 |   |    (810)                        |   |  (401)   |   |      (888)     |   | (4,400)        |   | (16,070)                                                                                         |   | (11,300)  |
|  

Net (savings) deficiency on losses from directly-produced                        business                        |   | 648                                       |   | (820)         |   | (2,340)                                 |   | (4,382)        |   |    (4,110)                                                                             |   | (6,168)   |
|  

(Savings)deficiency reported under reinsurance assumption                        agreements and residual markets |   | 18                                        |   | (25)          |   |      (295)          |   |  (1,917)  |   |    (2,151)                                                                             |   | 258       |
| Net (savings) deficiency                                                                                                 |   | $     666             |   | $  (845) |   | $      (2,635) |   | $ (6,299) |   | $                                 (6,261)           |   | $ (5,910) |

 

 

Loss and        loss expense developments, presented separately by line of business, were as        follows.

 

|                         |   | Year Ended December 31     |
|------------------------------|--------|----------------------------|
| **Line of Business**         |   | **2007**                   |   | 2006 |   | 2005 |
|                         |   |                       |   |   |   |   |
| Fleet trucking               |   | **$   (15,896)** |   |  $     (13,749) |   | $    (9,378) |
| Private passenger automobile |   | **(290)**                  |   | (1,064) |   | (1,934) |
| Small fleet trucking         |   | **(560)**                  |   | (564) |   | (919) |
| Reinsurance assumed          |   | **(4,112)**                |   | (1,288) |   | (1,730) |
| All other                    |   | **(426)**                  |   | (282) |   | 269 |
|                         |   | **$   (21,284)** |   | $    (16,947) |   |   $  (13,692) |
|                         |   |                       |   |   |   |   |

 

The fleet        trucking developments include developed redundancies from retrospectively-rated direct        business, as shown in the following table. The “All other” category includes        loss activity from involuntary residual markets, assigned risks and run-off of the        Company’s discontinued products, including small business workers’        compensation.

 

- 6        -

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In order to        better understand the dynamics of the loss developments shown above, the following table        separates developments into unique components, which are discussed below.

 

|                                  |   |   |   |   |   | Year Ended December 31    |
|---------------------------------------|--------|--------|--------|--------|--------|---------------------------|
|                                  |   |   |   |   |   | **2007**                  |   | 2006 |   | 2005 |
|                                  |   |   |   |   |   |                      |   |   |   |   |
| Retrospectively-rated direct business |   |   |   |   |   | ** $ (1,078)**       |   |   $(7,171) |   |   $(8,014) |
| Other direct business                 |   |   |   |   |   | **  (16,041)**  |   |  (7,994) |   |   (4,468) |
| Reinsurance assumed                   |   |   |   |   |   | **  (4,112)**        |   |  (1,288) |   |   (1,730) |
| Involuntary residual markets          |   |   |   |   |   | **  (56)**           |   |  (533) |   |   1,018 |
| Environmental damage                  |   |   |   |   |   | **  3**              |   |  39 |   |   (498) |
| Totals                                |   |   |   |   |   | **  $(21,284)** |   |   $(16,947) |   |  $(13,692) |
|                                  |   |   |   |   |   |                      |   |   |   |   |

 

A        significant component of the reserve savings in each of the years 2006 and 2005 is        attributable to retrospectively-rated policies which are included in Fleet Trucking        business. The majority of savings on these policies is returned to policyholders in the        form of a retrospective premium adjustment which is recorded concurrently with the        recognition of the reserve development. Accordingly, premium written and earned during        2007, 2006 and 2005 was reduced by approximately $.7 million, $5.4 million and $4.8        million, respectively, associated with prior year loss reserve development on these        policies and pre-tax income was increased by approximately $.3 million (.4%), $1.8 million        (3.3%) and $3.2 million (6.3%), respectively. As shown in 2007, the impact of        retrospectively-rated policies will be much less significant going forward as the last        major policy of this type expired early in 2006.

 

The other        direct business amounts include the non-retrospectively rated polices for Fleet Trucking,        private passenger automobile and small fleet lines, as well as runoff of discontinued        products which constitute part of the “all other” line of business shown in the        previous table. As shown, the savings from this category ranged from $4.5 million in 2005        to $16.0 million in 2007. This fluctuation reflects the variability associated with the        larger claims covered by the Company, particularly in more recent periods when the        Company’s net retentions have increased. The Company continues to incorporate more        recent loss development data into its loss reserving formulae; however, the change from        excess of loss to quota share treaties beginning in 2004, as well as the dynamic nature of        losses associated with the large fleet trucking business increases the importance of loss        reserve processes which are not overly optimistic. As discussed elsewhere, the Company has        experienced savings in its loss developments for several years owing to, among other        things, its long-standing policy of reserving for losses realistically and a willingness to        settle claims based upon a seasoned evaluation of its exposures. While the Company’s        basic assumptions have remained consistent, we continue to update loss data to reflect        changing trends which can be expected to result in fluctuations in loss developments over        time. Our goal is to produce an overall estimate of reserves which is sufficient and as        close to expected ultimate losses as possible. The $16.0 million savings developed during        2007 represents approximately 20.1% of pre-tax net income for 2007 but only approximately        9% of December 31, 2006 net loss and LAE reserves on the related business.

 

The        developments for reinsurance assumed and involuntary residual markets, which netted to $4.2        million of savings during 2007, are heavily dependent on the establishment of case basis        and IBNR reserves by other insurance and reinsurance companies and by managers of state run        residual market pools. While the Company evaluates the sufficiency of such reserving,        considering the number of different entities involved and the fact that the Company must        rely on external sources of information, the savings or deficiency developed from these        products will likely fluctuate from year to year. We have found this to be particularly        true during years when large catastrophic events occur near year end. The larger savings        developed during 2007, when compared to prior years, reflects reductions in estimates of        losses related to hurricane losses during 2004 and 2005 including additional reserves        recorded by the Company in excess of those estimated by ceding reinsurers.

Factors        affecting the development of environmental claims are more fully discussed in the following        paragraphs. The savings recognized in 2005 represent both case basis and IBNR reserve        reductions resulting from favorable outcomes related to large environmental claims while        activity during 2006 and 2007 has been insignificant.

The        Company has maintained a consistent, conservative posture in its reserving process and has        not significantly altered its assumptions used in the reserving process since the mid -        1980’s. This process has proven to be fully adequate with no overall deficiencies        developed since 1985. There were no significant changes in trends related to the numbers of        claims

- 7        -

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incurred (other than correlative variances with premium volume), average        settlement amounts, numbers of claims outstanding at period ends or the averages per claim        outstanding during the year ended December 31, 2007 for most lines of business. However,        the average settlement amounts of severe trucking claims have tended to increase        significantly in recent years and trends toward lower frequency in private passenger        automobile lines noted in recent years appears to have slowed dramatically during the last        half of 2007 while average severity is increasing.

In the        first table on page 6, the amounts identified as “Net (savings) deficiency on losses        from directly-produced business” consist of development on cases known at December        31, 2006, losses reported which were previously unknown at December 31, 2006 (incurred but        not reported), unallocated loss expense paid related to accident years 2006 and prior and        changes in the reserves for incurred but not reported losses and loss expenses. Bulk loss        reserves are established to provide for potential future adverse development on cases known        to the Company and for cases unknown at the reserve date. Changes in the reserves for        incurred but not reported losses and loss expenses occur based upon information received on        known and newly reported cases during the current year and the effect of that development        on the application of standard actuarial methods used by the Company.

Also shown        in the above table are amounts representing the “(savings) deficiency reported under        reinsurance assumption agreements and residual markets”. These amounts relate        primarily to the Company’s participation in property catastrophe treaties. The        Company records its share of losses from these treaties based on reports from the        retrocessionaires and does not directly establish case reserves related to this segment of        the Company’s business. The Company does, however, establish additional reserves for        reinsurance assumed losses to supplement case reserves reported by the ceding companies,        when considered necessary.

As        described on page 4, changes have occurred in the Company’s net per accident exposure        under reinsurance agreements in place during the periods presented in the above table. It        is much more difficult to reserve for losses where policy limits are as high as $10 million        per accident as opposed to those losses related to business which carries lower policy        limits, such as private passenger automobile. There are fewer policy limit losses in the        Company’s historical loss database on which to project future loss developments and        the larger the loss, the greater the likelihood that the courts will become involved in the        settlement process. As such, the level of uncertainty in the reserving process is much        greater when dealing with larger losses and will routinely result in fluctuations among        accident year developments.

The        differences between the liability for losses and LAE reported in the accompanying 2007        consolidated financial statements in accordance with generally accepted accounting        principles (“GAAP”) and that reported in the annual statements filed with state        and provincial insurance departments in the United States and Canada in accordance with        statutory accounting practices (“SAP”) are as follows (in        thousands):

*                                                    *

|   | Liability reported on a SAP basis - net of reinsurance                        recoverable |  $247,540 |
|--------|-------------------------------------------------------------------------------------------|----------------|

|   | Reinsurance recoverable on unpaid losses and LAE |  134,116 |
|--------|--------------------------------------------------|---------------|

|   | Additional reserve for residual market losses not |
|--------|---------------------------------------------------|

|   | reported to the Company at the current year end | 360 |
|--------|-------------------------------------------------|-----|

|   | Estimated salvage and subrogation recoveries recorded                        on |
|--------|---------------------------------------------------------------------------------|

|   | a cash basis for SAP and on an accrual basis for                        GAAP | (3,400) |
|--------|------------------------------------------------------------------------------|---------|

         

|   | Liability reported on a GAAP basis |  $378,616 |
|--------|------------------------------------|----------------|

         

         

The table        on page 11 presents the development of GAAP balance sheet insurance reserves for each        year-end 1997 through 2007, net of all reinsurance credits. The top line of the table shows        the estimated liability for unpaid losses and LAE recorded at the balance sheet date for        each of the indicated years. This liability represents the estimated amount of losses and        LAE for claims arising in all prior years that were unpaid at the respective balance sheet        date, including losses that had been incurred, but not yet reported, to the        Company.

 

- 8        -

----

 

The upper        portion of the table shows the re-estimated amount of the previously recorded liability        based on additional information available to the Company as of the end of each succeeding        year. The estimate is increased or decreased as more information becomes known about the        frequency and severity of individual claims and as claims are settled and paid.

 

The        “cumulative redundancy” represents the aggregate change in the estimates of        each calendar year end reserve through December 31, 2007. For example, the 1997 liability        has developed a $33.5 million redundancy over ten years. That amount has been reflected in        income over those ten years, as shown on the table. The effect on income of changes in        estimates of the liability for losses and LAE during each of the past three years is shown        in the table on page 5.

Historically, the Company’s loss developments have been favorable.        Reserve developments for all years ended in the period 1986 through 2006 have produced        redundancies as of December 31, 2007. In addition to refinements in reserving methods, loss        reserve developments since 1985 have been favorably affected by several other factors.        Perhaps the most significant single factor has been the improvement in safety programs by        the trucking industry in general and by the Company’s insureds specifically.        Statistics produced by the American Trucking Association show that driver quality has        improved markedly in the past decade resulting in fewer fatalities and serious accidents.        The Company’s experience also shows that improved safety and hiring programs have a        dramatic impact on the frequency and severity of trucking accidents and, more recently, the        introduction of numerous safety devices using state-of-the-art technology has reduced rear        end and cross over accidents which often produce the most serious injuries. Higher        self-insured retentions also play a part in reduced insurance losses. Higher retentions not        only raise the excess insurance entry point but also encourage trucking company management        to focus even more intensely on safety programs. To a small degree, reserve savings have        been achieved by the use of structured settlements on certain workers’ compensation        and liability claims of a long-term liability nature.

The        establishment of bulk reserves requires the use of historical data where available and        generally a minimum of ten years of such data is required to provide statistically valid        samples. As previously mentioned, numerous factors must be considered in reviewing        historical data including inflation, legislative actions, new coverages provided and trends        noted in the current book of business which are different from those present in the        historical data. Clearly, the Company’s book of business in 2007 is different from        that which generated much of the ten-year historical loss data used to establish reserves        in recent years. Management has noted trends toward significantly higher settlements and        jury awards associated with the more serious trucking liability claims over the past        several years. The inflationary factors affecting these claims appear to be more subjective        in nature and not in line with compensatory equity. In addition to the factors mentioned        above, savings realized in recent years upon the closing of claims, as reflected in the        tables on pages 5 and 11, are attributable to the Company’s experience in        specializing in long-haul trucking business for over 50 years as well as its long-standing        policy of reserving for losses realistically and a willingness to settle claims based upon        a seasoned evaluation of the underlying exposures. The Company will continue to review the        trends noted and, should it appear that such trends are permanent and projectable, they        will be reflected in future reserving method refinements.

The lower        section of the table on page 11 shows the cumulative amount paid with respect to the        previously recorded calendar year end liability as of the end of each succeeding year. For        example, as of December 31, 2007, the Company had paid $87.7 million of losses and LAE that        had been incurred, but not paid, as of December 31, 1997; thus an estimated $29.8 million        (25%) of losses incurred through 1997 remain unpaid as of the current financial statement        date ($117.5 million incurred less $87.7 million paid).

In        evaluating this information, it is important to note that the method of presentation causes        some development experience to be duplicated. For example, the amount of any redundancy or        deficiency related to losses settled in 2000, but incurred in 1997, will be included in the        cumulative development amount for each of the years-end 1997,1998,        and 1999. As such, this table does not present accident or policy year development data        which readers may be more accustomed to analyzing. Rather, this table is intended to        present an evaluation of the Company’s ability to establish its liability for losses        and loss expenses at a given balance sheet date. It is important to note that conditions        and trends that have affected development of the liability in the past may not necessarily        occur in the future. Accordingly, it would not be appropriate to extrapolate future        redundancies or deficiencies based on this table.

The table        presented on page 12 presents loss development data on a gross (before consideration of        reinsurance) basis for each of the ten years December 31, 1997 through December 31, 2006 as        of December 31, 2007 with a reconciliation of the data to the net amounts shown in the        table on page 11. Readers are reminded that the gross data presented on page 12 requires        significantly more subjectivity in the estimation of incurred but not reported and loss        expense reserves because of the high limits provided by Protective to its trucking        customers, much of which has been covered by excess of loss and

- 9        -

----

facultative        reinsurance. This is particularly true of excess of loss treaties where Protective retains        risk in only the lower, more predictable, layers of coverage. Accordingly, one would        generally expect more variability in development on a gross basis than on a net        basis.

*Environmental Matters:*The Company’s        reserves for unpaid losses and loss expenses at December 31, 2007 included amounts for        liability related to environmental damage claims. Given the Company’s principal        business is insuring trucking companies; it does on occasion receive claims involving a        trucking accident which has resulted in the spill of a pollutant. Certain of the        Company’s policies may cover these situations on the basis that they were caused by        an accident that resulted in the immediate spill of a pollutant. These claims are typically        reported and resolved within a short period of time.

However,        the Company has also received a few environmental claims that did not result from a        “sudden and accidental” event. Most of these claims fall under policies issued        in the 1970’s primarily to one account which was involved in the business of hauling        and disposing of hazardous waste. Although the Company had pollution exclusions in its        policies during that period, the courts have ignored such exclusions in many environmental        cases. Beginning with the year 1994 and through the year ended December 31, 2007, the        Company has recorded a total of $6.6 million in losses incurred with respect to        environmental claims. The Company received notification in 2007 of a new environmental case        involving a former insured during the 1970’s. Discovery regarding this case is in its        very early stages; however, management believes exposure to the Company will not be        significant. Incurred losses to date include a reserve for incurred but not reported        environmental losses of $1.5 million at December 31, 2007.

Establishing reserves for environmental claims is subject to uncertainties        that are greater than those represented by other types of claims. Factors contributing to        those uncertainties include a lack of historical data, long reporting delays, uncertainty        as to the number and identity of insureds with potential exposure, unresolved legal issues        regarding policy coverage, and the extent and timing of any such contractual liability.        Courts have reached different and sometimes inconsistent conclusions as to when the loss        occurred and what policies provide coverage, what claims are covered, whether there is an        insured obligation to defend, how policy limits are determined, how policy exclusions are        applied and interpreted, and whether cleanup costs represent insured property damage.        Management believes that those issues are not likely to be resolved in the near        future.

However,        to date, very few environmental claims have been reported to the Company. In addition, a        review of the businesses of our past and current insureds indicates that exposure to        further claims of an environmental nature is limited because most of the Company’s        accounts are not currently, and have not in the past been, involved in the hauling of        hazardous substances. Also, the revision of the pollution exclusion in the Company’s        policies since 1986 is expected to further limit exposure to claims from that point        forward.

The        Company has never been presented with an environmental claim relating to asbestos and,        based on the types of business the Company has insured over the years, it is not expected        that the Company will have any significant asbestos exposure.

Accordingly, management believes that the Company’s exposure to        environmental losses beyond those already provided for in the financial statements is not        material.

 

- 10        -

----

| ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE                        DEVELOPMENT--GAAP BASIS |
|---------------------------------------------------------------------------------------------|
| *(Dollars in thousands)*                                                                    |
|                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Year Ended December 31                                                                      |   | 1997 |   | 1998 |   | 1999 |   | 2000 |   | 2001 |   | 2002 |   | 2003 |   | 2004 |   | 2005 |   | 2006 |   | 2007 |
|                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Liability for Unpaid                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Losses and LAE, Net                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| of Reinsurance                                                                              |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Recoverables                                                                                |   | $                                    151,013 |   | $                                    143,515 |   | $             130,345 |   | $                                    119,905 |   | $                                    137,406 |   | $                                    144,267 |   | $                                    162,424 |   | $                                    207,137 |   | $                                    242,130 |   | $                                    249,495 |   | $          244,500 |
|                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Liability Reestimated                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| as of:                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| One Year Later                                                                              |   | 140,272 |   | 132,906 |   | 122,238 |   | 119,018 |   | 127,398 |   | 130,681 |   | 147,468 |   | 193,445 |   | 225,183 |   | 228,211 |   |   |
| Two Years Later                                                                             |   | 128,743 |   | 124,878 |   | 124,540 |   | 112,558 |   | 118,055 |   | 125,731 |   | 142,771 |   | 180,455 |   | 209,774 |   |   |   |   |
| Three Years Later                                                                           |   | 122,211 |   | 124,367 |   | 119,379 |   | 103,251 |   | 118,712 |   | 124,693 |   | 137,502 |   | 171,332 |   |   |   |   |   |   |
| Four Years Later                                                                            |   | 122,674 |   | 121,021 |   | 111,476 |   | 105,508 |   | 119,925 |   | 124,714 |   | 134,661 |   |   |   |   |   |   |   |   |
| Five Years Later                                                                            |   | 119,632 |   | 114,456 |   | 113,720 |   | 106,757 |   | 120,757 |   | 124,507 |   |   |   |   |   |   |   |   |   |   |
| Six Years Later                                                                             |   | 113,150 |   | 115,007 |   | 114,546 |   | 107,364 |   | 121,406 |   |   |   |   |   |   |   |   |   |   |   |   |
| Seven Years Later                                                                           |   | 113,917 |   | 115,321 |   | 115,166 |   | 108,040 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Eight Years Later                                                                           |   | 114,767 |   | 117,057 |   | 115,964 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Nine Years Later                                                                            |   | 116,110 |   | 118,136 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Ten Years Later                                                                             |   | 117,532 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cumulative Redundancy                                                                       | $               33,481 |   | $               25,379 |   | $               14,381 |   | $               11,865 |   | $               16,000 |   | $               19,760 |   | $               27,763 |   | $               35,805 |   | $               32,356 |   | $               21,284 |   |   |
|                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cumulative Amount of                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Liability Paid  Through:                                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| One Year Later                                                                              |   | $               25,088 |   | $                                      30,214 |   | $                                      30,239 |   | $                                      31,132 |   | $            30,249 |   | $            39,956 |   | $            38,234 |   | $                                      60,343 |   | $                                      59,581 |   | $            58,956 |   |   |
| Two Years Later                                                                             |   | 43,311 |   | 48,416 |   | 49,068 |   | 47,060 |   | 55,724 |   | 57,522 |   | 62,380 |   | 84,265 |   | 94,947 |   |   |   |   |
| Three Years Later                                                                           |   | 55,180 |   | 60,594 |   | 60,427 |   | 58,618 |   | 64,489 |   | 69,959 |   | 74,198 |   | 102,692 |   |   |   |   |   |   |
| Four Years Later                                                                            |   | 64,370 |   | 66,679 |   | 69,374 |   | 64,574 |   | 71,038 |   | 76,408 |   | 82,479 |   |   |   |   |   |   |   |   |
| Five Years Later                                                                            |   | 68,807 |   | 74,861 |   | 73,958 |   | 69,316 |   | 75,878 |   | 81,121 |   |   |   |   |   |   |   |   |   |   |
| Six Years Later                                                                             |   | 76,657 |   | 77,957 |   | 78,150 |   | 72,751 |   | 79,668 |   |   |   |   |   |   |   |   |   |   |   |   |
| Seven Years Later                                                                           |   | 79,428 |   | 81,530 |   | 81,337 |   | 76,126 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Eight Years Later                                                                           |   | 81,752 |   | 84,451 |   | 84,666 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Nine Years Later                                                                            |   | 84,624 |   | 87,593 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Ten Years Later                                                                             |   | 87,733 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |

 

 

- 11        -

----

| ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE                        DEVELOPMENT--GAAP BASIS |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |
|---------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------|----------------------------------------------------------------------------------|
| (*Dollars in thousands*)                                                                    |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
|                                                                                        |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| Year Ended December 31                                                                      |   | 1997                                                                                               | 1998                                                                                               | 1999                                                                                               | 2000                                                                                               | 2001                                                                             | 2002                                                                             | 2003 | 2004 | 2005 | 2006 | 2007 |
|                                                                                        |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| Direct and Assumed:                                                                         |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
|                                                                                        |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| Liability for Unpaid Losses                                                                 |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| and Loss Adjustment                                                                         |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| Expenses                                                                                    |   | $               196,715 | $               193,996 | $               173,115 | $               182,124 | $            246,816 | $            277,309 | $            342,449 | $            440,172 | $            430,273 | $            409,412 | $            378,616 |
|                                                                                        |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| Liability Reestimated as of                                                                 |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| December 31, 2007                                                                           |   | 144,801                                                                                            | 153,292                                                                                            | 179,428                                                                                            | 213,185                                                                                            | 261,490                                                                          | 297,922                                                                          | 322,062 | 387,386 | 372,592 | 374,470 |   |
|                                                                                        |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| Cumulative (Deficiency) Redundancy                                                          |   | 51,914                                                                                             | 40,704                                                                                             | (6,313)                                                                                            | (31,061)                                                                                           | (14,674)                                                                         | (20,613)                                                                         | 20,387 | 52,786 | 57,681 | 34,942 |   |
|                                                                                        |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| Ceded:                                                                                      |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
|                                                                                        |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| Liability for Unpaid Losses                                                                 |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| and Loss Adjustment                                                                         |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| Expenses                                                                                    |   | 45,702                                                                                             | 50,481                                                                                             | 42,770                                                                                             | 62,219                                                                                             | 109,410                                                                          | 133,042                                                                          | 180,025 | 233,035 | 188,143 | 159,917 | 134,116 |
|                                                                                        |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| Liability Reestimated as of                                                                 |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| December 31, 2007                                                                           |   | 27,269                                                                                             | 35,156                                                                                             | 63,464                                                                                             | 105,145                                                                                            | 140,084                                                                          | 173,415                                                                          | 187,401 | 216,054 | 162,818 | 146,259 |   |
|                                                                                        |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| Cumulative (Deficiency) Redundancy                                                          |   | 18,433                                                                                             | 15,325                                                                                             | (20,694)                                                                                           | (42,926)                                                                                           | (30,674)                                                                         | (40,373)                                                                         | (7,376) | 16,981 | 25,325 | 13,658 |   |
|                                                                                        |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| Net:                                                                                        |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
|                                                                                        |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| Liability for Unpaid Losses                                                                 |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| and Loss Adjustment                                                                         |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| Expenses                                                                                    |   | 151,013                                                                                            | 143,515                                                                                            | 130,345                                                                                            | 119,905                                                                                            | 137,406                                                                          | 144,267                                                                          | 162,424 | 207,137 | 242,130 | 249,495 | 244,500 |
|                                                                                        |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| Liability Reestimated as of                                                                 |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| December 31, 2007                                                                           |   | 117,532                                                                                            | 118,136                                                                                            | 115,964                                                                                            | 108,040                                                                                            | 121,406                                                                          | 124,507                                                                          | 134,661 | 171,332 | 209,774 | 228,211 |   |
|                                                                                        |   |                                                                                               |                                                                                               |                                                                                               |                                                                                               |                                                                             |                                                                             |   |   |   |   |   |
| Cumulative Redundancy                                                                       |   | 33,481                                                                                             | 25,379                                                                                             | 14,381                                                                                             | 11,865                                                                                             | 16,000                                                                           | 19,760                                                                           | 27,763 | 35,805 | 32,356 | 21,284 |   |

 

 

- 12        -

----

 

The        Company’s primary marketing areas are outlined on pages 2 and 3.

Since the        mid-1980’s, Protective has focused its marketing efforts on large and medium trucking        fleets. Protective has its largest market share in the larger trucking fleets (over 150        power units). These fleets self-insure a portion of their risk and such self-insurance        plans are a specialty of the Company. The indemnity contract provided to self-insured        customers is designed to cover all aspects of trucking liability, including third party        liability, property damage, physical damage, cargo and workers’ compensation, arising        from vehicular accident or other casualty loss. The self-insured program is supplemented        with large deductible workers’ compensation policies in states that do not allow for        self-insurance of this coverage. Protective also offers work-related accident insurance, on        a group basis, to independent contractors under contract to a fleet sponsor. Throughout the        1990’s, the market for Protective’s products grew increasingly competitive.        Competitive pressures eased significantly in the period 2001 through 2003, as competitors        experienced unfavorable operating results but competition has once again begun to increase        during 2004 through 2007 (see comments under “Competition” following). In 2007,        fleet trucking products generated approximately 67% of direct premium written and assumed        for the Company.

Since        1992, Protective has accepted reinsurance cessions and retrocessions, principally for        catastrophe exposures, from selected reinsurers on an opportunistic basis. Protective is        committed to participation in this market provided pricing remains conducive to profitable        results. In determining the volume of catastrophe reinsurance assumed that it will accept,        the Company first determines the exposure that it is willing to accept from a single        “maximum foreseeable loss” (MFL) and a “probable maximum loss”        (PML) within a given geographic area. As retrocessions are offered to the Company, computer        models of geographic exposure are evaluated against these maximums and programs are only        considered if they do not cause aggregate exposure to exceed the predetermined limits.        Currently, the Company’s estimate of its exposure to a MFL or a PML is approximately        10% and 6% of consolidated surplus, respectively. However, this amount is before state and        federal tax credits and reinstatement premiums which would significantly reduce the impact        of a MFL or a PML on the Company’s surplus.

Since 1995,        Sagamore has sold private passenger automobile insurance. This program is currently being        marketed in thirty mid-western and southern states through independent agents. Sagamore        utilizes state-of-the-art technology extensively in marketing its private passenger        automobile insurance product in order to provide superior service to its agents and        insureds.

 

Sagamore        also offers a program of coverages for “small fleet” trucking concerns        (owner-operators generally with one to six power units). This program is currently being        marketed in thirty-one states through independent agents. Small Fleet Trucking shares much        of the technology utilized by the private passenger automobile insurance division in        marketing its products.

Investments

The        Company’s investment portfolio consists of (1) funds which are considered necessary        to support insurance underwriting activities and (2) excess capital funds. In general,        funds invested in fixed maturity and short-term instruments are more than sufficient to        cover underwriting operations while equity securities and limited partnerships are utilized        to invest excess capital funds. The following discussion will concentrate on the different        investment strategies for these two major categories.

At        December 31, 2007 the financial statement value of the Company’s investment portfolio        was approximately $651 million, including $87 million of money market instruments        classified as cash equivalents. The adjusted cost of this portfolio was $594 million. A        comparison of the allocation of assets within the Company’s investment portfolio,        using adjusted cost as a basis, is as follows:

- 13        -

----

|   | December 31 |
|--------|-------------|

|   | 2007 | 2006 |
|--------|------|------|

 

|   | Municipal bonds | 46.9% | 38.3% |
|--------|-----------------|-------|-------|

|   | U.S. Government obligations | 4.6 | 14.5 |
|--------|-----------------------------|-----|------|

|   | Corporate and other bonds | 2.3 | 5.6 |
|--------|---------------------------|-----|-----|

|   | Mortgage-backed securities | 2.7 | 2.8 |
|--------|----------------------------|-----|-----|

|   | Short-term | 22.3 | 18.3 |
|--------|------------|------|------|

|   | Total fixed maturity and short-term | 78.8 | 79.5 |
|--------|-------------------------------------|------|------|

|   | Common stocks | 7.6 | 10.3 |
|--------|---------------|-----|------|

|   | Limited partnerships | 13.6 | 10.2 |
|--------|----------------------|------|------|

|   | 100.0% | 100.0% |
|--------|--------|--------|

 

 

*Fixed        Maturity and Short-Term Investments*

Fixed        maturity and short-term securities comprised 78.8% of the market value of the        Company’s total invested assets at December 31, 2007. With the exception of U.S.        Government obligations, the fixed maturity portfolio is widely diversified with no        concentrations in any single industry or municipality. The largest amount invested in any        single issuer was $6.9 million (1.2% of total invested assets) although most individual        investments, other than municipal bonds, are less than $500,000. The Company does not        actively trade fixed maturity securities but typically holds, and has the intent and        ability to hold, such investments until maturity. Exceptions exist in the rare instances        where the underlying credit for a specific issue is deemed to be diminished. In such cases,        the security will be considered for disposal prior to maturity. In addition, fixed maturity        securities may be sold when realignment of the portfolio is considered beneficial (i.e.        moving from taxable to non-taxable issues) or when valuations are considered excessive        compared to alternative investments.

The        Investment Committee has determined that the Company’s insurance subsidiaries will,        at all times, hold high grade fixed maturity securities and short-term investments with a        market value equal to at least 100% of reserves for losses and loss expenses, net of        applicable reinsurance credits. At December 31, 2007, investment grade bonds and short-term        instruments held by insurance subsidiaries equaled 174% of net loss and loss adjustment        expense reserves, thus providing a substantial margin above this conservative        guideline.

The        Company’s concentration of fixed maturity funds in relatively short-term investments        provides it with a level of liquidity which is more than adequate to provide for its        anticipated cash flow needs. The structure of the investment portfolio also provides the        Company with the ability to restrict premium writings during periods of intense        competition, which typically result in inadequate premium rates, and allows the Company to        respond to new opportunities in the marketplace as they arise. During the past several        years, short-term taxable yields have approximated those available for five and ten year        obligations and, accordingly, the Company had concentrated the investment of new and        maturing funds into high quality obligations with maturities of less than one year, which        are classified above as short-term. During 2007 and 2006, it was determined that after-tax        investment yields could be enhanced by moving portions of the taxable portfolio into high        grade municipal bonds with short to moderate maturities. As a result, the total of        investments in municipal bonds increased $68 million and $98 million in 2007 and 2006,        respectively and comprises almost half of the value of all invested assets at December 31,        2007.

The        following comparison of the Company’s bond and short-term investment portfolios,        using par value as a basis, indicates the changes in contractual maturities in the        portfolio during 2007. Note that the duration of the portfolio is less than the average        life shown below because the Company has, in some cases, the right to put obligations and        borrowers have, in some cases, the right to call or prepay obligations with or without call        or prepayment penalties.

- 14        -

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Maturities of Bonds and Short-Term Investments at        December 31 (Par Value)

|   |    2007 |        2006 |
|--------|-------------------|-------------------------------------------|

 

|   | Less than one year | 41.1% | 62.3% |
|--------|--------------------|-------|-------|

|   | 1 to 5 years | 45.3 | 27.0 |
|--------|--------------|------|------|

|   | 5 to 10 years | .5 | .8 |
|--------|---------------|----|----|

|   | More than 10 years | 13.1 | 9.9 |
|--------|--------------------|------|-----|

|   | 100.0% | 100.0% |
|--------|--------|--------|

 

|   | Average life of portfolio (years) | 3.7 | 3.0 |
|--------|-----------------------------------|-----|-----|

 

Approximately $15.7 million of fixed maturity investments (2.4% of total        invested assets) consists of bonds rated as less than investment grade at year end. These        investments are primarily composed of shares in three widely diversified high yield bond        funds where exposure to default by any single issuer is extremely limited. These funds        carry a Morningstar rating of four and five stars. We have included the investments in        these funds in the total of non-investment grade bonds since, under the investment        guidelines of the funds, the average bond quality rating could fall below BBB. At December        31, 2007, the market value of these bond funds was 1.7% less than cost.

The market        value of the consolidated fixed maturity portfolio was $2.2 million greater than cost at        December 31, 2007, before income taxes, which compares to a $.3 million unrealized loss at        December 31, 2006. Each individual issue with a market value less than cost at year end was        determined to result from interest rate increases and not from credit quality. As has been        the Company’s consistent policy, other-than-temporary impairment is recorded for any        individual issue which has sustained a decline in current market value of at least 20%        below original or adjusted cost, and the decline is ongoing for more than 6 months,        regardless of the evaluation of the creditworthiness of the issuer or the specific issue.        No fixed maturity investments met these criteria at December 31, 2007 or 2006. Gross        unrealized losses on fixed maturity securities were $.6 million in total at December 31,        2007.

*Equity Securities*

Because of        the large amount of high quality fixed maturity investments owned, relative to the        Company’s loss and loss expense reserves and other liabilities, amounts invested in        equity securities are not needed to fund current operations and, accordingly, can be        committed for long periods of time. Equity securities comprise 15.3% of the market value of        the consolidated investment portfolio at December 31, 2007, but only 7.6% of the related        cost basis, as long-term holdings have appreciated significantly. The Company’s        equity securities portfolio consists of over 90 separate issues with diversification from        large to small capitalization issuers and among several industries. The largest single        equity issue owned has a market value of $3.7 million at December 31, 2007 (.7% of total        investments).

In        general, the Company maintains a buy-and-hold philosophy with respect to equity securities.        Many current holdings have been continuously owned for more than ten years, accounting for        the large unrealized gain at the current year end. An individual equity security will be        disposed of when it is determined by investment managers or the Investment Committee that        there is little potential for future appreciation and all equity securities are considered        to be available for sale. Securities are not sold to meet any quarterly or annual earnings        quotas but, rather, are disposed of only when market conditions are deemed to dictate,        regardless of the impact, positively or negatively, on current period earnings. In        addition, equity securities may be sold when realignment of the portfolio is considered        beneficial or when valuations are considered excessive compared to alternative        investments.

During        2007, the Company disposed of numerous equity securities primarily to provide funds for a        new investment program which was initiated after year end. Most of these disposals occurred        during the fourth quarter. These sales generated both gains and losses but netted to a        realized gain of $16.8 million. The net effect of other-than-temporary impairment        adjustments included in the investment gains from equity securities was a positive $1.0        million, or fourcents per share, for the year. The reclassification        of other-than-temporary unrealized losses to realized occurred on each individual issue        where the current market value was at least 20% below original or adjusted cost, and the        decline was ongoing for more than 6 months at December 31, 2007, regardless of the        evaluation of the issuer or the potential for recovery. Net unrealized gains on the equity        security portfolio decreased to $54.5 million, before tax at December 31, 2007 from $73.0        million last year end primarily as the result of disposals, as noted above. The current net        unrealized gain consists of $55.9 million of gross

- 15        -

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unrealized        gains and $1.4 million of gross unrealized losses with the average decline in value on        issues where market was less than adjusted cost being 11.9%

*Limited Partnerships*

For        several years, the Company has invested in various limited partnerships engaged in        securities trading activities, real estate development and small venture capital funding,        as an alternative to direct equity investments. The funds used for these investments are        part of the Company’s excess capital strategy. At December 31, 2007, the aggregate        cost basis of these investments was $33.9 million and the aggregate market value was $80.9        million.

As a        group, these investments experienced very favorable earnings during 2007, with the        aggregate of the Company’s share of such earnings totaling approximately $23.2        million, producing a 40% pre-tax yield. The current year limited partnership value increase        is composed of estimated realized income of $7.9 million and estimated unrealized income of        $15.3 million, as reported to the Company by the various general partners.

The        Company follows the equity method of accounting for these investments and records the total        change in value as a component of net gains or losses on investments. However, readers are        cautioned that, to the extent that reported increases in equity value are unrealized, they        can be reduced or eliminated quickly by volatile market conditions. At December 31, 2007,        the total estimated unrealized gain included in the valuation of the Company’s        limited partnership portfolio was $30.4 million. In addition, a significant minority of the        investments included in the limited partnerships do not have readily ascertainable fair        market values and, accordingly, values assigned by the general partners may not be        realizable upon the sale or disposal of the related assets, which may not occur for several        years.

*Investment Yields*

The        interest rate environment was relatively stable for much of 2007 but began to decline        during the third quarter with accelerating decline during the fourth quarter. With few        exceptions, the yield curve remained flat with yields on 30 day securities essentially        equal to those on five and ten year obligations of similar quality considerations. As        previously noted, a substantial portion of the Company’s short-term investments were        redeployed to short to medium term municipal bonds during 2007 and 2006 to produce higher        after tax yields. Overall, pre-tax net investment income remained flat during 2007 and        after tax income increased $1.0 million, or 7%. A comparison of consolidated investment        yields, before consideration of investment expenses, is as follows:

|   |  2007 |    2006 |
|--------|------------|-------------------|

|   | Before federal tax: |
|--------|---------------------|

|   | Investment income | 4.2% | 4.0% |
|--------|-------------------|------|------|

|   | Investment income plus investment gains |  12.1 | 7.3 |
|--------|-----------------------------------------|------------|-----|

|   | After federal tax: |
|--------|--------------------|

|   | Investment income | 3.4 | 3.1 |
|--------|-------------------|-----|-----|

|   | Investment income plus investment gains | 8.5 | 5.2 |
|--------|-----------------------------------------|-----|-----|

 

Readers        are also directed to Note B to the consolidated financial statements and to the*Results of Operations*beginningon page 23 of this document for additional details of investment        operations.

Employees

 

As of        December 31, 2007, the Company had 284 employees, representing an increase of 8 employees        from December 31, 2006.

Competition

 

The        insurance brokerage and agency business is highly competitive. B&L competes with a        large number of insurance brokerage and agency firms and individual brokers and agents        throughout the country, many of which are considerably larger than B&L. B&L also        competes with insurance companies which write insurance directly with their        customers.

Insurance        underwriting is also highly competitive. The Insurance Subsidiaries compete with other        stock and mutual companies and inter-insurance exchanges (reciprocals). There are numerous        insurance companies offering the lines of

- 16        -

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insurance which        are currently written or may in the future be written by the Insurance Subsidiaries. Many        of these companies have been in business for longer periods of time, have significantly        larger volumes of business, offer more diversified lines of insurance coverage and have        greater financial resources than the Company. In many cases, competitors are willing to        provide coverage for rates lower than those charged by the Insurance Subsidiaries. Many        potential clients self-insure workers’ compensation and other risks for which the        Company offers coverage, and some concerns have organized “captive” insurance        companies as subsidiaries through which they insure their own operations. Some states have        workers’ compensation funds that preclude private companies from writing this        business in those states. Federal law also authorizes the creation of “Risk Retention        Groups” which may write insurance coverages similar to those offered by the        Company.

The        Company believes it has a competitive advantage in its major lines of business as the        result of the extensive experience of its long-tenured management and staff, its superior        service and products, its willingness to custom build insurance programs for its large        trucking customers and the extensive use of technology with respect to its insureds and        independent agent force. However, the Company is not “top-line” oriented and        will readily sacrifice premium volume during periods of unrealistic rate competition.        Accordingly, should competitors determine to “buy” market share with        unprofitable rates, the Company’s Insurance Subsidiaries will generally experience a        decline in business until pricing returns to profitable levels.

Availability of Documents

 

This Form        10-K as well as the Company’s Audit Committee Charter and Code of Conduct will be        sent to shareholders without charge upon written request to the Company’s Investor        Contact at the corporate address. These documents, along with all other filings with the        Securities and Exchange Commission are available for review, download or printing from the        Company’s web site at www.baldwinandlyons.com.

Item        101(b), (c)(1)(i) and (vii), and (d) of Regulation S-K:

Reference        is made to Note J to the consolidated financial statements which provides information        concerning industry segments and is filed herewith under Item 8, Financial Statements and        Supplementary Data.

 

**Item        1A.****RISK FACTORS**

***•  The Company operates in the Property and Casualty        insurance industry where many of its competitors are larger with far greater        resources.***Please see the caption “Competition”        on this page above for a complete discussion of this risk factor.

***•  The Company, through its insurance subsidiaries, requires        collateral from its insureds covering the insureds’ obligations for self-insured        retentions or deductibles related to policies of insurance provided. Should the Company, as        surety, become responsible for such insured obligations, the collateral held may prove to        be insufficient.***For further discussion regarding this risk        factor, see Note L to the consolidated financial statements beginning on page 56 of this        Form 10-K.

***•  The Company limits its risk of loss from policies of        insurance issued by its insurance subsidiaries through the purchase of reinsurance coverage        from other insurance companies. Such reinsurance does not relieve the Company from its        responsibility to policyholders should the reinsurers be unable to meet their obligations        to the Company under the terms of the underlying reinsurance agreements.***For further discussion regarding this risk factor, see the caption*Reinsurance Recoverable*and Notes D and L to        the consolidated financial statements on pages 28, 48 and 56, respectively, of this Form        10-K.

***•  Operating in the Property and Casualty insurance        industry, the Company is exposed to loss from policies of insurance issued to its        policyholders. A large portion of losses recorded by the Company are estimates of future        loss payments to be made. Such estimates of future loss payments may prove to be        inadequate.***For further discussion of this risk factor, see        the caption*Property/Casualty Losses and Loss Adjustment        Expenses*beginning on page 3, the caption*Loss and Loss Expense Reserves*beginning on        page 29 and Note C to the consolidated financial statements beginning on page 47,        respectively, of this Form 10-K.

***•  The Company derives a significant percentage of its        direct premium volume from a single major customer and its independent contractors. Loss of        this major customer would severely reduce the Company’s revenue and earnings        potential.***For further discussion regarding this risk factor,        see Notes Jand L to the consolidated financial statements beginning on pages 53 and 56,        respectively, of this Form 10-K.

- 17 -

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***•  Given the Company’s significant interest-bearing        investment portfolio, a drop in interest rates would likely have an adverse impact on the        Company’s earnings. Conversely, an increase in interest rates could have a        significant temporary impact on the market value of the Company’s fixed maturity        investment portfolio.***For further discussion regarding this        risk factor, see the caption*Market Risk*beginning on page 33 of this Form 10-K.

***•  The Company has a large portfolio of equity securities        and limited partnership investments which can fluctuate in value with a wide variety of        market conditions*****.**For further        discussion regarding this risk factor, see the captions Equity Securities and Limited        Partnerships beginning on page 15 and Market Risk on page 33 of this Form 10-K.

***•  The Company operates in a regulated        industry.***Changes in laws and regulations governing the        insurance industry could have a significant impact on the Company’s ability to        generate income from its insurance company operations.

 

**Item        2.****PROPERTIES**

 

The Company        leases office space at 1099 North Meridian Street, Indianapolis, Indiana. This building is        located approximately one mile from downtown Indianapolis. The lease covers approximately        72,000 square feet and expires in August, 2008, with an option to renew for an additional        five years.

 

The Company        owns two buildings and the adjacent real estate approximately two miles and eleven miles        from its main office. The buildings contain approximately 3,300 and 15,000 square feet of        usable space respectively, and are used primarily as off-site data storage and as a        contingent back up and disaster recovery site.

 

The        Company’s entire operations are conducted from these facilities. The current        facilities are expected to be adequate for the Company’s operations for the        foreseeable future.

 

**Item        3.****LEGAL PROCEEDINGS**

 

In the        ordinary, regular and routine course of their business, the Company and its Insurance        Subsidiaries are frequently involved in various matters of litigation relating principally        to claims for insurance coverage provided. No currently pending matter is deemed by        management to be material to the Company.

 

| **Item 4.****SUBMISSION OF                        MATTERS TO A VOTE OF SECURITY HOLDERS** |
|-------------------------------------------------------------------------------------------|

 

Nothing to        report.

 

- 18        -

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**PART II**

 

**Item 5.        MARKET FOR REGISTRANT’S COMMON EQUITY**

|   | **AND RELATED STOCKHOLDER MATTERS** |
|--------|-------------------------------------|

 

The        Company’s Class A and Class B common stocks are traded on The NASDAQ Stock        Market® under the symbols BWINA and BWINB, respectively. The Class A and Class B common        shares have identical rights and privileges except that Class B shares have no voting        rights other than on matters for which Indiana law requires class voting. As of December        31, 2007, there were approximately 400 record holders of Class A Common Stock and        approximately 1,000 record holders of Class B Common Stock.

The table        below sets forth the range of high and low sale prices for the Class A and Class B Common        Stock for 2007 and 2006, as reported by the National Association of Security Dealers, Inc.        and published in the financial press. The quotations reflect interdealer prices without        retail markup, markdown or commission and do not necessarily represent actual        transactions.

 

 

|                    |   |   |   |        |      |   |   |        |   |      |   |          |   |   |      |    |   |   |   | **Cash**     |
|-------------------------|--------|--------|--------|-------------|-----------|--------|--------|-------------|--------|-----------|--------|---------------|--------|--------|-----------|---------|--------|--------|--------|--------------|
|                    |   |   |   | **Class A** |      |   |   | **Class B** |   |      |   | **Dividends** |
|                    |   |   |   | **High**    |      |   |   | **Low**     |   |      |   | **High**      |   |   |      | **Low** |   |   |   | **Declared** |
| Year ended December 31: |   |   |   |        |      |   |   |        |   |      |   |          |   |   |      |    |   |   |   |         |   |   |   |   |   |
| **2007:**               |   |   |   |        |      |   |   |        |   |      |   |          |   |   |      |    |   |   |   |         |   |   |   |   |   |
| **Fourth Quarter**      |   |   |   | **$**       | **28.00** |   |   |        | **$**  | **22.83** |   |          |   | **$**  | **29.00** |    |   |   | **$**  | **25.10**    |   |   |   | **$** | **.35** |
| **Third Quarter**       |   |   |   |        | **28.77** |   |   |        |   | **25.01** |   |          |   |   | **29.61** |    |   |   |   | **25.10**    |   |   |   |   | **.60** |
| **Second Quarter**      |   |   |   |        | **27.85** |   |   |        |   | **23.42** |   |          |   |   | **26.79** |    |   |   |   | **24.25**    |   |   |   |   | **.25** |
| **First Quarter**       |   |   |   |        | **29.25** |   |   |        |   | **24.03** |   |          |   |   | **26.55** |    |   |   |   | **23.48**    |   |   |   |   | **.45** |
|                    |   |   |   |        |      |   |   |        |   |      |   |          |   |   |      |    |   |   |   |         |   |   |   |   |   |
| 2006:                   |   |   |   |        |      |   |   |        |   |      |   |          |   |   |      |    |   |   |   |         |   |   |   |   |   |
| Fourth Quarter          |   |   |   |        | 28.00     |   |   |        |   | 25.05     |   |          |   |   | 27.68     |    |   |   |   | 23.47        |   |   |   |   | .45 |
| Third Quarter           |   |   |   |        | 26.75     |   |   |        |   | 24.15     |   |          |   |   | 26.20     |    |   |   |   | 22.90        |   |   |   |   | .25 |
| Second Quarter          |   |   |   |        | 28.98     |   |   |        |   | 24.09     |   |          |   |   | 26.89     |    |   |   |   | 22.70        |   |   |   |   | 1.50 |
| First Quarter           |   |   |   |        | 26.71     |   |   |        |   | 22.51     |   |          |   |   | 26.55     |    |   |   |   | 24.01        |   |   |   |   | .35 |
|                    |   |   |   |        |      |   |   |        |   |      |   |          |   |   |      |    |   |   |   |         |   |   |   |   |   |

 

 

The        Company has paid quarterly cash dividends continuously since 1974. The current regular        quarterly dividend rate is $.25 per share. The Company expects to continue its policy of        paying regular cash dividends although there is no assurance as to future dividends because        they are dependent on future earnings, capital requirements and financial conditions and        are subject to regulatory restrictions as described in Note F to the consolidated financial        statements.

Since the        fourth quarter of 2003, the Company has paid an extra cash dividend in all but three        quarters in recognition of the Company’s more than adequate capitalization, the        favorable income tax rates available to individuals on dividends as well as the        Company’s excellent earnings over the past three years. Total extra dividends paid in        2007 and 2006 were $.65 and $1.70 per share, respectively. The Board intends to address the        subject of dividends at each of its future meetings considering the Company’s        earnings, returns on investments and its capital needs; however, shareholders should not        expect extra dividends, if any, in the future to follow any predetermined        pattern.

- 19        -

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The        following graph shows a five year comparison of cumulative total return for the        Corporation’s Class B common shares, the NASDAQ Insurance Stock Index and the Russell        2000 Index. The basis of comparison is a $100 investment at December 31, 2002, in each of        (i) Baldwin & Lyons, Inc., (ii) Nasdaq Insurance Stocks, and (iii) the Russell 2000        Index. All dividends are assumed to be reinvested.

 

 

 

 

|   |                      |     | **Period Ending** |     |
|--------|---------------------------|----------|-------------------|----------|
|   | **Index**                 | **2002** | **2003**          | **2004** | **2005** | **2006** | **2007** |
|   | Baldwin & Lyons, Inc. | 100.00   | 153.01            | 157.99   | 148.64 | 172.64 | 197.11 |
|   | NASDAQ Insurance Index    | 100.00   | 121.43            | 145.46   | 158.92 | 178.17 | 176.75 |
|   | Russell 2000              | 100.00   | 147.25            | 174.24   | 182.18 | 215.64 | 212.26 |

 

- 20        -

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|                                                          |   | Year Ended December 31                                                                                                        |
|---------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------|
|                                                          |   | **2007**                                                                                                                      |   | 2006 |   | 2005 |   | 2004 |   | 2003 |
|                                                          |   | *(Dollars in thousands, except per share                        data)*                                                        |
|                                                          |   |                                                                                                                          |   |   |   |   |   |   |   |   |
| **Direct and assumed premiums written**                       |   | **$**     **202,567**                                                                                |   | $     197,064 |   | $     222,445 |   | $     247,099 |   | $     227,614 |
|                                                          |   |                                                                                                                          |   |   |   |   |   |   |   |   |
| **Net premiums earned**                                       |   | **179,065**                                                                                                                   |   | 169,766 |   | 186,165 |   | 172,145 |   | 146,153 |
|                                                          |   |                                                                                                                          |   |   |   |   |   |   |   |   |
| **Net investment income**                                     |   | **19,595**                                                                                                                    |   | 19,548 |   | 14,840 |   | 12,287 |   | 12,873 |
|                                                          |   |                                                                                                                          |   |   |   |   |   |   |   |   |
| **Net gains (losses) on investments**                         |   | **40,096**                                                                                                                    |   | 17,064 |   | 22,981 |   | 9,770 |   | 9,990 |
|                                                          |   |                                                                                                                          |   |   |   |   |   |   |   |   |
| **Losses and loss expenses incurred**                         |   | **107,781**                                                                                                                   |   | 112,604 |   | 140,622 | 5 | 126,298 |   | 95,738 |
|                                                          |   |                                                                                                                          |   |   |   |   |   |   |   |   |
| **Net income**                                                |   | **55,131**                                                                                                                    |   | 38,185 |   | 34,223 |   | 30,306 |   | 33,075 |
|                                                          |   |                                                                                                                          |   |   |   |   |   |   |   |   |
| **Earnings per share -- net income                        1** |   | **3.63**                                                                                                                      |   | 2.54 |   | 2.30 |   | 2.05 |   | 2.25 |
|                                                          |   |                                                                                                                          |   |   |   |   |   |   |   |   |
| **Cash dividends per share 2**                                |   | **1.65**                                                                                                                      |   | 2.55 |   | .95 |   | 2.05 |   | .65 |
|                                                          |   |                                                                                                                          |   |   |   |   |   |   |   |   |
| **Investment portfolio 3**                                    |   | **650,538**                                                                                                                   |   | 626,753 |   | 622,920 |   | 577,428 |   | 515,843 |
|                                                          |   |                                                                                                                          |   |   |   |   |   |   |   |   |
| **Total assets**                                              |   | **842,833**                                                                                                                   |   | 853,719 |   | 862,081 |   | 866,914 |   | 768,582 |
|                                                          |   |                                                                                                                          |   |   |   |   |   |   |   |   |
| **Shareholders' equity**                                      |   | **380,718**                                                                                                                   |   | 357,627 |   | 346,685 |   | 326,548 |   | 324,574 |
|                                                          |   |                                                                                                                          |   |   |   |   |   |   |   |   |
| **Cost of treasury shares purchased**                         |   | **                    -** |   | 401 |   |                   - |   |                   - |   |                                          - |
|                                                          |   |                                                                                                                          |   |   |   |   |   |   |   |   |
| **Book value per share 1**                                    |   | **24.98**                                                                                                                     |   | 23.60 |   | 23.31 |   | 22.04 |   | 22.00 |
|                                                          |   |                                                                                                                          |   |   |   |   |   |   |   |   |
| **Underwriting ratios 4**                                     |   |                                                                                                                          |   |   |   |   |   |   |   |   |
|                                                          |   |                                                                                                                          |   |   |   |   |   |   |   |   |
| Losses and loss expenses                                      |   | **60.2%**                                                                                                                     |   | 66.3% |   | 75.5% |   | 73.4% |   | 65.5% |
|                                                          |   |                                                                                                                          |   |   |   |   |   |   |   |   |
| Underwriting expenses                                         |   | **30.9%**                                                                                                                     |   | 26.6% |   | 22.0% |   | 24.0% |   | 26.5% |
|                                                          |   |                                                                                                                          |   |   |   |   |   |   |   |   |
| Combined                                                      |   | **91.1%**                                                                                                                     |   | 92.9% |   | 97.5% |   | 97.4% |   | 92.0% |

 

1 Earnings and book value per share are adjusted for the dilutive        effect of stock options outstanding.

2 Includes extra dividends of $.65, $1.70, $.55, $1.65 and $.25        per share for 2007, 2006, 2005, 2004 and 2003, respectively.

3 Includes money market instruments classified with cash in the        Consolidated Balance Sheets.

4 Data is for all coverages combined, does not include fee income        and is presented based upon generally accepted accounting principles.

5 Includes $17,595 relating to Hurricanes Katrina, Rita and        Wilma.

 

- 21        -

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| **Item 7.** | **MANAGEMENT’S DISCUSSION AND ANALYSIS                        OF** |
|-------------|--------------------------------------------------------------------------|

**FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Liquidity and Capital Resources

The        primary sources of the Company’s liquidity are (1) funds generated from insurance        operations including net investment income, (2) proceeds from the sale of investments and        (3) proceeds from maturing investments. The Company generally experiences positive cash        flow from operations resulting from the fact that premiums are collected on insurance        policies in advance of the disbursement of funds in payment of claims. Operating costs of        the insurance subsidiaries, other than loss and loss expense payments, generally average        less than 30% of premiums earned on a consolidated basis and the remaining amount is        available for investment for varying periods of time depending on the type of insurance        coverage provided. Because losses are often settled in periods subsequent to when they are        incurred, operating cash flows may, at times, turn negative as loss settlements on claim        reserves established in prior years exceed net premium revenue and receipts of investment        income. During 2007, positive cash flow from operations totaled $27.3 million compared to        $16.6 million in 2006. This comparative increase in operating cash flow resulted from        non-recurring refunds of premium related to retrospectively rated policies during 2006 of        approximately $11 million.

For        several years, the Company’s investment philosophy has emphasized the purchase of        short-term bonds with maximum quality and liquidity. As interest rates and yield curves        have not provided a strong incentive to lengthen maturities in recent years, the Company        has continued to maintain its fixed maturity portfolio at very conservative levels. The        average contractual life of the Company’s bond and short-term investment portfolio        increased from 3.0 to 3.7 years during 2007 as it was determined that after-tax investment        yields could be enhanced by moving portions of the short-term portfolio into high grade        municipal bonds with short to moderate maturities. The average duration of the        Company’s fixed maturity portfolio is shorter than the contractual maturity average        and much shorter than the duration of the Company’s liabilities. The Company also        remains an active participant in the equity securities market using capital which is in        excess of amounts considered necessary to fund current operations. The long-term horizon        for the Company’s equity investments allows it to invest in positions where ultimate        value, and not short-term market fluctuation, is the primary focus. Investments made by the        Company’s domestic insurance subsidiaries are regulated by guidelines promulgated by        the National Association of Insurance Commissioners which are designed to provide        protection for both policyholders and shareholders.

The        Company’s assets at December 31, 2007 included $131 million in short-term and cash        equivalent investments which are readily convertible to cash without market penalty and an        additional $60.2 million of fixed maturity investments (at par) maturing in less than one        year. The Company believes that these liquid investments, plus the expected cash flow from        current operations, are more than sufficient to provide for projected claim payments and        operating cost demands. In the event competitive conditions produce inadequate premium        rates and the Company chooses to further restrict volume, the liquidity of its investment        portfolio would permit management to continue to pay claims as settlements are reached        without requiring the disposal of investments at a loss, regardless of interest rates in        effect at the time. In addition, the Company’s reinsurance program is structured to        avoid serious cash drains that accompany large losses.

Net        premiums written by the Company’s U.S. insurance subsidiaries for 2007 equaled        approximately 36% of the combined statutory surplus of these subsidiaries. Premium writings        of 100% to 200% of surplus are generally considered acceptable by regulatory authorities.        Further, the statutory capital of each of the insurance subsidiaries substantially exceeds        minimum risk based capital requirements set by the National Association of Insurance        Commissioners. Accordingly, the Company has the ability to significantly increase its        business without seeking additional capital to meet regulatory guidelines.

As more        fully discussed in Note F to the consolidated financial statements, at December 31, 2007,        $70.5 million, or 19% of shareholders’ equity, represented net assets of the        Company’s insurance subsidiaries which, at that time, could not be transferred in the        form of dividends, loans or advances to the parent company because of minimum statutory        capital requirements. However, management believes that these restrictions pose no material        liquidity concerns for the Company. The financial strength and stability of the        subsidiaries permit ready access by the parent company to short-term and long-term sources        of credit. The Company has no debt outstanding at December 31, 2007.

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Results        of Operations

 

*2007        Compared to 2006*

Direct        premiums written for 2007 totaled $176.1 million, a decrease of $8.0 million (4%) from        2006. This decrease is primarily attributable to a decrease in the Company’s private        passenger automobile business of $10.4 million (31%), a small fleet trucking program        decrease of $8.3 million (32%) and a large trucking fleet decrease of $14.2 million (22%).        These decreases were partially offset by increases in the Company’s independent        contractor program of $23.9 million (42%). Decreases in direct premiums written volume were        a result of ongoing rate competition and the resultant loss of business. The higher premium        volume from the independent contractor program resulted from the addition of contractors by        existing accounts and from modifications to the program whereby workers’ compensation        coverages were offered to employees of the independent contractors.

Premiums        assumed from other insurers and reinsurers totaled $26.4 million during 2007, an increase        of $13.5 million (105%) from 2006. The reinsurance assumed increase resulted primarily from        new business generated by the Company’s affiliation with Paladin Catastrophe        Management. Protective is the exclusive market for property catastrophe business produced        by Paladin which focuses on soliciting coverage from insurance companies with risks        throughout the U.S. Midwest and limited coastal regions excluding Florida and California.        This business complements other reinsurance assumed by Protective in different geographic        regions. Premium volume from reinsurance assumed will often fluctuate depending on the        favorability of pricing for the coverages provided. Further, premium volume for this        segment is limited by the Company’s self-imposed limitation to loss from a single        catastrophic event.

Premiums        ceded to reinsurers on direct business increased $8.1 million (32.8%) during 2007 to $33.0        million as the consolidated percentage of premiums ceded to direct premiums written        increased to 19% for 2007 from 14% for 2006. This increase is reflective of the        Company’s decreased retention under reinsurance treaties effective June 2007 covering        large fleet trucking risks, resulting in a higher percentage of the direct premiums ceded        to reinsurers.

After        giving effect to changes in unearned premiums, net premiums earned increased 5% to $179.1        million for 2007 from $169.8 million for 2006. Net premiums earned from all        trucking-related insurance products (large trucking fleet, independent contractor and small        fleet trucking) program increased by $1.8 million (2%). Additionally, net premiums earned        from non-affiliated reinsurance assumed increased by $13.4 million (102%). Net premiums        earned from the Company’s private passenger automobile decreased by $6.8 million        (19%).

Pre-tax        investment income of $19.6 million was essentially flat during 2007 compared to 2006 as        pre-tax yields were up 4% on average and were largely offset by a 3% decrease in average        invested assets. Average invested assets decreased primarily due to the payment of over $25        million in cash dividends to shareholders during the year partially offset by increased        cash flow from operations. After tax investment income increased by 7% during 2007,        compared to the prior year. The after-tax investment income yield increased by 10% from        2006 reflecting a significantly higher proportion of the Company’s bond portfolio        allocated to municipal bonds in 2007.

Net gains        on investments totaled $40.1 million in 2007 compared to $17.1 million last year. These        totals include gains from both direct securities trading and investments in limited        partnerships. The gains in 2007 are attributable to $16.8 million in equity security net        gains, $23.2 million in limited partnerships net gains and $.1 in debt security net gains.        During 2007, the Company disposed of numerous equity securities primarily to provide funds        for a new investment program initiated after year end which will be managed by a        consolidated entity in 2008. The Company’s investments in limited partnership        ventures, consists primarily of securities trading which include foreign securities and        small venture capital activities and, to a lesser extent, real estate development. The        estimated market value of limited partnership ventures investments was $80.9 million at        December 31, 2007 and the aggregate of the Company’s share of earnings in these        entities represented a return of over 40% for 2007 and 25% for 2006. The Company follows        the equity method of accounting for its investments in limited partnerships. To the extent        that the limited partnerships include realized and unrealized gains or losses in their net        income, the Company’s proportionate share of net income will include unrealized as        well as realized gains or losses. The current year limited partnership total is composed of        estimated realized income of $7.9 million and estimated unrealized income of $15.3 million,        as reported to the Company by the general partners. Inception to date unrealized gains        included in the December 31, 2007 asset valuation total $30.4 million. The final component        of investment gains, consisting of adjustments attributable to “other-than-temporary        impairment,” was not significant during 2007 or 2006 and is more fully explained in        Note B to the consolidated financial statements.

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Losses and        loss expenses incurred during 2007 decreased $4.8 million (4%) to $107.8 million. The        decrease in losses incurred is due to increased savings on prior accident year losses,        primarily from fleet trucking and reinsurance assumed, continued low frequency of large        trucking claims, and premium volume declines in the Company’s private passenger        automobile and small fleet products. The aforementioned decreases in loss and loss expenses        were largely offset by $12.2 million in losses from the Company’s expansion of its        property catastrophe business during 2007. The 2007 consolidated loss and loss expense        ratio was 60.2% compared to 66.3% for 2006. The Company’s loss and loss expense        ratios for individual product lines are summarized in the following table.

|                          |   | **2007**  |   | 2006  |
|-------------------------------|--------|-----------|--------|-------|
| Fleet trucking                |   | **58.5%** |   | 70.7% |
| Private passenger automobile  |   | **67.7**  |   | 64.8  |
| Small fleet trucking          |   | **58.1**  |   | 68.6  |
| Voluntary reinsurance assumed |   | **60.8**  |   | 35.9  |
| All lines                     |   | **60.2**  |   | 66.3  |

 

The Fleet        trucking loss ratio for 2007 was favorably impacted by an increase in savings on prior year        losses and a continued low frequency of extremely severe accidents. Factors such as        fluctuations in premium volume, the levels of self-insured retentions and the        Company’s higher net retention under reinsurance treaties in recent years tend to        allow for more volatility in losses. The increase in the private passenger automobile loss        ratio is associated with product modifications as competitive market conditions are        ongoing. The lower small fleet trucking loss ratio resulted from a decrease in the        frequency and severity of current year accidents as the Company discontinued marketing its        products in certain unfavorable geographic areas and insured groups. The loss ratio for        reinsurance assumed increased as the result of the Company’s expansion of catastrophe        coverages to the U.S. Midwest during 2007. An unusually large number of tornado and hail        losses were incurred resulting in a loss ratio of 94.5% on this book of business. The        reinsurance assumed loss ratio for the year was 33.0%, or slightly lower than 2006 on our        other reinsurance assumed book of business.

The        Company produced an overall savings on the handling of prior year claims during 2007 of        $21.3 million. This net savings is included in the computation of loss ratios shown in the        table insert, as is the $16.9 million savings produced during 2006 on prior year claims.        Approximately $9.0 million of the $15.9 million savings from fleet trucking relates to        favorable claim settlements in the Company’s independent contractor program. The        remaining savings relates to the Company’s large fleet trucking business and is        generally consistent with recent prior years before consideration of savings related to        retrospectively-rated contracts. Because of the high limits provided by the Company to its        large trucking fleet insureds, the length of time necessary to settle larger, more complex        claims and the volatility of the trucking liability insurance business, the Company        believes it is important to take a conservative posture in its reserving process. As claims        are settled in years subsequent to their occurrence, the Company’s claim handling        process has, historically, tended to produce savings from the reserves provided. Changes in        both gross premium volumes and the Company’s reinsurance structure for its fleet        trucking business can have a significant impact on future loss developments and, as a        result, loss and loss expense ratios and prior year reserve development may not be        consistent year to year.

Other        operating expenses for 2007, before credits for allowances from reinsurers, increased $9.7        million (19.9%) to $58.4 million. This increase is due primarily to a $5.2 million increase        in commission expense related to non-affiliated workers’ compensation business.        Commission expense increased by an additional $2.9 million related to commissions on        increased reinsurance assumed premium volume. Additionally, 2006 operating expenses were        favorably impacted by a recovery of nearly $1 million previously written off related to        bankrupt reinsurers. After consideration for these three items, expenses before ceding        allowances increased $.6 million, or 1.2% from 2006. In general, only commissions to        independent agents, premium taxes and other acquisition costs vary directly with premium        volume. Much of the Company’s expense structure is fixed, that is, expenses do not        vary directly with revenue, as revenue consists principally of net premiums earned by the        insurance subsidiaries.

Reinsurance ceded credits were $.8 million (69%) higher in 2007, resulting        from the Company retaining a lesser percentage of the gross premium for its own account        under recent reinsurance treaties.

Substantially all fleet trucking business is produced by direct sales        efforts of Baldwin & Lyons, Inc. employees and, accordingly, this business does not        incur commission expense on a consolidated basis. Instead, the expenses of the agency        operations, including salaries and bonuses of salesmen, travel expenses, etc. are included        in operating expenses. In general, commissions paid by the insurance subsidiaries to the        parent company exceed related acquisition costs incurred in the

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production of fleet trucking business. The ratio of net        operating expenses of the insurance subsidiaries to net premiums earned was 30.9% during        2007 compared to 26.6% for 2006. Including the agency operations, and after elimination of        inter-company commissions, the ratio of other operating expenses to operating revenue        (defined as total revenue less gains on investments) was 27.7% for 2007 compared with 24.2%        for 2006, reflective of the increase in commission expense, as discussed above.

The        effective federal tax rate for consolidated operations for 2007 was 30.8%. This rate is        lower than the statutory rate primarily because of tax-exempt investment income.

As a        result of the factors mentioned above, net income for 2007 was $55.1 million compared to        $38.2 million for 2006. Diluted earnings per share increased to $3.63 in 2007 from $2.54 in        2006. Earnings per share from operations, before gains on investments, was $1.91 compared        to $1.80 in 2006.

*2006        Compared to 2005*

Direct        premiums written for 2006 totaled $184.1 million, a decrease of $25.4 million (12%) from        2005. This decrease is primarily attributable to a decrease in fleet trucking liability        premiums of $38.8 million (37%) from 2005 levels. Direct premium writings from the        Company’s private passenger automobile program also decreased by $4.5 million (12%).        These decreases were partially offset by increases in the Company’s independent        contractor and small fleet trucking programs of $7.8 million (15%) and $10.5 million (67%),        respectively. Large trucking fleet volume decreased as the result of ongoing rate        competition, which resulted in the loss of business and the writing of lower limits for        renewed accounts. Increased competitive pressures were also responsible for the decline in        premium volume from the private passenger automobile program. The higher premium volume        from the independent contractor program resulted from the addition of contractors by        existing accounts and the increase in premium volume from the small fleet trucking program        was due to geographic expansion, increased marketing efforts and slightly improved        competitive conditions.

Premiums        assumed from other insurers and reinsurers totaled $12.9 million during 2006, an increase        of $1.2 million (10%) from 2005, which included $2.0 million of reinstatement premiums        related to the 2005 hurricanes. The increase disregarding reinstatement premiums was 33%,        reflective of higher premium rates following the hurricane activity of 2004 and 2005.        Premium volume from reinsurance assumed will fluctuate depending on the favorability of        pricing for the coverages provided. Further, premium volume for this segment is limited by        the Company’s self-imposed limitation to loss from a single catastrophic        event.

Premiums        ceded to reinsurers decreased $14.8 million (37%) during 2006 to $24.8 million as the        consolidated percentage of premiums ceded to direct premiums written decreased to 14% for        2006 from 19% for 2005. This decrease is reflective of the Company’s increased        retention under reinsurance treaties effective in 2004 through 2006 covering large fleet        trucking risks. The Company’s maximum retained loss under these treaties has        increased over the last two years and, as a result, a lower percentage of the direct        premiums are ceded to reinsurers. There were no other significant changes to reinsurance        treaties during 2006.

After        giving effect to changes in unearned premiums, net premiums earned decreased 9% to $169.8        million for 2006 from the record $186.2 million for 2005. Excluding inter-company        reinsurance arrangements, net premiums earned from all trucking-related insurance products        decreased by $9.6 million (7%). Net premiums earned from the Company’s private        passenger automobile and discontinued small business workers’ compensation programs        also decreased by $4.1 million (11%) and $2.7 million (99%), respectively. An increase in        net premiums earned from non-affiliated reinsurance assumed of $1.2 million (10%) was        offset by a $1.0 million (73%) decrease in premiums assumed from involuntary residual        markets.

Pre-tax        investment income increased 32% during 2006 to $19.5 million as yields were up 24% on        average and invested assets increased by 5% despite lower cash flow from operations and the        payment of over $38 million in cash dividends to shareholders during the year. This        improvement followed similar increases in 2005. Short-term pre-tax rates increased most        dramatically during 2006, averaging 55% higher than 2005. The after-tax investmentincome yield increased by 36% from 2005 as the movement of substantial        portions of short-term funds into short and moderate term municipal bonds enhanced        after-tax yields by 29% compared to the prior year.

Net gains        on investments totaled $17.1 million in 2006 compared to $23.0 million in 2005. These        totals include gains from both direct securities trading and investments in limited        partnerships. The decrease in gains in 2006 is attributable to lower direct investing        activities and a $3.6 million decline in the earnings of limited partnership investments.        The Company’s investments in limited partnership ventures, consists primarily of        securities trading and small venture capital activities and,

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to a lesser        extent, real estate development. The estimated market value of these investments was $44.7        million at December 31, 2005 and the aggregate of the Company’s share of earnings in        these entities totaled approximately $11.2 million during 2006. While this lagged the $14.8        million of appreciation reported during 2005, it represented a return of over 25% for the        year. The Company follows the equity method of accounting for its investments in limited        partnerships. To the extent that the limited partnerships include realized and unrealized        gains or losses in their net income, the Company’s proportionate share of net income        will include unrealized as well as realized gains or losses. The current year limited        partnership total is composed of estimated realized income of $5.0 million and estimated        unrealized income of $6.2 million, as reported to the Company by the general partners.        Inception to date unrealized gains included in the December 31, 2006 asset valuation total        $23.8 million. The final component of investment gains, consisting of adjustments        attributable to “other-than-temporary impairment,” was not significant during        2006 or 2005 and is more fully explained in Note B.

Losses and        loss expenses incurred during 2006 decreased $28.0 million (20%) to $112.6 million. The        decrease in losses incurred is due primarily to the lack of hurricane losses in 2006 and        lower premium volume during 2006. 2006 loss and loss expenses included $1.5 million in        hurricane losses, resulting from late reporting by ceding reinsurers of Hurricane Rita and        Wilma losses, compared to $17.6 million during 2005. The 2006 consolidated loss and loss        expense ratio was 66.3% compared to 75.5% for 2005. The Company’s loss and loss        expense ratios for individual product lines are summarized in the following        table.

|                                       |   | **2006**  |   | 2005  |
|--------------------------------------------|--------|-----------|--------|-------|
| Fleet trucking                             |   | **70.7%** |   | 73.2% |
| Private passenger automobile               |   | **64.8**  |   | 60.0  |
| Small fleet trucking                       |   | **68.6**  |   | 59.2  |
| Voluntary reinsurance assumed              |   | **35.9**  |   | 154.0 |
| Small business workers’ compensation |   | **-**     |   | 62.7  |
| All lines                                  |   | **66.3**  |   | 75.5  |

 

The Fleet        trucking loss ratio for 2006 was favorably impacted by an increase in savings on prior year        loss developments and a lack of extremely severe accidents. The number of severe fleet        trucking losses during 2005 was also below recent historical averages. Factors such as        fluctuations in premium volume, the levels of self-insured retentions and the        Company’s higher net retention under reinsurance treaties in recent years tend to        allow for more volatility in losses. The increase in the private passenger automobile loss        ratio is associated with product modifications in response to competitive conditions and        the higher small fleet trucking loss ratio resulted largely from geographic expansion with        higher loss ratios during the first half of the year and more favorable results in the        second half.

The        Company produced an overall savings on the handling of prior year claims during 2006 of        $16.9 million. This net savings is included in the computation of loss ratios shown in the        table insert. Approximately $7.2 million of this savings relates to retrospectively-rated        contracts whereby return premiums were recorded concurrently with the loss savings. The        majority of the remaining $9.7 million in savings relates to the Company’s large        fleet trucking business, generally consistent with, but higher than, recent prior years.        Because of the high limits provided by the Company to its large trucking fleet insureds,        the length of time required to settle larger, more complex claims and the volatility of the        trucking liability insurance business, the Company has long favored a conservative posture        in its reserving process. As claims are settled in years subsequent to their occurrence,        the Company’s claim handling process has, historically, tended to produce savings        from the reserves provided. Changes in both gross premium volumes and the Company’s        reinsurance structure for its large trucking fleets can have a significant impact on future        loss developments and, as a result, loss and loss expense ratios and prior year reserve        development may not be consistent year to year.

Other        operating expenses for 2006, before credits for allowances from reinsurers, increased $1.2        million (2.6%) to $48.7 million. This increase is due primarily to a $1.4 million increase        in commission expense related to reinsurance assumed. A large portion of commission on        reinsurance assumed is dependent on experience. During 2005, hurricane losses resulted in        significant reductions to contingent commissions on this business. The favorable experience        during 2006 returned commissions to normal levels in relation to premium volume. Offsetting        much of the reinsurance assumed commission change was the recovery during 2006 of nearly $1        million previously written off related to bankrupt reinsurers. After consideration for        these two items, expenses before ceding allowances increased $.7 million, or 1.7% from        2005. Because much of the Company’s expense structure is fixed, expenses do not vary        directly with revenue, which consists principally of net premiums earned from the insurance        subsidiaries. In general, only commissions to independent agents, premium taxes and other        acquisition costs vary directly with premium volume.

 

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Reinsurance ceded credits were $6.6 million (85%) lower in 2006, resulting        from the Company retaining a greater percentage of the gross premium for its own account        under recent reinsurance treaties. This loss of ceding commission was the primary cause for        the $7.8 million increase in net operating expenses for the year.

Substantially all fleet trucking business is produced by direct sales        efforts of Baldwin & Lyons, Inc. employees and, accordingly, this business does not        incur commission expense on a consolidated basis. Instead, the expenses of the agency        operations, including salaries and bonuses of salesmen, travel expenses, etc. are included        in operating expenses. In general, commissions paid by the insurance subsidiaries to the        parent company exceed related acquisition costs incurred in the production of fleet        trucking business. The ratio of net operating expenses of the insurance subsidiaries to net        premiums earned was 26.6% during 2006 compared to 22.0% for 2005. Including the agency        operations, and after elimination of inter-company commissions, the ratio of other        operating expenses to operating revenue (defined as total revenue less gains on        investments) was 24.2% for 2006 compared with 19.0% for 2005, reflective of the loss of        nearly 85% of ceding commissions from reinsurers, as discussed above.

The        effective federal tax rate for consolidated operations for 2006 was 28.0%. This rate is        lower than the statutory rate primarily because of tax-exempt investment income and the        reversal of accruals related to tax uncertainties rendered no longer necessary by the        conclusion of IRS audits during 2006.

As a        result of the factors mentioned above, net income for 2006 was $38.2 million compared to        $34.2 million for 2005. Diluted earnings per share increased to $2.54 in 2006 from $2.30 in        2005. Earnings per share from operations, before gains on investments, was $1.80 in 2006        compared to $1.30, including hurricane losses that reduced operating income by $.68 per        share in 2005.

Critical Accounting Policies

The        Company’s significant accounting policies are discussed in Note A to the consolidated        financial statements. The following discussion is provided to highlight areas of the        Company’s accounting policies which are material and/or subject to significant        degrees of judgment.

***Investment Valuation***

 

All        marketable securities are included in the Company’s balance sheet at current fair        market value.

 

Approximately 77% of the Company’s assets are composed of investments        at December 31, 2007. Approximately 88% of these investments are publicly-traded, owned        directly and have readily-ascertainable market values. The remaining 12% of investments are        composed of minority interests in several limited partnerships. These limited partnerships        are engaged in the trading of public and non-public equity securities and debt, hedging        transactions, real estate development and venture capital investment. These partnerships,        themselves, do not have readily-determinable market values. Rather, the fair values        recorded are those provided to the Company by the respective partnerships based on the        underlying assets of the partnerships. While the majority of the underlying assets at        December 31, 2007 are publicly-traded securities, some have been valued by the respective        partnerships using their experience and judgment. In addition, approximately $15.7 million        of fixed maturity investments (2.4% of total invested assets) consists of bonds rated as        less than investment grade at year end. These investments are primarily composed of shares        in three widely diversified high yield bond funds where exposure to default by any single        issuer is likely to be limited. These funds carry a Morningstar rating of four and five        stars. We have included theinvestments in these funds in the total        of non-investment grade bonds since, under the investment guidelines of the funds, the        average bond quality rating could fall below BBB. At December 31, 2007, the market value of        these bond funds was 1.7% less than cost.

 

In        determining if and when a decline in market value below cost is other-than-temporary, we        first make an objective analysis of each individual security where current market value is        less than cost. For any security where the unrealized loss exceeds 20% of original or        adjusted cost, and where that decline has existed for a period of at least six months, the        decline is treated as an other-than-temporary impairment, without any subjective evaluation        as to possible future recovery. For individual issues where the decline in value is less        than 20% but the amount of the decline is considered significant, we will also evaluate the        market conditions, trends of earnings, price multiples and other key measures for the        securities to determine if it appears that the decline is other-than-temporary. In those        instances, the Company also considers its intent and ability to hold investments until        recovery or maturity. For any decline which is considered to be other-than-temporary, we        recognize

 

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an        impairment loss in the current period earnings as an investment loss. Declines which are        considered to be temporary are recorded as a reduction in shareholders’ equity, net        of related federal income tax credits.

 

It is        important to note that all investments included in the Company’s financial statements        are valued at current fair market values. The evaluation process for determination of        other-than-temporary decline in value of investments does not change these valuations but,        rather, determines when the decline in value will be recognized in the income statement        (other-than-temporary decline) as opposed to a charge to shareholders’ equity        (temporary decline). Subsequent recoveries in value of investments which have incurred        other-than-temporary impairment adjustments are accounted for as unrealized gains until the        security is actually disposed of or sold. At December 31, 2007, unrealized gains include        $4.8 million of appreciation on investments previously adjusted for other-than-temporary        impairment, compared to $2.7 million of impairment write-downs at that date. See Note B to        the consolidated financial statements for additional detail with respect to this process.        This evaluation process is subject to risks and uncertainties since it is not always clear        what has caused a decline in value of an individual security or since some declines may be        associated with general market conditions or economic factors which relate to an industry,        in general, but not necessarily to an individual issue. The Company has attempted to        minimize many of these uncertainties by adopting a largely objective evaluation process        which results in income statement recognition of any investment which, over a six month        period, is unable to recover from a 20% decline in value from our cost basis. However, to        the extent that certain declines in value are reported as unrealized at December 31, 2007,        it is possible that future earnings charges will result should the declines in value        increase or persist or should the security actually be disposed of while market values are        less than cost. At December 31, 2007, the total gross unrealized loss included in the        Company’s investment portfolio was less than $2.0 million. No individual issue        constituted a material amount of this total. Had this entire amount been considered        other-than-temporary at December 31, 2006, investment gains would have decreased by $.09        per share for the year, after tax. There would, however, have been no impact on total        shareholders equity or book value per share since the decline in value of these securities        was already recognized as a reduction to shareholders equity at December 31,        2007.

 

***Reinsurance Recoverable***

 

For the        three years in the period ended December 31, 2007, reinsurance ceded transactions were as        follows:

|                                                                                 |   | Year Ended December 31 |
|--------------------------------------------------------------------------------------|--------|------------------------|
|                                                                                 |   | **2007**               |   | 2006 |   | 2005 |
|                                                                                 |   |                   |   |   |   |   |
| Premium ceded (reduction to premium earned)                                          |   | **$ 32,974**           |   | $    24,841 |   | $    39,825 |
| Losses ceded (reduction to losses incurred)                                          |   | **4,981**              |   | 14,026 |   | 39,389 |
| Commissions from reinsurers (reduction to operating                        expenses) |   | **2,044**              |   | 1,205 |   | 7,806 |

 

A        discussion of the Company’s reinsurance strategies is presented in Item 1, Business,        on page 2.

 

Amounts        recoverable under the terms of reinsurance contracts comprise approximately 16% of total        Company assets as of December 31, 2007. In order to be able to provide the high limits        required by the Company’s truckingcompany insureds, we share a        significant amount of the insurance risk of the underlying contracts with various insurance        entities through the use of reinsurance contracts. Some reinsurance contracts provide that        a loss be shared among the Company and its reinsurers on a predetermined pro-rata basis        (“quota-share”) while other contracts provide that the Company keep a fixed        amount of the loss, similar to a deductible, with reinsurers taking all losses above this        fixed amount (“excess of loss”). Some risks are covered by a combination of        quota-share and excess of loss contracts. The computation of amounts due from reinsurers is        based upon the terms of the various contracts and follows the underlying estimation process        for loss and loss expense reserves, as described below. Accordingly, the uncertainties        inherent in the loss and loss expense reserving process also affect the amounts recorded as        recoverable from reinsurers. Estimation uncertainties are greatest for claims which have        occurred but which have not yet been reported to the Company. Further, the high limits        provided by the Company’s insurance policies for trucking liability and        workers’ compensation, provide more variability in the estimation process than lines        of business with lower coverage limits.

 

It should        be noted, however, that a change in the estimate of amounts due from reinsurers on unpaid        claims will not, in itself, result in charges or credits to losses incurred. This is        because any change in estimated recovery follows the estimate of the underlying loss. Thus,        it is the computation of the underlying loss that is critical.

 

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As with any        receivable, credit risk exists in the recoverability of reinsurance. This is even more        pronounced than in normal receivable situations since recoverable amounts are not generally        due until the loss is settled which, in some cases, may be many years after the contract        was written. If a reinsurer is unable, in the future, to meet its financial commitments        under the terms of the contracts, the Company would be responsible for the        reinsurer’s portion of the loss. The financial condition of each of the        Company’s reinsurers is initially determined upon the execution of a given treaty and        only reinsurers with the highest credit ratings available are utilized. However, as noted        above, reinsurers are often not called upon to satisfy their obligations for several years        and changes in credit worthiness can occur in the interim period. Reviews of the current        financial strength of each reinsurer are made continually and, should impairment in the        ability of a reinsurer be determined to exist, current year operations would be charged in        amounts sufficient to provide for the Company’s additional liability. Such charges        are included in other operating expenses, rather than losses and loss expenses incurred,        since the inability of the Company to collect from reinsurers is a credit risk rather than        a deficiency associated with the loss reserving process. See Notes D and L to the        consolidated financial statements, on pages 48 and 56, for further discussion of        reinsurance and concentrations of credit risk with respect to reinsurance        recoverable.

 

***Loss        and Loss Expense Reserves***

 

The        Company’s loss and loss expense reserves for each significant segment are shown in        the following table for direct and assumed and on a net of reinsurance basis at December        31, 2007 and 2006. Those lines of business individually comprising less than three percent        of the Company’s total reserves are shown in the aggregate as “All        other”.

 

|                           | Direct and Assumed       |   | Net       |
|--------------------------------|--------------------------|--------|-----------|
| **Line of Business (Segment)** | **2007**                 |   | 2006      |   | **2007** |   | 2006 |
|                           | *(dollars in thousands)* |
| Fleet trucking                 | **$ 293,744**            |   | $ 322,849 |   | **$ 177,748** |   | $ 178,752 |
| Reinsurance assumed            | **33,252**               |   | 34,155    |   | **33,252** |   | 34,155 |
| Private passenger automobile   | **11,701**               |   | 12,692    |   | **11,701** |   | 12,692 |
| Small fleet trucking           | **22,736**               |   | 19,808    |   | **8,896** |   | 8,741 |
| All other                      | **17,184**               |   | 19,908    |   | **12,903** |   | 15,156 |
|                           | **$ 378,616**            |   | $ 409,412 |   | **$ 244,500** |   | $ 249,495 |
|                           |                     |   |      |   |   |   |   |

 

The        Company’s reserves for losses and loss expenses (“reserves”) are        determined based on complex estimation processes using historical experience, current        economic information and, when necessary, available industry statistics. Reserves are        evaluated in three basic categories (1) “case basis”, (2) “incurred but        not reported” and (3) “loss adjustment expense” reserves. Case basis        reserves are established for specific known loss occurrences at amounts dependent upon        various criteria such as type of coverage, severity and the underlying policy limits,        asexamples. Case basis reserves are generally estimated by        experienced claims adjusters using established Company guidelines and are subject to review        by claims management. Incurred but not reported reserves, which are established for those        losses which have occurred, but have not yet been reported to the Company, are not linked        to specific claims but are computed on a “bulk” basis. Common actuarial methods        are employed in the establishment of incurred but not reported loss reserves using company        historical loss data, consideration of changes in the Company’s business and study of        current economic trends affecting ultimate claims costs. Loss adjustment expense reserves,        or reserves for the costs associated with the investigation and settlement of a claim, are        also bulk reserves representing the Company’s estimate of the costs associated with        the claims handling process. Loss adjustment expense reserves include amounts ultimately        allocable to individual claims as well as amounts required for the general overhead of the        claims handling operation that are not specifically allocable to individual claims.        Historical analyses of the ratio of loss adjusting expenses to losses paid on prior closed        claims and study of current economic trends affecting loss settlement costs are used to        estimate the loss adjustment reserve needs related to the established loss reserves. Each        of these reserve categories contain elements of uncertainty which assure variability when        compared to the ultimate costs to settle the underlying claims for which the reserves are        established. The reserving process requires management to continuously monitor and evaluate        the life cycle of claims based on the class of business and the nature of claims. Our        claims range from the very routine private passenger automobile “fender bender”        to the highly complex and costly third party bodily injury claim involving large        tractor-trailer rigs. Reserving for each class of claims requires a set of assumptions        based upon historical experience, knowledge of current industry trends and seasoned        judgment. The high limits provided in the Company’s trucking liability policies        provide for greater volatility in the reserving process for more serious claims. Court        rulings, legislative actions and trends in jury awards also play a significant role in the        estimation process of larger

 

- 29        -

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claims. The        Company continuously reviews and evaluates loss developments subsequent to each measurement        date and adjusts its reserve estimation assumptions, as necessary, in an effort to achieve        the best possible estimate of the ultimate remaining loss costs at any point in time.        Changes to previously established reserve amounts are charged or credited to losses and        loss expenses incurred in the accounting periods in which they are determined. Note C to        the consolidated financial statements includes additional information relating to loss and        loss adjustment expense reserve development.

 

The        Company’s methods for determining loss and loss expense reserves are essentially        identical for interim and annual reporting.

 

A detailed        analysis and discussion for each of the above basic reserve categories follows.

 

*Reserves for known losses (Case reserves)* 

The        Company’s reserves for known claims are determined on an individual case basis and        can range from the routine private passenger “fender bender” valued at a few        hundred dollars to the very complex long-haul trucking claim involving multiple vehicles,        severe injuries and extensive property damage costing several millions of dollars to        settle. Each known claim, regardless of complexity, is handled by a claims adjuster        experienced with claims of this nature and a “case” reserve, appropriate for        the individual loss occurrence, is established. For very routine “short-tail”        claims such as private passenger physical damage, the Company initially records a minimum        reserve that is based upon historical loss settlements adjusted for current trends. As        information regarding the loss occurrence is gathered in the claim handling process, the        reserve is adjusted to reflect the anticipated ultimate cost to settle the claim. For more        complex claims which can tend toward being “long-tail” in nature, an        experienced claims adjuster will review the facts and circumstances surrounding the loss        occurrence to make a determination of the reserve to be established. Many of the more        complex claims involve litigation and necessitate an evaluation of potential jury awards in        addition to the factual information to determine the value of each claim. Each claim is        continually monitored and the recorded reserve is increased or decreased relative to        information gathered during the settlement life cycle.

 

*Reserves for incurred but not reported losses*

The Company        uses both standard actuarial techniques common to most insurance companies as well as        techniques developed by the Company in consideration of its specialty business products.        For its short-tail lines of business, the Company uses predominantly the incurred or paid        loss development factor methods. The Company has found that the use of accident quarter        loss development triangles, rather than those based upon accident year, are most responsive        to claim settlement trends and fluctuations in premium exposures for its short-tail lines.        A minimum of12 running accident quarters is used to project the        reserve necessary for incurred but not reported losses for its short-tail lines.

 

The Company        also uses the loss development factor approach for its long-tail lines of business. A        minimum of 15 accident years is included in the loss development triangles used to        calculate link ratios and the selected loss development factors used to determine the        reserves for incurred but not reported losses. A minimum of 20 accident years is used for        long-tail workers’ compensation reserve projections. More emphasis is placed on the        use of tail factors for the Company’s long-tail lines of business.

 

For the        Company’s large fleet trucking risks, which are covered by annually-changing        reinsurance agreements and which contain wide-ranging self-insured retentions        (“SIR”) as low as $25,000 per loss occurrence and as high as several million        dollars per occurrence, traditional actuarial methods are supplemented by other methods in        consideration of the Company’s exposures to loss. In situations where the        Company’s reinsurance structure, the insured’s SIR selections, policy volume,        and other factors are changing, current accident period loss exposures may not be        homogenous with historical loss data to allow for reliable projection of future developed        losses. Therefore, the Company supplements the above-described actuarial methods with loss        ratio reserving techniques developed from our databases to arrive at the reserve for losses        incurred but not reported for the calendar/accident period under review. Management relies        on its extensive historical pricing and loss history databases to produce reserve factors        unique to this specialty business. As losses for a given calendar/accident period develop        with the passage of time, management evaluates such development on a quarterly basis and        will adjust reserve factors, as necessary, to reflect current judgment with regard to the        anticipated ultimate incurred losses. This process continues until all losses are settled        for each period subject to this method.

 

- 30        -

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*Reserves for loss adjustment expenses*

 

The Company        uses historical analysis of the ratios of allocated loss adjustment expenses paid to losses        paid on closed claims to arrive at the expected ultimate incurred loss adjustment expense        factors for each of its major products. Once developed, the factors are applied to the        expected ultimate incurred losses, including IBNR, on all open claims. The resulting        ultimate incurred allocated loss adjustment expense is then reduced by amounts paid to date        on all open claims to arrive at the reserve for allocated loss adjustment expenses to be        incurred in the future for the handling of specific claims.

 

For those        loss adjustment expenses not specific to individual claims (general claims handling        expenses referred to as unallocated LAE) the Company uses standard industry loss adjustment        expenses paid to losses paid (net of reinsurance) ratio analysis to establish the necessary        reserves. The selected factors are applied to 100% of IBNR reserves and to case reserves        with consideration given for that portion of loss adjustment expense already paid at the        reserve measurement date. Such factors are monitored and revised, as necessary, on a        quarterly basis.

 

The        reserving process requires management to continuously monitor and evaluate the life cycle        of claims based on the class of business and the nature of claims. Our claims range from        the very routine private passenger automobile “fender bender” to the highly        complex and costly third party bodily injury claim involving large tractor-trailer rigs.        Reserving for each class of claims requires a set of assumptions based upon historical        experience, knowledge of current industry trends and seasoned judgment. The high limits        provided in the Company’s trucking liability policies provide for greater volatility        in the reserving process for more serious claims. Court rulings, legislative actions and        trends in jury awards also play a significant role in the estimation process of larger        claims. The Company continuously reviews and evaluates loss developments subsequent to each        measurement date and adjusts its reserve estimation assumptions, as necessary, in an effort        to achieve the best possible estimate of the ultimate remaining loss costs at any point in        time. Changes to previously established reserve amounts are charged or credited to losses        and loss expenses incurred in the accounting periods in which they are determined. Note C        to the consolidated financial statements includes additional information relating to loss        and loss adjustment expense reserve development.

 

The        Company’s methods for determining loss and loss expense reserves are essentially        identical for interim and annual reporting.

 

*Sensitivity Analysis - Potential impact on reserve volatility from        changes in key assumptions*

Management        is aware of the potential for variation from the reserves established at any particular        point in time. Redundancies or deficiencies could develop in future valuations of the        currently established loss and loss expense reserve estimates under a variety of reasonably        possible scenarios. The Company’s reserve selections are developed to be a        “best estimate” of unpaid loss at a point in time and, due to the unique nature        of our exposures, particularly in the large fleet trucking excess product where        insured’s policies of insurance combine large self-insured retentions with high        policy limits, ranges of reserve estimates are not established during the reserving        process. However, basic assumptions that could potentially impact future volatility of our        valuations of current loss and loss expense reserve estimates include, but are not limited        to, the following:

         

•  Consistency in the individual case reserving        processes

•  The selection of loss development factors in the establishment        of bulk reserves for incurred but reported losses and loss expenses

•  Projected future loss trend

•  Expected loss ratios for the current book of business,        particularly the Company’s large fleet excess product, where the number of accounts        insured, selected self-insured 

   retentions, policy limits and reinsurance structure may vary        widely period to period        

                      

Under        reasonably possible scenarios, it is conceivable that the Company’s selected loss        reserve estimates could be 10%, or more, redundant or deficient. As shown in the table on        page 29, the majority of the Company’s reserves for losses and loss expenses, on        either a gross or a net of reinsurance basis, relates to the Fleet trucking product.        Perhaps the most significant example of sensitivity to variation in the key assumptions is        the loss ratio selection for the Company’s large fleet excess product for policies        subject to certain recent major reinsurance treaties (approximately $77.9 million, or        approximately 27% of, carried direct reserves for Fleet trucking). A 10 percentage point        increase or decrease in the loss factors actually utilized in the Company’s reserve        determination at December 31, 2007 would increase or decrease gross and net loss reserves        by approximately $12.1 million and $5.9 million, respectively. Similarly, a 20 percentage        point increase or decrease would increase or decrease gross and net loss reserves by $24.3        million and $11.8 million, respectively.

 

- 31        -

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Federal        Income Tax Considerations

The        liability method is used in accounting for federal income taxes. Using this method,        deferred tax assets and liabilities are determined based on differences between financial        reporting and tax bases of assets and liabilities and are measured using the enacted tax        rates and laws that will be in effect when the differences are expected to reverse. The        provision for deferred federal income tax was based on items of income and expense that        were reported in different years in the financial statements and tax returns and were        measured at the tax rate in effect in the year the difference originated. Net deferred tax        liabilities reported at December 31, 2007 and 2006 consisted of (dollars in        thousands):

*                             *

|                             |   | **2007**     |   | 2006     |
|----------------------------------|--------|--------------|--------|----------|
| Total deferred tax liabilities   |   | **33,168**   |   | 33,659   |
| Total deferred tax assets        |   | **22,050**   |   | 14,805   |
| **Net deferred tax liabilities** |   | **$ 11,118** |   | $ 18,854 |

 

Deferred        tax assets at December 31, 2007, include approximately $10,412 related to policy liability        discounts required by the Internal Revenue Code which are perpetual in nature and, in the        absence of the termination of business, will not reverse to a material degree in the        foreseeable future. An additional $1.0 million relates to impairment adjustments made        to investments, as required by accounting regulations. Deferred tax assets also incluse        $7.8 million related to FIN 48 reclassification. See FIN 48 discussion below. The        sizable unrealized gains in the Company’s investment portfolios would allow for the        recovery of this deferred tax at any time. The balance of deferred tax assets,        approximately $2.9 million, consists of various normal operating expense accruals and is        not considered to be material. As a result of its analysis, management does not consider        any of these assets to be impaired at December 31, 2007.

Financial        Accounting Standards Board Interpretation (FIN) No. 48,*Accounting for Uncertainty in Income        Taxes* *— an Interpretation of        FASB Statement No.* *109,*provides guidance for recognizing and measuring uncertain tax positions, as        defined in SFAS No. 109,*Accounting for Income        Taxes*. FIN 48 prescribes a threshold condition that a tax        position must meet for any of the benefit of the uncertain tax position to be recognized in        the financial statements. Based on this guidance, we regularly analyze tax positions taken        or expected to be taken in a tax returnbased on the threshold        condition prescribed under FIN 48. Tax positions that do not meet or exceed this        threshold condition are considered uncertain tax positions. We accrue interest related to        these uncertain tax positions which is recognized in income tax expense. Penalties, if any,        related to uncertain tax positions would be recorded in income tax expenses.

Forward-Looking Information

Any        forward-looking statements in this report including, without limitation, statements        relating to the Company’s plans, strategies, objectives, expectations, intentions and        adequacy of resources, are made pursuant to the safe harbor provisions of the Private        Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking        statements involve risks and uncertainties including, without limitation, the following:        (i) the Company’s plans, strategies, objectives, expectations and intentions are        subject to change at any time at the discretion of the Company; (ii) the Company’s        business is highly competitive and the entrance of new competitors into or the expansion of        the operations by existing competitors in the Company’s markets and other changes in        the market for insurance products could adversely affect the Company’s plans and        results of operations; and (iii) other risks and uncertainties indicated from time to time        in the Company’s filings with the Securities and Exchange Commission.

Impact        of Inflation

To the        extent possible, the Company attempts to recover the costs of inflation by increasing the        premiums it charges. Within the fleet trucking business, a majority of the Company’s        premiums are charged as a percentage of an insured’s gross revenue or payroll. As        these charging bases increase with inflation, premium revenues are immediately increased.        The remaining premium rates charged are adjustable only at periodic intervals and often        require state regulatory approval. Such periodic increases in premium rates may lag far        behind cost increases.

 

To the        extent inflation influences yields on investments, the Company is also affected. The        Company’s short-term and fixed investment portfolios are structured in direct        response to available interest rates over the yield curve. As available market interest        rates fluctuate in response to the presence or absence of inflation, the yields on the        Company’s investments are

 

- 32        -

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impacted.        Further, as inflation affects current market rates of return, previously committed        investments might increase or decline in value depending on the type and maturity of        investment. (See comments under Market Risk, following.)

Inflation        must also be considered by the Company in the creation and review of loss and loss        adjustment expense reserves since portions of these reserves are expected to be paid over        extended periods of time. The anticipated effect of inflation is implicitly considered when        estimating liabilities for losses and loss adjustment expenses.

Market        Risk

The Company        operates solely within the property and casualty insurance industry and, accordingly, has        significant invested assets which are exposed to various market risks. These market risks        relate to interest rate fluctuations, equities market prices and, to a far lesser extent,        foreign currency rate fluctuations. All of the Company’s invested assets, with the        exception of investments in limited partnerships, are classified as available for sale and        are listed as such in Note B to the consolidated financial statements.

 

The most        significant of the three identified market risks relates to prices in the equities market.        Though not the largest category of the Company’s invested assets, equity securities        have a high potential for short-term price fluctuation. The market value of the        Company’s equity positions at December 31, 2007 was $99.7 million or approximately        15% of invested assets. This market valuation includes $54.5 million of appreciation over        the cost basis of the equity security investments. Funds invested in the equities market        are not considered to be assets necessary for the Company to conduct its daily operations        and, therefore, can be committed for extended periods of time. The long-term nature of the        Company’s equity investments allows it to invest in positions where ultimate value,        and not short-term market fluctuations, is the primary focus.

 

Reference        is made to the discussion of limited partnership investments in the Critical Accounting        Policies portion of this report. All of the market risks, attendant to equity securities,        apply to the underlying assets in these partnerships, and to a greater degree because of        the generally more aggressive investment philosophies utilized by the partnerships. In        addition, these investments are illiquid. There is no primary or secondary market on which        these limited partnerships trade and, in most cases, the Company is prohibited from        disposing of its limited partnershipinterests for some period of        time and must seek approval from the general partner for any such disposal. Distributions        of earnings from these partnerships are largely at the sole discretion of the general        partners and distributions are generally not received by the Company for many years after        the earnings have been reported. Finally, through the application of the equity method of        accounting, the Company’s share of net income reported by the limited partnerships        may include significant amounts of unrealized appreciation on the underlying investments.        As such, the likelihood that reported income from limited partnership investments will be        ultimately returned to the Company in the form of cash is markedly lower than the        Company’s other investments, where income is reported only when a security is        actually sold.

 

The        Company’s fixed maturity portfolio totaled $338.0 million at December 31, 2007.        Approximately 91% of this portfolio is made up of U.S. Government and government agency        obligations and state and municipal debt securities; 87% of the portfolio matures within 5        years; and the average life of the Company’s fixed maturity investments is        approximately 3.7 years. Although the Company is exposed to interest rate risk on its fixed        maturity investments, given the anticipated duration of the Company’s liabilities        (principally insurance loss and loss expense reserves) relative to investment maturities,        even a 100 to 200 basis point increase in interest rates would not have even a moderate        impact on the Company’s ability to conduct daily operations or to meet its        obligations.

 

There is an        inverse relationship between interest rate fluctuations and the fair value of the        Company’s fixed maturity investments. Additionally, the fair value of interest rate        sensitive instruments may be affected by the financial strength of the issuer, prepayment        options, relative values of alternative investments, liquidity of the investment and other        general market conditions. The Company monitors its sensitivity to interest rate risk by        measuring the change in fair value of its fixed maturity investments relative to        hypothetical changes in interest rates. As previously indicated, several other factors can        impact the fair values of fixed maturity investments and, therefore, significant variations        in market interest rates could produce quite different results from the hypothetical        estimates presented in the next paragraph.

 

We estimate        that a 100 basis point increase in market interest rates would have resulted in a pre-tax        loss in the fair value of fixed maturity investments of approximately $5.6 million at        December 31, 2007. Similarly, a 100 basis point decrease in market interest rates would        have resulted in an estimated pre-tax gain in the fair value of these instruments of        approximately $6.1 million at December 31, 2007. Note, however, that the hypothetical loss        mentioned above would only be realized if the Company was obligated to sell bonds prior to        maturity, which is extremely unlikely. The aggregate value of money

 

- 33        -

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market and        short-term investments, bonds maturing within twelve months and expected positive cash flow        from operations for 2007 is equal to more than 100% of net loss and loss expense reserves        at December 31, 2007.

 

The        Company’s exposure to foreign currency risk is not material

Contractual Obligations

The table        below sets forth the amounts of the Company’s contractual obligations at December 31,        2007.

 

 

|                           |   | **Payments Due by Period**                             |
|--------------------------------|--------|--------------------------------------------------------|
|                           |   | **Total**                                              |   | **Less than 1 year** |   | **1 - 3 Years** |   | **3 - 5 Years** |   | **More Than 5 Years** |
|                           |   | *(dollars in millions)*                                |
| Loss and loss expense reserves |   | $        378.6 |   | $            106.0 |   | $          98.4 |   | $          39.8 |   | $        134.4 |
|                           |   |                                                   |   |   |   |   |   |   |   |   |
| Investment commitments         |   | 51.6                                                   |   | 51.6 |   | - |   | - |   | - |
|                           |   |                                                   |   |   |   |   |   |   |   |   |
| Operating leases               |   | 0.8                                                    |   | 0.8 |   | - |   | - |   | - |
|                           |   |                                                   |   |   |   |   |   |   |   |   |
| Total                          |   | $        431.0 |   | $            158.4 |   | $          98.4 |   | $          39.8 |   | $        134.4 |

 

The        Company’s loss and loss expense reserves do not have contractual maturity dates and        the exact timing of the payment of claims cannot be predicted with certainty. However,        based upon historical payment patterns, we have included an estimate of when we might        expect our direct loss and loss expense reserves (without the benefit of reinsurance        recoveries) to be paid in the preceding table. Timing of the collection of the related        reinsurance recoverable, estimated to be $132.8 million at December 31, 2007, would        approximate that of the above projected direct reserve payout.

 

The        investment commitments in the above table relate to maximum unfunded capital obligations        for limited partnership investments and other investments at December 31, 2007 and were        funded through the disposal of equity securities during the fourth quarter of 2007, the        proceeds of which are included in cash equivalent investments at year end.

 

- 34        -

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ANNUAL        REPORT ON FORM 10-K

 

 

         

**ITEM 8--FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

         

 

 

YEAR ENDED        DECEMBER 31, 2007

 

BALDWIN        & LYONS, INC.

 

INDIANAPOLIS, INDIANA

 

- 35        -

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***REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING        FIRM***

 

The Board        of Directors and Shareholders of

Baldwin        & Lyons, Inc.

We have        audited the accompanying consolidated balance sheets of Baldwin & Lyons, Inc. and        subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of        income, changes in equity other than capital, and cash flows for each of the three years in        the period ended December 31, 2007. Our audits also included the financial statement        schedules listed in the Index at Item 15(a). These financial statements and schedules are        the responsibility of the Company’s management. Our responsibility is to express an        opinion on these financial statements and schedules based on our 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 audit        to obtain reasonable assurance about whether the financial statements are free of material        misstatement. An audit includes examining, on a test basis, evidence supporting the amounts        and disclosures in the financial statements. An audit also includes assessing the        accounting principles used and significant estimates made by management, as well as        evaluating the overall financial statement presentation. We believe that our audits provide        a reasonable basis for our opinion.

 

In our        opinion, the financial statements referred to above present fairly, in all material        respects, the consolidated financial position of Baldwin & Lyons, Inc. and subsidiaries        at December 31, 2007 and 2006, and the consolidated results of their operations and their        cash flows for each of the three years in the period ended December 31, 2007, in conformity        with U.S. generally accepted accounting principles. Also, in our opinion, the related        financial statement schedules, when considered in relation to the basic financial        statements taken as a whole, present fairly in all material respects the information set        forth therein.

 

We also        have audited, in accordance with the standards of the Public Company Accounting Oversight        Board (United States), Baldwin & Lyons, Inc.’s internal control over financial        reporting as of December 31, 2007, based on criteria established in Internal        Control—Integrated Framework issued by the Committee of Sponsoring Organizations of        the Treadway Commission and our report dated March 12, 2008 expressed an unqualified        opinion thereon.

 

 

|   | /s/ ERNST & YOUNG LLP |
|--------|---------------------------|

 

 

Indianapolis, Indiana

March 12,        2008

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| ***Consolidated Balance Sheets***                                                   |   |                                                                                                                                                    |   |                                                                                            |   |
|-------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------|--------|
| Baldwin & Lyons, Inc. and Subsidiaries                                          |   |                                                                                                                                                    |   |                                                                                            |   |
|                                                                                |   | December 31                                                                                                                                             |
|                                                                                |   | **2007**                                                                                                                                                |   | 2006                                                                                            |   |
|                                                                                |   | *(dollars in thousands)*                                                                                                                                |
| **Assets**                                                                          |   |                                                                                                                                                    |   |                                                                                            |   |
| Investments:                                                                        |   |                                                                                                                                                    |   |                                                                                            |   |
| Fixed maturities                                                                    |   | **$ 338,011**                                                                                                                                           |   | $ 338,466                                                                                       |   |
| Equity securities                                                                   |   | **99,736**                                                                                                                                              |   | 129,817                                                                                         |   |
| Limited partnerships                                                                |   | **80,884**                                                                                                                                              |   | 57,313                                                                                          |   |
| Short-term and other                                                                |   | **44,768**                                                                                                                                              |   | 59,325                                                                                          |   |
|                                                                                |   | **563,399**                                                                                                                                             |   | 584,921                                                                                         |   |
|                                                                                |   |                                                                                                                                                    |   |                                                                                            |   |
| Cash and cash equivalents                                                           |   | **82,137**                                                                                                                                              |   | 35,490                                                                                          |   |
| Accounts receivable--less allowance (2007, $820; 2006,                        $994) |   | **33,412**                                                                                                                                              |   | 37,994                                                                                          |   |
| Accrued investment income                                                           |   | **4,762**                                                                                                                                               |   | 5,009                                                                                           |   |
| Reinsurance recoverable                                                             |   | **132,811**                                                                                                                                             |   | 163,426                                                                                         |   |
| Prepaid reinsurance premiums                                                        |   | **5,844**                                                                                                                                               |   | 3,486                                                                                           |   |
| Deferred policy acquisition costs                                                   |   | **3,193**                                                                                                                                               |   | 4,742                                                                                           |   |
| Property and equipment--less accumulated                        depreciation        |   |                                                                                                                                                    |   |                                                                                            |   |
| (2007, $7,676; 2006, $6,875)                                                        |   | **9,265**                                                                                                                                               |   | 6,347                                                                                           |   |
| Notes receivable from employees                                                     |   | **2,228**                                                                                                                                               |   | 2,343                                                                                           |   |
| Other assets                                                                        |   | **5,782**                                                                                                                                               |   | 8,348                                                                                           |   |
| Current federal income taxes                                                        |   | **                                         -** |   |                1,613 |   |
|                                                                                |   | **$ 842,833**                                                                                                                                           |   | $ 853,719                                                                                       |   |
|                                                                                |   |                                                                                                                                                    |   |                                                                                            |   |
| **Liabilities and Shareholders’ Equity**                                      |   |                                                                                                                                                    |   |                                                                                            |   |
| Reserves:                                                                           |   |                                                                                                                                                    |   |                                                                                            |   |
| Losses and loss expenses                                                            |   | **$ 378,616**                                                                                                                                           |   | $ 409,412                                                                                       |   |
| Unearned premiums                                                                   |   | **22,678**                                                                                                                                              |   | 32,145                                                                                          |   |
|                                                                                |   | **401,294**                                                                                                                                             |   | 441,557                                                                                         |   |
|                                                                                |   |                                                                                                                                                    |   |                                                                                            |   |
| Reinsurance payable                                                                 |   | **7,261**                                                                                                                                               |   | 2,696                                                                                           |   |
| Accounts payable and other liabilities                                              |   | **31,874**                                                                                                                                              |   | 32,985                                                                                          |   |
| Current federal income taxes                                                        |   | **10,568**                                                                                                                                              |   | -                                                                                               |   |
| Deferred federal income taxes                                                       |   | **11,118**                                                                                                                                              |   | 18,854                                                                                          |   |
|                                                                                |   | **462,115**                                                                                                                                             |   | 496,092                                                                                         |   |
| Shareholders’ equity:                                                         |   |                                                                                                                                                    |   |                                                                                            |   |
| Common stock, no par value:                                                         |   |                                                                                                                                                    |   |                                                                                            |   |
| Class A voting -- authorized 3,000,000 shares;                                      |   |                                                                                                                                                    |   |                                                                                            |   |
| outstanding – 2007 and 2006, 2,650,059                        shares          |   | **113**                                                                                                                                                 |   | 113                                                                                             |   |
| Class B non-voting -- authorized 20,000,000                        shares;          |   |                                                                                                                                                    |   |                                                                                            |   |
| outstanding -- 2007, 12,592,555; 2006, 12,485,205                        shares     |   | **537**                                                                                                                                                 |   | 533                                                                                             |   |
| Additional paid-in capital                                                          |   | **47,899**                                                                                                                                              |   | 45,692                                                                                          |   |
| Unrealized net gains on investments                                                 |   | **36,876**                                                                                                                                              |   | 47,229                                                                                          |   |
| Retained earnings                                                                   |   | **295,293**                                                                                                                                             |   | 264,060                                                                                         |   |
|                                                                                |   | **380,718**                                                                                                                                             |   | 357,627                                                                                         |   |
|                                                                                |   | **$ 842,833**                                                                                                                                           |   | $ 853,719                                                                                       |   |
| *See notes to consolidated financial                        statements.*            |   |                                                                                                                                                    |   |                                                                                            |   |

 

- 37        -

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| ***Consolidated Statements of Income***                                  |   |                                                                   |   |      |   |      |   |
|--------------------------------------------------------------------------|--------|------------------------------------------------------------------------|--------|-----------|--------|-----------|--------|
| Baldwin & Lyons, Inc. and Subsidiaries                               |   |                                                                   |   |      |   |      |   |
|                                                                     |   |                                                                   |   |      |   |      |   |
|                                                                     |   |                                                                   |   |      |   |      |   |
|                                                                     |   | Year Ended December 31                                                 |   |
|                                                                     |   | **2007**                                                               |   | 2006      |   | 2005      |   |
|                                                                     |   | *(dollars in thousands, except per share                        data)* |   |
| **Revenue:**                                                             |   |                                                                   |   |      |   |      |   |
| Net premiums earned                                                      |   | **$ 179,065**                                                          |   | $ 169,766 |   | $ 186,165 |   |
| Net investment income                                                    |   | **19,595**                                                             |   | 19,548    |   | 14,840    |   |
| Net gains on investments                                                 |   | **40,096**                                                             |   | 17,064    |   | 22,981    |   |
| Commissions, service fees and other income                               |   | **5,007**                                                              |   | 6,691     |   | 6,918     |   |
|                                                                     |   | **243,763**                                                            |   | 213,069   |   | 230,904   |   |
| **Expenses:**                                                            |   |                                                                   |   |      |   |      |   |
| Losses and loss expenses incurred                                        |   | **107,781**                                                            |   | 112,604   |   | 140,622   |   |
| Other operating expenses                                                 |   | **56,330**                                                             |   | 47,455    |   | 39,607    |   |
|                                                                     |   | **164,111**                                                            |   | 160,059   |   | 180,229   |   |
| **Income before federal income taxes**                                   |   | **79,652**                                                             |   | 53,010    |   | 50,675    |   |
|                                                                     |   |                                                                   |   |      |   |      |   |
| Federal income taxes                                                     |   | **24,521**                                                             |   | 14,825    |   | 16,452    |   |
| **Net income**                                                           |   | **$ 55,131**                                                           |   | $ 38,185  |   | $ 34,223  |   |
|                                                                     |   |                                                                   |   |      |   |      |   |
| **Per share data:**                                                      |   |                                                                   |   |      |   |      |   |
| **Diluted earnings**                                                     |   | **$ 3.63**                                                             |   | $ 2.54    |   | $ 2.30    |   |
|                                                                     |   |                                                                   |   |      |   |      |   |
| **Basic earnings**                                                       |   | **$ 3.63**                                                             |   | $ 2.54    |   | $ 2.32    |   |
|                                                                     |   |                                                                   |   |      |   |      |   |
| **Dividends**                                                            |   | **$ 1.65**                                                             |   | $ 2.55    |   | $ .95     |   |
|                                                                     |   |                                                                   |   |      |   |      |   |
| *See notes to consolidated financial                        statements.* |   |                                                                   |   |      |   |      |   |

 

- 38        -

----

***    Consolidated Statements of Changes in Equity Other        Than Capital***

| Baldwin & Lyons, Inc. and Subsidiaries                                          |   |                     |   |      |   |      |   |
|-------------------------------------------------------------------------------------|--------|--------------------------|--------|-----------|--------|-----------|--------|
|                                                                                |   |                     |   |      |   |      |   |
|                                                                                |   | **2007**                 |   | 2006      |   | 2005      |   |
|                                                                                |   | *(dollars in thousands)* |   |
| **Balances at beginning of year:**                                                  |   |                     |   |      |   |      |   |
| Retained earnings                                                                   |   | **$ 264,060**            |   | $ 264,719 |   | $ 244,340 |   |
| Unrealized gains on investments                                                     |   | **47,229**               |   | 42,440    |   | 44,497    |   |
|                                                                                |   | **311,289**              |   | 307,159   |   | 288,837   |   |
|                                                                                |   |                     |   |      |   |      |   |
| **Changes arising from income-producing                        activities:**        |   |                     |   |      |   |      |   |
| Net income                                                                          |   | **55,131**               |   | 38,185    |   | 34,223    |   |
|                                                                                |   |                     |   |      |   |      |   |
| Gains on investments:                                                               |   |                     |   |      |   |      |   |
| Pre-tax holding gains on debt and equity                        securities          |   |                     |   |      |   |      |   |
| arising during period                                                               |   | **1,027**                |   | 13,241    |   | 4,987     |   |
| Federal income taxes                                                                |   | **359**                  |   | 4,634     |   | 1,746     |   |
|                                                                                |   | **668**                  |   | 8,607     |   | 3,241     |   |
|                                                                                |   |                     |   |      |   |      |   |
| Pre-tax gains on debt and equity securities included                        in      |   |                     |   |      |   |      |   |
| net income during period                                                            |   | **(16,955)**             |   | (5,874)   |   | (8,150)   |   |
| Federal income taxes                                                                |   | **(5,934)**              |   | (2,056)   |   | (2,852)   |   |
|                                                                                |   | **(11,021)**             |   | (3,818)   |   | (5,298)   |   |
|                                                                                |   |                     |   |      |   |      |   |
| Change in unrealized gains on investments                                           |   | **(10,353)**             |   | 4,789     |   | (2,057)   |   |
|                                                                                |   |                     |   |      |   |      |   |
| Foreign exchange adjustment                                                         |   | **1,164**                |   | (20)      |   | 186       |   |
|                                                                                |   |                     |   |      |   |      |   |
| **Total realized and unrealized income**                                            |   | **45,942**               |   | 42,954    |   | 32,352    |   |
|                                                                                |   |                     |   |      |   |      |   |
| **Other changes affecting retained earnings:**                                      |   |                     |   |      |   |      |   |
| Cash dividends paid to shareholders                                                 |   | **(25,062)**             |   | (38,435)  |   | (14,030)  |   |
| Cost of treasury shares in excess of original issue                        proceeds |   | **-**                    |   | (389)     |   | -         |   |
|                                                                                |   | **(25,062)**             |   | (38,824)  |   | (14,030)  |   |
| **Total changes**                                                                   |   | **20,880**               |   | 4,130     |   | 18,322    |   |
|                                                                                |   |                     |   |      |   |      |   |
| **Balances at end of year:**                                                        |   |                     |   |      |   |      |   |
| Retained earnings                                                                   |   | **295,293**              |   | 264,060   |   | 264,719   |   |
| Unrealized gains on investments                                                     |   | **36,876**               |   | 47,229    |   | 42,440    |   |
|                                                                                |   | **$ 332,169**            |   | $ 311,289 |   | $ 307,159 |   |
| *See notes to consolidated financial                        statements.*            |   |                     |   |      |   |      |   |

 

- 39 -

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| ***Consolidated Statements of Cash                        Flows***                        |   |                                            |   |                                  |   |                                         |
|-------------------------------------------------------------------------------------------|--------|-------------------------------------------------|--------|---------------------------------------|--------|----------------------------------------------|
| Baldwin & Lyons, Inc. and Subsidiaries                                                |   |                                            |   |                                  |   |                                         |
|                                                                                      |   | **2007**                                        |   | 2006                                  |   | 2005                                         |
|                                                                                      |   | *(dollars in thousands)*                        |
| **Operating activities**                                                                  |   |                                            |   |                                  |   |                                         |
| Net income                                                                                |   | **$ 55,131**                                    |   | $ 38,185                              |   | $ 34,223                                     |
| Adjustments to reconcile net income to net cash                                           |   |                                            |   |                                  |   |                                         |
| provided by operating activities:                                                         |   |                                            |   |                                  |   |                                         |
| Change in accounts receivable and unearned                        premiums                |   | **(4,891)**                                     |   | (5,262)                               |   | (162)                                        |
| Change in accrued investment income                                                       |   | **247**                                         |   | (1,496)                               |   | 261                                          |
| Change in reinsurance recoverable on paid losses                                          |   | **4,921**                                       |   | (619)                                 |   | (2,127)                                      |
| Change in losses and loss expenses reserves net of                        reinsurance     |   | **(5,097)**                                     |   | 7,767                                 |   | 35,433                                       |
| Change in other assets, other liabilities and current income                        taxes |   | **5,376**                                       |   | (10,458)                              |   | (4,389)                                      |
| Amortization of net policy acquisition costs                                              |   | **18,941**                                      |   | 12,950                                |   | 6,259                                        |
| Net policy acquisition costs deferred                                                     |   | **(17,392)**                                    |   | (13,316)                              |   | (5,839)                                      |
| Provision for deferred income taxes                                                       |   | **5,620**                                       |   | 2,222                                 |   | 3,084                                        |
| Bond amortization                                                                         |   | **2,453**                                       |   | 2,295                                 |   | 2,858                                        |
| (Gain) loss on sale of property                                                           |   | **35**                                          |   | (20)                                  |   | 16                                           |
| Depreciation                                                                              |   | **2,337**                                       |   | 1,953                                 |   | 2,045                                        |
| Net gains on investments                                                                  |   | **(40,096)**                                    |   | (17,064)                              |   | (22,981)                                     |
| Excess tax benefit related to stock options                                               |   | **(253)**                                       |   | (604)                                 |   | -                                            |
| Compensation expense related to discounted stock                        options           |   | **-**                                           |   | 20                                    |   | 197                                          |
| **Net cash provided by operating activities**                                             |   | **27,332**                                      |   | 16,553                                |   | 48,878                                       |
|                                                                                      |   |                                            |   |                                  |   |                                         |
| **Investing activities**                                                                  |   |                                            |   |                                  |   |                                         |
| Purchases of fixed maturities and equity                        securities                |   | **(232,147)**                                   |   | (246,679)                             |   | (133,625)                                    |
| Purchases of limited partnership interests                                                |   | **(5,995)**                                     |   | (4,957)                               |   | (16,433)                                     |
| Proceeds from maturities                                                                  |   | **164,739**                                     |   | 112,095                               |   | 124,480                                      |
| Proceeds from sales of fixed maturities                                                   |   | **44,508**                                      |   | 37,774                                |   | 35,559                                       |
| Proceeds from sales of equity securities                                                  |   | **55,866**                                      |   | 33,153                                |   | 43,123                                       |
| Net sales (purchases) of short-term investments                                           |   | **14,557**                                      |   | (8,265)                               |   | (14,654)                                     |
| Distributions from limited partnerships                                                   |   | **5,565**                                       |   | 3,562                                 |   | 2,302                                        |
| Decrease in principal balance of notes receivable from                        employees   |   | **110**                                         |   | 15                                    |   | 169                                          |
| Purchases of property and equipment                                                       |   | **(6,225)**                                     |   | (3,000)                               |   | (2,420)                                      |
| Proceeds from disposals of property and equipment                                         |   | **935**                                         |   | 116                                   |   | 200                                          |
| **Net cash provided by (used in) investing                        activities**            |   | **41,913**                                      |   | (76,186)                              |   | 38,701                                       |
|                                                                                      |   |                                            |   |                                  |   |                                         |
| **Financing activities**                                                                  |   |                                            |   |                                  |   |                                         |
| Dividends paid to shareholders                                                            |   | **(25,062)**                                    |   | (38,435)                              |   | (14,030)                                     |
| Proceeds from sale of common stock                                                        |   | **2,211**                                       |   | 6,804                                 |   | 1,618                                        |
| Excess tax benefit related to stock options                                               |   | **253**                                         |   | 604                                   |   | -                                            |
| Repayment on line of credit                                                               |   | **-**                                           |   | -                                     |   | (6,000)                                      |
| Cost of treasury shares                                                                   |   | **-**                                           |   | (401)                                 |   | -                                            |
| **Net cash used in financing activities**                                                 |   | **(22,598)**                                    |   | (31,428)                              |   | (18,412)                                     |
| **Increase (decrease) in cash and cash                        equivalents**               |   | **46,647**                                      |   | (91,061)                              |   | 69,168                                       |
| Cash and cash equivalents at beginning of year                                            |   | **35,490**                                      |   | 126,551                               |   | 57,384                                       |
| **Cash and cash equivalents at end of                        year**                       |        | **$                          82,137** |        |  $    35,490 |        |  $     126,551 |

| *See notes to consolidated financial                        statements.* |   |   |   |  |   |     |
|--------------------------------------------------------------------------|--------|--------|--------|--|--------|--------------------|

 

- 40 -

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Baldwin        & Lyons, Inc. and Subsidiaries

*(Dollars        in thousands)*

 

**Note A - Summary of Significant Accounting Policies**

***Basis        of Presentation:***The consolidated financial statements        include the accounts of Baldwin & Lyons, Inc. and its wholly owned subsidiaries (the        “Company”). All significant inter-company transactions and accounts have been        eliminated in consolidation.

***Use        of estimates:***Preparation of the consolidated financial        statements requires management to make estimates and assumptions that affect the amounts        reported in the consolidated financial statements and accompanying notes. Actual results        could differ from those estimates.

***Cash        and cash equivalents:***The Company considers investments in        money market funds to be cash equivalents. Carrying amounts for these instruments        approximate their fair values.

***Investments:***Carrying amounts for fixed        maturity securities (bonds and notes) represent fair value and are based on quoted market        prices, where available, or broker/dealer quotes for specific securities where quoted        market prices are not available. Equity securities (common stocks) are carried at quoted        market prices (fair value). Limited partnerships are accounted for using the equity method        with the corresponding change in value recorded as a component of net gains or losses on        investments. Other investments are carried at either market value or cost, depending on the        nature of the investment. All fixed maturity and equity securities are considered to be        available for sale; the related unrealized net gains or losses (net of applicable tax        effect) are reflected directly in shareholders’ equity unless a decline in value is        determined to be other-than-temporary, in which case, the loss is charged to income. In        determining if and when a decline in market value below cost is other-than-temporary, an        objective analysis is made of each individual security where current market value is less        than cost. For any security where the unrealized loss exceeds 20% of original or adjusted        cost, and where that decline has existed for a period of at least six months, the decline        is treated as an other-than-temporary impairment, without subjective evaluation as to        possible future recovery. Although the Company has classified fixed maturity investments as        available for sale, it has the ability to, and generally does, hold its fixed maturity        investments to maturity. Short-term investments are carried at cost which approximates        their fair values. Realized gains and losses on disposals of investments are determined by        specific identification of cost of investments sold and are included in income.

***Property and Equipment:***Property and        equipment is carried at cost. Depreciation is computed principally by the straight-line        method.

***Reserves for Losses and Loss Expenses:***The reserves for losses and loss expenses, minor portions of which are        discounted, are determined using case basis evaluations and statistical analyses and        represent estimates of the ultimate cost of all reported and unreported losses which are        unpaid at year end. These reserves include estimates of future trends in claim severity and        frequency and other factors which could vary as the losses are ultimately settled. Although        it is not possible to measure the degree of variability inherent in such estimates,        management believes that the reserves for losses and loss expenses are adequate. The        estimates are continually reviewed and as adjustments to these reserves become necessary,        such adjustments are reflected in current operations.

***Recognition of Revenue and Costs:***Premiums are earned over the period for which insurance protection is        provided. A reserve for unearned premiums, computed by the daily pro-rata method, is        established to reflect amounts applicable to subsequent accounting periods. Commissions to        unaffiliated companies and premium taxes applicable to unearned premiums are deferred and        expensed as the related premiums are earned. The Company does not defer acquisition costs        which are not directly variable with the production of premium and are not refundable in        the event of policy cancellation. If it is determined that expected losses and deferred        expenses will likely exceed the related unearned premiums, the asset representing deferred        policy acquisition costs is reduced and an expense is charged against current operations to        reflect any such premium deficiency. In the event that the expected premium deficiency        exceeds deferred policy acquisition costs, an additional liability would be recorded with a        corresponding expense to current operations for the amount of the excess premium        deficiency. Anticipated investment income is considered in determining recoverability of        deferred

acquisition        costs.

- 41        -

----

**Note A -        Significant Accounting Policies (continued)**

 

***Reinsurance***: Reinsurance premiums,        commissions, expense reimbursements and reserves related to reinsured business are        accounted for on bases consistent with those used in accounting for the original policies        issued and the terms of the reinsurance contracts. Premiums ceded to other insurers have        been reported as a reduction of premium earned. Amounts applicable to reinsurance ceded for        unearned premium and claim loss reserves have been reported as reinsurance recoverable        assets. Certain reinsurance contracts provide for additional or return premiums and        commissions based upon profits or losses to the reinsurer over prescribed periods.        Estimates of additional or return premiums and commissions are adjusted quarterly to        recognize actual loss experience to date as well as projected loss experience applicable to        the various contract periods. Estimates of reinstatement premiums on reinsurance assumed        contracts covering catastrophic events are recorded concurrently with the related        loss.

Should        impairment in the ability of a reinsurer to satisfy its obligations to the Company be        determined to exist, current year operations would be charged in amounts sufficient to        provide for the Company’s additional liability. Such charges, when incurred, are        included in other operating expenses, rather than losses and loss expenses incurred, since        the inability of the Company to collect from reinsurers is a credit risk rather than a        deficiency associated with the loss reserving process.

The Company        accounts for foreign reinsurance assumed using the periodic method. Under the periodic        method, premiums from foreign reinsurance assumed are recognized as revenue over the        contract term, and claims, including an estimate of claims incurred but not reported, are        recognized as they occur.

***Federal Income Taxes:***A consolidated        federal income tax return is filed by the Company and includes all wholly owned        subsidiaries.

In the        ordinary course of business, the Company’s federal income tax returns are audited by        the Internal Revenue Service. Deferred income tax assets and liabilities are recognized for        temporary differences between the financial statement and tax return bases of assets and        liabilities based on enacted tax rates and laws. The deferred tax benefits of the deferred        tax assets are recognized to the extent realization of such benefits is more likely than        not. Deferred income tax expense or benefit generally represents the net change in deferred        income tax assets and liabilities during the year. Current income tax expense represents        the tax consequences of revenues and expenses currently taxable or deductible on various        income tax returns for the year reported.

***Share-Based Payments:***The Company uses a        “Black-Scholes-Merton” option pricing model to value options granted to        employees and non-employee directors in accordance with Statement of Financial Accounting        Standards No. 123R,*Share-Based Payment*,        adopted January 1, 2006 with no material effect. Compensation costs for all share-based        awards to employees and non-employee directors are measured based on the grant date fair        value of the award and are recognized over the period(s) during which the employee or        non-employee director is required to perform service in exchange for the award (the vesting        period).

***Earnings Per Share:***Diluted earnings per        share of common stock are based on the average number of shares of Class A and Class B        common stock outstanding during the year, adjusted for the dilutive effect, if any, of        options outstanding. Basic earnings per share are presented exclusive of the effect of        options outstanding. See*Note K - Earnings Per        Share*.

***Comprehensive Income:***The Company        records accumulated other comprehensive income from unrealized gains and losses on        available-for-sale securities as a separate component of shareholders’ equity.        Foreign exchange adjustments are generally not material and the Company has no defined        benefit pension plan.

The        enclosed*Statement of Changes in Equity Other Than        Capital*refers to comprehensive income as*Total realized and unrealized income*. Items of        other comprehensive income included in this statement are referred to as*Change in unrealized gains (losses) on investments*and*Foreign exchange        adjustment*. A reclassification adjustment to other comprehensive        income is made for*Gains during period included in net        income*.

***Reclassification:***Certain prior year        balances have been reclassified to conform to the current year presentation.

- 42 -

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| **Note B - Investments**                                                         |   |                                                                                                |   |                                                                                          |   |                                                                                                               |   |                                                                                                                                 |   |                                                                                                                           |
|----------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------|
|                                                                             |   |                                                                                                |   |                                                                                          |   |                                                                                                               |   |                                                                                                                                 |   |                                                                                                                           |
| The following is a summary of investments at December                        31: |   |                                                                                                |   |                                                                                          |   |                                                                                                               |   |                                                                                                                                 |
|                                                                             |   |                                                                                                |   |                                                                                          |   |                                                                                                               |   |                                                                                                                                 |   |                                                                                                                           |
|                                                                             |   |                                                                                                |   | Cost or                                                                                       |   | Gross                                                                                                              |   | Gross                                                                                                                                |   | Net                                                                                                                            |
|                                                                             |   | Fair                                                                                                |   | Amortized                                                                                     |   | Unrealized                                                                                                         |   | Unrealized                                                                                                                           |   | Unrealized                                                                                                                     |
|                                                                             |   | Value                                                                                               |   | Cost                                                                                          |   | Gains                                                                                                              |   | Losses                                                                                                                               |   | Gains (Losses)                                                                                                                 |
| **2007:**                                                                        |   |                                                                                                |   |                                                                                          |   |                                                                                                               |   |                                                                                                                                 |   |                                                                                                                           |
| U. S. government obligations                                                     |   | **$**                                  **27,484** |   | **$**                                 **27,222** |   | **$**                                     **267** |   | **$**                                        **(5)** |   | **$**                                       **262** |
| Mortgage-backed securities                                                       |   | **16,153**                                                                                          |   | **16,226**                                                                                    |   | **58**                                                                                                             |   | **(131)**                                                                                                                            |   | **(73)**                                                                                                                       |
| Obligations of states and                                                        |   |                                                                                                |   |                                                                                          |   |                                                                                                               |   |                                                                                                                                 |   |                                                                                                                           |
| political subdivisions                                                           |   | **280,665**                                                                                         |   | **278,752**                                                                                   |   | **2,337**                                                                                                          |   | **(424)**                                                                                                                            |   | **1,913**                                                                                                                      |
| Corporate securities                                                             |   | **5,791**                                                                                           |   | **5,696**                                                                                     |   | **105**                                                                                                            |   | **(10)**                                                                                                                             |   | **95**                                                                                                                         |
| Foreign government obligations                                                   |   | **7,918**                                                                                           |   | **7,868**                                                                                     |   | **50**                                                                                                             |   | **-**                                                                                                                                |   | **50**                                                                                                                         |
| Total fixed maturities                                                           |   | **338,011**                                                                                         |   | **335,764**                                                                                   |   | **2,817**                                                                                                          |   | **(570)**                                                                                                                            |   | **2,247**                                                                                                                      |
| Equity securities                                                                |   | **99,736**                                                                                          |   | **45,251**                                                                                    |   | **55,885**                                                                                                         |   | **(1,400)**                                                                                                                          |   | **54,485**                                                                                                                     |
| Limited partnerships                                                             |   | **80,884**                                                                                          |   | **80,884**                                                                                    |   | **-**                                                                                                              |   | **-**                                                                                                                                |   | **-**                                                                                                                          |
| Short-term                                                                       |   | **44,768**                                                                                          |   | **44,768**                                                                                    |   | **-**                                                                                                              |   | **-**                                                                                                                                |   | **-**                                                                                                                          |
| Total investments                                                                |   | **$**        **563,399**                                    |   | **$**       **506,667**                                    |   | **$**        **58,702**                                                    |   | **$**                                  **(1,970)**                                 |   | **56,732**                                                                                                                     |
|                                                                             |   |                                                                                                |   |                                                                                          |   |                                                                                                               |   |                                                                                                                                 |   |                                                                                                                           |
|                                                                             |   |                                                                                                |   | Applicable federal income taxes                                                               |   | **  (19,856)**                                                                                                |
|                                                                             |   |                                                                                                |   |                                                                                          |   |                                                                                                               |   |                                                                                                                                 |   |                                                                                                                           |
|                                                                             |   |                                                                                                |   | Net unrealized gains - net of tax                                                             |   | **$**                                  **36,876**                |
| 2006:                                                                            |   |                                                                                                |   |                                                                                          |   |                                                                                                               |   |                                                                                                                                 |   |                                                                                                                           |
| U. S. government obligations                                                     |   | $          66,928                                 |   | $         67,291                                 |   | $               32                      |   | $            (395)                                                       |   | $              (363)                                     |
| Mortgage-backed securities                                                       |   | 20,488                                                                                              |   | 20,851                                                                                        |   | 12                                                                                                                 |   | (375)                                                                                                                                |   | (363)                                                                                                                          |
| Obligations of states and                                                        |   |                                                                                                |   |                                                                                          |   |                                                                                                               |   |                                                                                                                                 |   |                                                                                                                           |
| political subdivisions                                                           |   | 212,589                                                                                             |   | 212,033                                                                                       |   | 1,134                                                                                                              |   | (578)                                                                                                                                |   | 556                                                                                                                            |
| Corporate securities                                                             |   | 31,721                                                                                              |   | 31,875                                                                                        |   | 118                                                                                                                |   | (272)                                                                                                                                |   |  (154)                                                                                                                    |
| Foreign government obligations                                                   |   | 6,740                                                                                               |   | 6,722                                                                                         |   | 18                                                                                                                 |   | -                                                                                                                                    |   | 18                                                                                                                             |
| Total fixed maturities                                                           |   | 338,466                                                                                             |   | 338,772                                                                                       |   | 1,314                                                                                                              |   | (1,620)                                                                                                                              |   |  (306)                                                                                                                    |
| Equity securities                                                                |   | 129,817                                                                                             |   | 56,851                                                                                        |   | 73,442                                                                                                             |   | (476)                                                                                                                                |   | 72,966                                                                                                                         |
| Limited partnerships                                                             |   | 57,313                                                                                              |   | 57,313                                                                                        |   | -                                                                                                                  |   | -                                                                                                                                    |   | -                                                                                                                              |
| Short-term                                                                       |   | 59,325                                                                                              |   | 59,325                                                                                        |   | -                                                                                                                  |   | -                                                                                                                                    |   | -                                                                                                                              |
| Total investments                                                                |   | $        584,921                                            |   | $       512,261                                            |   | $        74,756                                                            |   | $          (2,096)                                                                 |   | 72,660                                                                                                                         |
|                                                                             |   |                                                                                                |   |                                                                                          |   |                                                                                                               |   |                                                                                                                                 |   |                                                                                                                           |
|                                                                             |   |                                                                                                |   | Applicable federal income taxes                                                               |   |   (25,431)                                                                                                    |
|                                                                             |   |                                                                                                |   |                                                                                          |   |                                                                                                               |   |                                                                                                                                 |   |                                                                                                                           |
|                                                                             |   |                                                                                                |   | Net unrealized gains - net of tax                                                             |   | $                                  47,229                        |

 

- 43        -

----

**Note B        – Investments (continued)**

 

The        following table summarizes, for fixed maturity and equity security investments in an        unrealized loss position at December 31, the aggregate fair value and gross unrealized loss        categorized by the duration those securities have been continuously in an unrealized loss        position.

 

|                                       |   | **2007**              |   | 2006                                                                             |
|--------------------------------------------|--------|-----------------------|--------|----------------------------------------------------------------------------------|
|                                       |   | Number of

Securities |   | Fair Value                                                                       |   | Gross

Unrealized

Loss |   | Number of

Securities |   | Fair Value |   | Gross

Unrealized

Loss |
| Fixed maturity securities:                 |   |                  |   |                                                                             |   |   |   |   |   |   |   |   |
| 12 months or less                          |   | **15**                |   | **  $**      **22,051**                  |   | **$**                                  **(476)** |   | 83 |   | $       143,673 |   | $             (674) |
| Greater than 12 months                     |   | **9**                 |   | **7,551**                                                                        |   | **(94)** |   | 59 |   | 66,078 |   |                                       (946) |
| Total fixed maturities                     |   | **24**                |   | **29,602**                                                                       |   | **(570)** |   | 142 |   | 209,751 |   |                                    (1,620) |
| Equity securities:                         |   |                  |   |                                                                             |   |   |   |   |   |   |   |   |
| 12 months or less                          |   | **15**                |   | **$**                               **9,194** |   | **(1,230)** |   | 10 |   | 6,693 |   |                (281) |
| Greater than 12 months                     |   | **3**                 |   | **1,165**                                                                        |   | **(170)** |   | 3 |   | 1,604 |   |                                       (195) |
| Total equity securities                    |   | **18**                |   | **10,359**                                                                       |   | **(1,400)** |   | 13 |   | 8,297 |   |                                       (476) |
| Total fixed maturity and equity securities |   | **42**                |   | **$**      **39,961**                              |   | **$**        **(1,970)** |   | 155 |   | $       218,048 |   | $          (2,096) |

 

The        Company’s fixed maturity investment portfolio is sensitive to interest rate        fluctuations, which impact the fair value of individual securities. Accordingly, unrealized        losses on fixed maturity securities reported above were generally caused by the effect of a        rising interest rate environment on certain securities with stated interest rates currently        below market rates. The Company has the ability and intent to hold these fixed maturity        securities until their full cost can be recovered. Therefore, the Company does not believe        the unrealized losses represent an other-than-temporary impairment as of December 31,        2007.

 

The fair        value and the cost or amortized cost of fixed maturity investments, at December 31, 2007,        by contractual maturity, are shown below. Actual maturities may differ from contractual        maturities because borrowers have, in some cases, the right to call or prepay obligations        with or without call or prepayment penalties.

 

|                              |   |   |   |   |   | Fair Value                                                    |   | Cost or Amoritzed Cost                                        |
|-----------------------------------|--------|--------|--------|--------|--------|---------------------------------------------------------------|--------|---------------------------------------------------------------|
|                              |   |   |   |   |   |                                                          |   |                                                          |
| One year or less                  |   |   |   |   |   | $         60,214 |   | $         60,328 |
| Excess of one year to five years  |   |   |   |   |   | 211,838                                                       |   | 209,443                                                       |
| Excess of five years to ten years |   |   |   |   |   | -                                                             |   | -                                                             |
| Excess of ten years               |   |   |   |   |   | 49,806                                                        |   | 49,767                                                        |
| Total maturities                  |   |   |   |   |   | 321,858                                                       |   | 319,538                                                       |
| Mortgage-backed securities        |   |   |   |   |   | 16,153                                                        |   | 16,226                                                        |
|                              |   |   |   |   |   | $       338,011            |   | $       335,764            |

 

 

| Major categories of investment income for the years ended                        December 31 are summarized as follows: |   |                      |
|-------------------------------------------------------------------------------------------------------------------------|--------|---------------------------|
|                                                                                                                    |   |                      |   |   |   | **2007** |   | 2006 |   | 2005 |
| Fixed maturities                                                                                                        |   |                      |   |   |   | **$**        **14,329** |   | $         12,511 |   |                                    $         9,847 |
| Equity securities                                                                                                       |   |                      |   |   |   | **1,866** |   | 1,719 |   | 2,117 |
| Money market funds                                                                                                      |   |                      |   |   |   | **2,613** |   | 3,882 |   | 2,595 |
| Short-term and other                                                                                                    |   |                      |   |   |   | **2,602** |   | 3,087 |   | 1,722 |
|                                                                                                                    |   |                      |   |   |   | **21,410** |   | 21,199 |   | 16,281 |
| Investment expenses                                                                                                     |   |                      |   |   |   | **(1,815)** |   | (1,651) |   | (1,441) |
|                                                                                                                    |   | **Net investment income** |   | **$**                               **19,595** |   | $         19,548 |   | $        14,840 |

 

- 44        -

----

**Note B        – Investments (continued)**

 

Gains and        losses on investments, including equity method earnings from limited partnerships, for the        years ended December 31 are summarized below:

|                            |   |                |   |                                                      |
|---------------------------------|--------|---------------------|--------|-----------------------------------------------------------|
|                            |   |                |   |                                                      |   |   |   |   |   |   |
|                            |   |                |   |                                                      |   | **2007** |   | 2006 |   | 2005 |
| Fixed maturities:               |   |                |   |                                                      |   |   |   |   |   |   |
| Gross gains                     |   |                |   |                                                      |   | ** $**                                    **536** |   | $             157 |   | $              265 |
| Gross losses                    |   |                |   |                                                      |   | **(680)** |   | (714) |   |                                       (586) |
| Net gains (losses)              |   |                |   |                                                      |   | **(144)** |   | (557) |   |                (321) |
|                            |   |                |   |                                                      |   |   |   |   |   |   |
| Equity securities:              |   |                |   |                                                      |   |   |   |   |   |   |
| Gross gains                     |   |                |   |                                                      |   | **          19,293** |   |           10,226 |   |                                    10,094 |
| Gross losses                    |   |                |   |                                                      |   | **  (2,483)** |   |      (3,795) |   |              (1,529) |
| Net gains                       |   |                |   |                                                      |   | **          16,810** |   |             6,431 |   |                                      8,565 |
|                            |   |                |   |                                                      |   |   |   |   |   |   |
| Limited partnerships - net gain |   |                |   |                                                      |   | **          23,141** |   |                                   11,190 |   |                                    14,831 |
|                            |   |                |   |                                                      |   |   |   |   |   |   |
| Other - net gain (loss)         |   |                |   |                                                      |   | **               289** |   | - |   |                                         (94) |
|                            |   |                |   |                                                      |   |   |   |   |   |   |
|                            |   | **Total net gains** |   | **$**       **40,096** |   | $        17,064 |   | $          22,981 |

 

The 2007        net gains from limited partnerships, as shown in the above table, include approximately        $15,300 of unrealized gains as reported in the net income of the various partnerships.        Shareholders’ equity includes approximately $30,500 million, net of deferred federal        income taxes, of earnings yet undistributed by limited partnerships as of December 31,        2007.

Gain and        loss activity for fixed maturity and equity security investments, as shown in the previous        table, include adjustments for other-than-temporary impairment for the years ended December        31 and is summarized as follows:

|                                                                      |   |                                                                                                                                 |   |                                                                                                              |   |                                                                                                                          |
|---------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------|
|                                                                      |   | **2007**                                                                                                                             |   | 2006                                                                                                              |   | 2005                                                                                                                          |
|                                                                      |   |                                                                                                                                 |   |                                                                                                              |   |                                                                                                                          |
| Cumulative charges to income at beginning of year                         |   | **$**                                    **3,717**                       |   | $             5,070                              |   | $             4,523                                          |
| Writedowns based on objective criteria                                    |   | **                  593**                  |   |                                       1,423 |   |                1,260                               |
| Recovery of prior writedowns upon sale or                        disposal |   | **             (1,576)**                                            |   |               (2,776)                       |   |                                         (713) |
| Cumulative charges to income at end of year                               |   | **$**                                    **2,734**                       |   | $             3,717                              |   | $             5,070                                          |
|                                                                      |   |                                                                                                                                 |   |                                                                                                              |   |                                                                                                                          |
| Net pre-tax realized gain (loss)                                          |   | **$**                                       **983**       |   | $             1,353                              |   | $                                    ($ 547)                      |
|                                                                      |   |                                                                                                                                 |   |                                                                                                              |   |                                                                                                                          |
| Addition (reduction) to earnings per share                                |   | **$**                                        **.04** |   | $                 .06        |   | $                                    ($ .02)                      |
|                                                                      |   |                                                                                                                                 |   |                                                                                                              |   |                                                                                                                          |
| Unrealized gain on investments previously                                 |   |                                                                                                                                 |   |                                                                                                              |   |                                                                                                                          |
| written down at end of the year - see note below                          |   | **$**                                   **4,878**                             |   | $             6,428                              |   | $             5,957                                          |

 

 

Note:        Recovery in market value of an investment which has previously been adjusted for        other-than-temporary impairment is treated as an unrealized gain until the investment is        disposed of.

There is no        primary or secondary market for the Company’s investments in limited partnerships        and, in most cases, the Company is prohibited from disposing of its limited partnership        interests for some period of time and must seek approval from the general partner for any        such disposal. Distributions of earnings from these partnerships are largely at the sole        discretion of the general partners and distributions are generally not received by the        Company for many years after the earnings have been reported. The Company has commitments        to contribute an additional $1,600 to various limited partnerships as of December 31,        2007.

The Company        has invested a total of $24,000 in three limited partnerships, with an aggregate market        value of $58,380 at December 31, 2007, that are managed by organizations in which two        directors of the Company are executive officers, directors and owners. The Company’s        ownership interest in these limited partnerships ranges from 4% to 25%. These limited        partnerships added $19,177, $7,942 and $7,145, net of fees, to investment gains in 2007,        2006 and 2005

 

- 45        -

----

**Note        B – Investments (continued)**

respectively. During 2007, 2006 and 2005, the Company has recorded        management fees of $765, $604 and $481, respectively, and performance-based fees of $4,902,        $1,587 and $1,687, respectively, to these organizations for management of these limited        partnerships. The Company has been informed that the fee rates applied to its investments        in these limited partnerships are the same as, or lower than, the fee rates charged to        unaffiliated customers for similar investments.

The Company        utilized the services of a broker-dealer firm of which a director of the Company is an        executive officer and owner. This broker-dealer serves as agent for purchases and sales of        securities and manages an equity securities portfolio and fixed maturity portfolio with        market values of approximately $2,349 and $16,862, respectively, at December 31, 2007. The        Company has been informed that commission and management rates charged by this        broker-dealer to the Company are commensurate with rates charged to non-affiliated        customers for similar investments. Total commissions and fees earned by the broker-dealer        and affiliates on these transactions and for advice and consulting were approximately $170,        $148 and $279 during 2007, 2006 and 2005, respectively. The Company had previously entered        into an agreement with an associate of this broker-dealer for management of a portion of        its equity securities portfolio. That agreement was terminated during 2005. That associate        earned performance-based compensation and management services fees and expense        reimbursements totaling approximately $90 during 2005. The Company has been informed that        the broker-dealer retained none of this compensation for its own account.

The fair        value of regulatory deposits with various insurance departments in the United States and        Canada totaled $23,432 at December 31, 2007.

Short-term        investments at December 31, 2007 include $2,900 in foreign time certificates of        deposit.

The        Company’s limited partnerships include one significant investment accounted for using        the equity method, which exceeds 10% of earnings. This limited partnership        investment’s value as of December 31, 2007 and 2006 was $44,716 and $27,492,        respectively. At December 31, 2007, the Company’s ownership interest in this limited        partnership investment was less than 4%.

The        Company’s share of earnings from this limited partnership investment was as follows        for the years ended December 31:

|                        |   | **2007**                                                                                                                                 |   | 2006                                                                                                                               |   | 2005                                                                                       |
|-----------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------|
| Estimated realized income   |   | **$**                                        **4,241**        |   | $                                         971 |   | $              1,445 |
| Estimated unrealized income |   | **                                         12,983** |   | 5,566                                                                                                                              |   | 4,510                                                                                      |
| Equity method earnings      |   | **$**                                      **17,224**                   |   | $                                      6,537                 |   | $              5,955 |

 

The        summarized financial information of the significant limited partnership investment as of        and for the years ended December 31 is as follows:

|                                                                               |   | **2007**                                                                                    |   | 2006                                                                                   |   | 2005                                          |
|------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------|--------|-----------------------------------------------|
| Total assets                                                                       |   | **$**                                 **1,466,882** |   | $                                 703,315 |   | $       366,937 |
| Total partners' capital                                                            |   | ****1,389,232****                                                                           |   | 701516                                                                                 |   | 344,903                                       |
| Net increase in partners' capital resulting                        from operations |   | ****666,966****                                                                             |   | 161,674                                                                                |   | 93,998                                        |

- 46        -

----

**Note C - Loss and Loss Expense Reserves**

Activity in the reserves for losses and loss expenses is summarized as        follows. All amounts are shown net of reinsurance, unless otherwise indicated.

 

|                                                                                   |   |        |   |    |   | Year Ended December 31                                     |
|----------------------------------------------------------------------------------------|--------|-------------|--------|---------|--------|------------------------------------------------------------|
|                                                                                   |   |        |   |    |   | **2007**                                                   |   | 2006 |   | 2005 |
| Reserves at the beginning of the year                                                  |   |        |   |    |   | **$**       **249,495** |   | $       242,130 |   | $       207,137 |
|                                                                                   |   |        |   |    |   |                                                       |   |   |   |   |
| Provision for losses and loss expenses:                                                |   |        |   |    |   |                                                       |   |   |   |   |
| Claims occurring during the current year                                               |   |        |   |    |   | **129,065**                                                |   | 129,551 |   | 154,314 |
| Claims occurring during prior years                                                    |   |        |   |    |   | **(21,284)**                                               |   | (16,947) |   | (13,692) |
| Total incurred                                                                         |   |        |   |    |   | **107,781**                                                |   | 112,604 |   | 140,622 |
|                                                                                   |   |        |   |    |   |                                                       |   |   |   |   |
| Loss and loss expense payments:                                                        |   |        |   |    |   |                                                       |   |   |   |   |
| Claims occurring during the current year                                               |   |        |   |    |   | **53,820**                                                 |   | 45,658 |   | 45,286 |
| Claims occurring during prior years                                                    |   |        |   |    |   | **58,956**                                                 |   | 59,581 |   | 60,343 |
| Total paid                                                                             |   |        |   |    |   | **112,776**                                                |   | 105,239 |   | 105,629 |
|                                                                                   |   |        |   |    |   |                                                       |   |   |   |   |
| Reserves at the end of the year                                                        |   |        |   |    |   | **244,500**                                                |   | 249,495 |   | 242,130 |
|                                                                                   |   |        |   |    |   |                                                       |   |   |   |   |
| Reinsurance recoverable on unpaid losses at the end of the                        year |   | **134,116** |   | 159,917 |   | 188,143                                                    |
| Reserves, gross of reinsurance                                                         |   |        |   |    |   |                                                       |   |   |   |   |
| recoverable, at the end of the year                                                    |   |        |   |    |   | **$**       **378,616** |   | $       409,412 |   | $       430,273 |

 

 

The table        above shows that a savings of $21,284 was developed during 2007 in the settlement of claims        occurring on or before December 31, 2006, with similar savings being developed during the        prior two calendar years on losses occurring on or before years ended December 31, 2005 and        2004. These savings are the result of the settlement of claims at amounts lower than        previously reserved and changes in estimates of losses incurred but not reported as part of        the normal reserving process.

 

| The major components of the developments shown above are as                        follows: |   |   |   |   |   |                                                                                                              |
|---------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|-------------------------------------------------------------------------------------------------------------------|
|                                                                                        |   |   |   |   |   | Year Ended December 31                                                                                            |
|                                                                                        |   |   |   |   |   | **2007**                                                                                                          |   | 2006 |   | 2005 |
|                                                                                        |   |   |   |   |   |                                                                                                              |   |   |   |   |
| Retrospectively-rated direct business                                                       |   |   |   |   |   | **$ (1,078)**                                                                                                     |   | $  (7,171) |   | $(8,014) |
| Other direct business                                                                       |   |   |   |   |   | **(16,041)**                                                                                                      |   | (7,994) |   | (4,468) |
| Reinsurance assumed                                                                         |   |   |   |   |   | **(4,112)**                                                                                                       |   | (1,288) |   | (1,730) |
| Involuntary residual markets                                                                |   |   |   |   |   | **(56)**                                                                                                          |   | (533) |   | 1,018 |
| Environmental damage                                                                        |   |   |   |   |   | **                                      3** |   |                                      39 |   | (498) |
| Totals                                                                                      |   |   |   |   |   | **$(21,984)**                                                                                                     |   | $(16,947) |   | $(13,692) |

 

Favorable        loss development is influenced by the Company’s long-standing policy of reserving for        losses realistically and a willingness to settle claims based upon a seasoned evaluation of        its exposures. Reserve savings developed related to retrospectively-rated accident and        health business resulted in the concurrent recording of return premiums of approximately        $662, $4,738 and $4,484 for the years ended December 31, 2007, 2006 and 2005, respectively.        As more fully discussed in Note D, the Company has generally increased its per occurrence        retention of risk related to trucking liability business over the past several years. The        increased net retention per occurrence is reflected in the increasingly favorable        developments on other direct business during 2007, 2006 and 2005. These trends were        considered in the establishment of the Company’s reserves at December 31, 2007 and        2006.

The Company        has not changed its original estimate for the loss sustained as a result of the terrorist        attacks of September 11, 2001. Therefore, there is no impact on the loss developments shown        in the above table except for payments against the original established reserves. The        Company has paid $11,100 to date and carries a remaining reserve of  $8,900 at        December 31, 2007.

- 47        -

----

**Note C - Loss and Loss Expense Reserves (continued)**

The Company        participates in mandatory residual market pools in various states. The Company records the        results from participation in these pools as the information is reported to the Company and        also records an additional provision in the financial statements for operating periods        unreported by the pools.

Loss        reserves on certain permanent total disability workers’ compensation reserves have        been discounted to present value at pre-tax rates not exceeding 3.5%. At December 31, 2007        and 2006, loss reserves have been reduced by approximately $5,591 and $4,883, respectively.        Discounting is applied to these claims since the amount of periodic payments to be made        during the lifetime of claimants is fixed and determinable.

Loss        reserves have been reduced by estimated salvage and subrogation recoverable of        approximately $4,069 and $3,845 at December 31, 2007 and 2006, respectively.

 

**Note        D - Reinsurance**

The        insurance subsidiaries cede portions of their gross premiums written to certain other        insurers under excess and quota share treaties and by facultative placements. Risks are        reinsured with other companies to permit the recovery of a portion of related direct        losses. Management determines the amount of net exposure it is willing to accept generally        on a product line basis. Certain treaties covering large fleet trucking include annual        deductibles which must be exceeded before the Company can recover under the terms of the        treaty. In these cases, the Company retains a higher percentage of the direct premium in        consideration of the deductible provisions. The Company remains liable to the extent the        reinsuring companies are unable to meet their obligations under reinsurance        contracts.

The        Company also serves as an assuming reinsurer on treaties with direct writing insurance        companies for catastrophic property coverages as well as under retrocessions from certain        other reinsurers. The retrocessions include individual risks but are comprised primarily of        high layer catastrophe treaties. Accordingly, the occurrence of catastrophic events can        have a significant impact on the Company’s operations. In addition, the insurance        subsidiaries participate in certain involuntary reinsurance pools which require insurance        companies to provide coverages on assigned risks. The assigned risk pools allocate        participation to all insurers based upon each insurer’s portion of premium writings        on a state or national level. Historically, the operation of these assigned risk pools have        resulted in net losses allocated to the Company although such losses have generally not        been material in relation to the Company’s direct and voluntary assumed        operations.

|            |   | Premiums Written                                           |   | Premiums Earned                                          |
|-----------------|--------|------------------------------------------------------------|--------|----------------------------------------------------------|
|            |   | **2007**                                                   |   | 2006                                                     |   | 2005 |   | **2007** |   | 2006 |   | 2005 |
| Direct          |   | **$**       **176,121** |   | $        184,148 |   | $        209,527 |   | **$**        **185,566** |   | $        181,491 |   | $        212,997 |
| Ceded on direct |   | **   (32,980)**                                  |   | (24,836)                                                 |   | (39,652) |   | **  (32,974)** |   |   (24,841) |   | (39,825) |
| Assumed         |   | **26,446**                                                 |   | 12,916                                                   |   | 12,918 |   | **26,473** |   | 13,116 |   | 12,993 |
| Net             |   | **$**      **169,587**       |   | $        172,228 |   | $        182,793 |   | **$**     **179,065** |   | $        169,766 |   | $        186,165 |

 

Reinsurance assumed premiums for 2007, as shown in the table above, are        presented net of a retrocession purchased to limit the Company’s probable maximum        loss to amounts considered prudent by management. The cost of this retrocession was        $4,800.

Net losses        and loss expenses incurred for 2007, 2006 and 2005 have been reduced by ceded reinsurance        recoveries of approximately $4,981, $14,026 and $39,389, respectively. Ceded reinsurance        premiums and loss recoveries for catastrophe reinsurance contracts were not        material.

Net losses        and loss expenses incurred for 2007, 2006 and 2005 include approximately $14,638, $2,623        and $20,152 relating to reinsurance assumed from non-affiliated insurance or reinsurance        companies, including involuntary residual market pools. The assumed reinsurance losses in        2006 and 2005 included $1,457 and $17,595 respectively, related to hurricanes Katrina and        Wilma, before reinstatement premium.

 

- 48        -

----

**Note        D – Reinsurance (continued)**

| Components of reinsurance recoverable at December 31 are as                        follows: |   |   |   |                                                       |
|---------------------------------------------------------------------------------------------|--------|--------|--------|------------------------------------------------------------|
|                                                                                        |   |   |   |                                                       |   | **2007** |   | 2006 |
| Unpaid losses and loss expenses, net of valuation                        allowance          |   |   |   | **$**       **131,727** |   | $     157,426 |
| Paid losses and loss expenses                                                               |   |   |   |                                                       |   | **1,079** |   | 6,000 |
| Unearned premiums                                                                           |   |   |   |                                                       |   | **6** |   | **-** |
|                                                                                        |   |   |   |                                                       |   | **$**     **132,812** |   | $       163,426 |

 

**Note E -        Income Taxes**

Deferred        income taxes reflect the net tax effects of temporary differences between the carrying        amounts of assets and liabilities for financial reporting purposes and the amounts used for        income tax purposes. Significant components of the Company’s deferred tax assets and        liabilities as of December 31 are as follows:

 

|                                                                                   |   |   |   |                                                                                                      |   | **2007**                                                                                                  |   | 2006                                                                                  |
|----------------------------------------------------------------------------------------|--------|--------|--------|-----------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------|
| **Deferred tax liabilities:**                                                          |   |   |   |                                                                                                      |   |                                                                                                      |   |                                                                                  |
| Unrealized gain on fixed income and equity security                        investments |   |   |   | **$**                                   **19,856** |   | $            25,431                           |
| Limited partnership investments                                                        |   |   |   |                                                                                                      |   | **10,632**                                                                                                |   | 5,278                                                                                 |
| Deferred acquisition costs                                                             |   |   |   |                                                                                                      |   | **1,118**                                                                                                 |   | 1,660                                                                                 |
| Other                                                                                  |   |   |   |                                                                                                      |   | **1,562**                                                                                                 |   | 1,290                                                                                 |
| Total deferred tax liabilities                                                         |   |   |   |                                                                                                      |   | **33,168**                                                                                                |   | 33,659                                                                                |
|                                                                                   |   |   |   |                                                                                                      |   |                                                                                                      |   |                                                                                  |
| **Deferred tax assets:**                                                               |   |   |   |                                                                                                      |   |                                                                                                      |   |                                                                                  |
| Discounts of loss and loss expense reserves                                            |   |   |   |                                                                                                      |   | **8,825**                                                                                                 |   | 10,006                                                                                |
| FIN 48 reclassification                                                                |   |   |   |                                                                                                      |   | **7,781**                                                                                                 |   | -                                                                                     |
| Unearned premiums discount                                                             |   |   |   |                                                                                                      |   | **1,587**                                                                                                 |   | 2,250                                                                                 |
| Other than temporary investment declines                                               |   |   |   |                                                                                                      |   | **957**                                                                                                   |   | 1,301                                                                                 |
| Deferred compensation                                                                  |   |   |   |                                                                                                      |   | **2,689**                                                                                                 |   | 1,033                                                                                 |
| Other                                                                                  |   |   |   |                                                                                                      |   | **211**                                                                                                   |   | 215                                                                                   |
| Total deferred tax assets                                                              |   |   |   |                                                                                                      |   | **22,050**                                                                                                |   | 14,805                                                                                |
| **Net deferred tax liabilities**                                                       |   |   |   |                                                                                                      |   | **$**                                   **11,118** |   | $             18,854 |

 

 

A summary        of the difference between federal income tax expense computed at the statutory rate and        that reported in the consolidated financial statements is as follows:

 

|                                                                          |   | **2007**                                                                                                  |   | 2006                                                                |   | 2005                                                                |
|-------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------|--------|---------------------------------------------------------------------|
|                                                                          |   |                                                                                                      |   |                                                                |   |                                                                |
| Statutory federal income rate applied to pretax                        income |   | **$**                                   **27,878** |   | $          18,553 |   | $          17,736 |
| Tax effect of (deduction):                                                    |   |                                                                                                      |   |                                                                |   |                                                                |
| Tax-exempt investment income                                                  |   | **(3,298)**                                                                                               |   | (2,313)                                                             |   | (1,410)                                                             |
| Net addition to (reduction of) tax positions                                  |   | **125**                                                                                                   |   | (1,617)                                                             |   | 96                                                                  |
| Other                                                                         |   | **(184)**                                                                                                 |   | 202                                                                 |   | 30                                                                  |
| Federal income tax expense                                                    |   | **$**                                   **24,521** |   | $          14,825 |   | $          16,452 |

 

 

| Federal income tax expense consists of the                        following: |   |   |   |                                                                                                      |   |                                                          |
|------------------------------------------------------------------------------|--------|--------|--------|-----------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------|
|                                                                         |   |   |   | **2007**                                                                                                  |   | 2006                                                          |   | 2005 |
| Taxes (credits) on pre-tax income:                                           |   |   |   |                                                                                                      |   |                                                          |   |   |
| Current                                                                      |   |   |   | **$**                                   **18,901** |   | $         12,603 |   | $        13,368 |
| Deferred                                                                     |   |   |   | **5,620**                                                                                                 |   | 2,222                                                         |   | 3,084 |
|                                                                         |   |   |   | **$**                                   **24,521** |   | $         14,825 |   | $        16,452 |

 

 

- 49        -

----

**Note E -        Income Taxes (continued)**

 

| The components of the provision for deferred federal income                        taxes (credits) are as follows: |   |                                                                             |
|--------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------|
|                                                                                                               |   |                                                                             |   |   |   |   |   |   |
|                                                                                                               |   |                                                                             |   | **2007** |   | 2006 |   | 2005 |
| Limited partnerships                                                                                               |   |                                                                             |   | **$**           **5,354** |   | $            1,871 |   | $                                          3,600 |
| Discounts of loss and loss expense reserves                                                                        |   |                                                                             |   | **32** |   | 92 |   | (1,469) |
| Unearned premium discount                                                                                          |   |                                                                             |   | **663** |   | (172) |   | 236 |
| Deferred compensation                                                                                              |   |                                                                             |   | **(508)** |   | (149) |   | 694 |
| Other than temporary investment declines                                                                           |   |                                                                             |   | **344** |   | 474 |   | (191) |
| Other                                                                                                              |   |                                                                             |   | **(265)** |   | 106 |   | 214 |
| **Provision for deferred federal income tax**                                                                      |   | **$**           **5,620** |   | $            2,222 |   | $                                         3,084 |

 

 

Cash flows        related to federal income taxes paid, net of refunds received, for 2007, 2006 and 2005 were        $14,502, $16,097, and $12,147, respectively.

 

The Company        is required to establish a valuation allowance for any portion of the gross deferred tax        asset that management believes will not be realized. Management has determined that no such        valuation allowance is necessary at December 31, 2007. As of December 31, 2007, the        Internal Revenue Service had completed examinations and settled all audits through the        Company’s 2004 tax year.

 

The Company        adopted FIN 48 on January 1, 2007 with no adjustment necessary to beginning retained        earnings. The total amount of unrecognized tax benefits from uncertain tax positions at        January 1, 2007 was $10,301. The tax positions are uncertain as to the timing of        deductibility and therefore, if recognized would have no impact on the Company’s        effective tax rate.

 

The Company        recognizes accrued interest and penalties, if any, related to unrecognized tax benefits in        income tax expense and changes in such accruals would impact the Company’s effective        tax rate. Amounts accrued for the payment of interest at December 31, 2007 and December 31,        2006 were not material.

 

A        reconciliation of the beginning and ending amounts of unrecognized federal income taxes        (credits) is as follows:

 

|                                             |   |   |   |                                                                                                                        |
|--------------------------------------------------|--------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------|
|                                             |   |   |   | **2007**                                                                                                                    |
| Balance at January 1, 2007                       |   |   |   | **$**             **10,301**                               |
| Reductions for tax positions of the current year |   |   |   | **  (142)**                                                                                                            |
| Reductions for tax positions of prior years      |   |   |   | **  (2,378)**                                                                                                          |
| Balance at December 31, 2007                     |   |   |   | **$**                                       **7,781** |

 

- 50        -

----

 

| **Note F - Shareholders' Equity**                                                                        |   |                                            |   |                                                       |   |                |   |                                                 |   |                                                    |
|----------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------|--------|------------------------------------------------------------|--------|---------------------|--------|------------------------------------------------------|--------|---------------------------------------------------------|
|                                                                                                     |   |                                            |   |                                                       |   |                |   |                                                 |   |                                                    |
| Changes in common stock outstanding and additional paid-in                        capital are as follows |   |                                            |   |                                                       |   |                |
|                                                                                                     |   |                                            |   |                                                       |   |                |   |                                                 |   |                                                    |
|                                                                                                     |   |  

Class A

                          |   |  

Class B

                                     |   | Additional

Paid-in |
|                                                                                                     |   | Shares                                          |   | Amount                                                     |   | Shares              |   | Amount                                               |   | Capital                                                 |
| Balance at January 1, 2005                                                                               |   |  2,666,666                                 |   | $        114            |   | 12,056,124          |   | $        514      |   | $        37,083 |
| Stock options issued                                                                                     |   | -                                               |   | -                                                          |   | -                   |   | -                                                    |   | 197                                                     |
| Stock options exercised                                                                                  |   | -                                               |   | -                                                          |   | 79,547              |   | 4                                                    |   | 1,614                                                   |
| Balance at December 31, 2005                                                                             |   | 2,666,666                                       |   | 114                                                        |   | 12,135,671          |   | 518                                                  |   | 38,894                                                  |
| Stock options issued                                                                                     |   | -                                               |   | -                                                          |   | -                   |   | -                                                    |   | 20                                                      |
| Stock options exercised                                                                                  |   | -                                               |   | -                                                          |   | 349,534             |   | 15                                                   |   | 6,789                                                   |
| Treasury shares purchased                                                                                |   | (16,607)                                        |   | (1)                                                        |   | -                   |   | -                                                    |   | (11)                                                    |
| Balance at December 31, 2006                                                                             |   | 2,650,059                                       |   |        113              |   | 12,485,205          |   |    533                                |   |       45,692              |
| Stock options exercised                                                                                  |   | -                                               |   | -                                                          |   | 107,350             |   | 4                                                    |   | 2,207                                                   |
| Balance at December 31, 2007                                                                             |   | $ 2,650,059                                     |   | $         113 |   | 12,592,555          |   | $        537 |   | $        47,899 |

 

The        Company’s Class A and Class B common stock has a stated value of approximately $.04        per share.

Shareholders’ equity at December 31, 2007 includes $371,712        representing GAAP shareholder’s equity of insurance subsidiaries, of which $55,363        may be transferred by dividend or loan to the parent company during calendar year 2008 with        proper notification to, but without approval from, regulatory authorities. An additional        $233,951 of shareholder’s equity of such insurance subsidiaries may be advanced or        loaned to the parent company with prior notification to and approval from regulatory        authorities.

Net income        of the insurance subsidiaries, as determined in accordance with statutory accounting        practices, was $35,605, $26,632, and $18,221 for 2007, 2006 and 2005, respectively.        Consolidated statutory surplus for these subsidiaries was $360,965 and $343,974 at December        31, 2007 and 2006, respectively.

Minimum        statutory surplus necessary for the insurance subsidiaries to satisfy statutory risk based        capital requirements was $70,489 at December 31, 2007.

| **Note G - Other Operating Expenses**                                                       |   |                               |   |                      |   |                                        |   |                                   |
|---------------------------------------------------------------------------------------------|--------|------------------------------------|--------|---------------------------|--------|---------------------------------------------|--------|----------------------------------------|
|                                                                                        |   |                               |   |                      |   |                                        |   |                                   |
| Details of other operating expenses for the years ended                        December 31: |   |                               |   |                      |   |                                        |
|                                                                                        |   |                               |   |                      |   |                                        |   |                                   |
|                                                                                        |   |                               |   | **2007**                  |   | 2006                                        |   | 2005                                   |
| Amortization of deferred policy acquisition costs                                           |   |                               |   | **$   20,985**  |   | $   14,155                        |   | $      14,066 |
| Other underwriting expenses                                                                 |   |                               |   | **21,688**                |   | 18,789                                      |   | 17,656                                 |
| Expense allowances from reinsurers                                                          |   |                               |   | **(2,044)**               |   | (1,205)                                     |   | (7,806)                                |
| **Total underwriting expenses**                                                             |   | **40,629**                         |   | 31,739                    |   | 23,916                                      |
|                                                                                        |   |                               |   |                      |   |                                        |   |                                   |
| Operating expenses of non-insurance companies                                               |   |                               |   | **15,701**                |   | 15,716                                      |   | 15,691                                 |
| **Total other operating expenses**                                                          |   | **$**    **56,330** |   | $   47,455 |   | $      39,607 |

 

- 51        -

----

**Note H -        Employee Benefit Plans**

The Company        maintains a defined contribution 401(k) Employee Savings and Profit Sharing Plan        (“the Plan”) which covers all employees who have completed one year of service.        The Company’s contributions to the Plan for 2007, 2006 and 2005 were $1,132, $1,137,        and $1,093, respectively.

 

**Note I -        Stock Purchase and Option Plans**

In        accordance with the terms of the 1981 Stock Purchase Plan (1981 Plan), the Company is        obligated to repurchase shares issued under the 1981 Plan, at a price equal to 90% of the        book value of the shares at the end of the quarter immediately preceding the date of        repurchase. No shares have ever been repurchased under the 1981 Plan. At December 31, 2007        there were 158,503 shares (Class A) and 438,583 shares (Class B) outstanding which are        eligible for repurchase by the Company.

The Company        maintains two stock option plans which are described below. Compensation cost charged        against income for those plans was $0, $20, and $197, for 2007, 2006, and 2005,        respectively.

*Director        Option Plan:*

Under the        Director Option Plan (the Director Plan), which is shareholder approved, the Company has        reserved 300,000 shares of Class B common stock for the granting of discounted and market        value options to non-employee directors. Approximately 167,000 shares of Class B common        stock are available for future grants. No options were granted to directors during 2007 and        2006. Additionally, no discounted options were outstanding at December 31, 2007 and 2006.        Prior to May, 2005, discounted options were granted to non-employee directors in lieu of        cash directors’ fees. In addition, during 2005 non-employee directors were each        granted 1,500 options at market value on the date of grant as part of their regular annual        directors’ fees. During 2006, all market value options were terminated, without        compensation to the directors, and all subsequent directors’ fees have been paid in        cash. It is not anticipated that any additional grants will be made to directors under this        plan as part of their regular directors’ compensation.

The fair        value of the market value options granted during 2005 was determined using a        Black-Scholes-Merton option pricing model with the following assumptions: risk-free        interest rate of 3.0% and 1.0%, respectively; dividend yield of 1.6%; volatility factor of        the expected market price of the Company’s common stock of .30; and an expected life        of the option of 7 years.

The        weighted-average grant-date fair value of options granted during 2005 at prices below        market value was $25.10. The weighted-average grant-date fair value of options granted        during 2005 at market was $5.33. The total intrinsic value of options exercised during        2007, 2006 and 2005 was $0, $484, and $27, respectively.

*Employee        Option Plan:*

Under the        Employee Option Plan (the Employee Plan), which is shareholder approved, the Company has        reserved 1,125,000 shares of Class B common stock for the granting of discounted and market        value options to employees. Approximately 259,000 shares of Class B common stock are        available for future grants. No options were granted to employees during the three year        period ended December 31, 2007. Discounted options granted to employees in the past were        exercisable immediately. Market value options granted to employees in the past vested over        three years. All options expired ten years from the date of grant. No options remain        outstanding at December 31, 2007. During 2007 all options were exercised at $20.60 per        share.

A summary        of option activity under the Employee Plan as of December 31, 2007, and changes during the        year then ended is presented below:

 

|                                       |   |    |   | Aggregate                                                                                                |
|--------------------------------------------|--------|---------|--------|----------------------------------------------------------------------------------------------------------|
|                                       |   |    |   | Intrinsic                                                                                                |
|                                       |   | Options |   | Value ($000)                                                                                             |
|                                       |   |    |   |                                                                                                     |
| Outstanding at beginning of year           |   | 107,350 |   | $                                     - |
| Exercised                                  |   | 107,350 |   |                                                                                                     |
| Outstanding and exercisable at end of year |   | -       |   | $                                     - |

 

- 52        -

----

**Note I -        Stock Purchase and Option Plans (continued)**

The total        intrinsic value of options exercised during 2007, 2006 and 2005 was $722, $1,684, and $420,        respectively.

Cash        received from option exercise under all share-based payment arrangements for the years        ended December 31, 2007, 2006, and 2005 was $2,211 , $6,804, and $1,618, respectively. The        federal tax benefit realized for the tax deductions from option exercise of the share-based        payment arrangements totaled $253, $759, and $157, respectively, for the years ended        December 31, 2007, 2006, and 2005. Under the terms of the Employee Plan, $253, $589, and        $147, respectively, of tax benefits realized were passed on to employees in the form of        cash for the years ended December 31, 2007, 2006 and 2005.

The        Company’s policy is to issue new shares to satisfy share option exercises.

During 2002        and 2001, the Company offered loans to certain employees for the sole purpose of purchasing        the Company’s Class B common stock in the open market. Principal and interest        totaling $2,228 and $2,343 relating to such loans was outstanding at December 31, 2007 and        2006, respectively. Loans carry interest rates ranging from 4.75% to 6%, payable annually.        The underlying securities, with value in excess of the related debt, serve as collateral        for these full-recourse loans, which must be repaid no later than 10 years from the date of        issue. This loan program was terminated in 2002.

**Note J -        Reportable Segments**

The        Company and its consolidated subsidiaries market and underwrite casualty insurance in four        major specialty areas (reportable segments): (1) fleet trucking, (2) private passenger        automobile, (3) small fleet trucking and (4) the assumption of reinsurance. The fleet        trucking segment provides multiple line insurance coverage to large trucking fleets which        generally retain substantial amounts of self-insurance and to medium-sized trucking fleets        on a first dollar or small deductible basis. The private passenger automobile segment        provides motor vehicle liability and physical damage coverages to individuals. The small        fleet trucking segment provides commercial automobile coverages to small trucking fleets        and owner/operators. The reinsurance assumed segment accepts cessions from other insurance        companies as well as retrocessions from selected reinsurance companies, principally        reinsuring against catastrophes.

The        Company’s reportable segments are business units that operate in the        property/casualty insurance industry and each offers products to different classes of        customers. The reportable segments are managed separately due to the differences in        underwriting criteria used to market products to each class of customer and the methods of        distribution of the products each reportable segment provides. Segment information shown in        the table below as “all other” includes products provided by the Company to        assigned risks and residual markets as well as the runoff of discontinued product lines,        including small business workers’ compensation discontinued in the fourth quarter of        2004.

The Company        evaluates performance and allocates resources based on gain or loss from insurance        underwriting operations before income taxes. Underwriting gain or loss does not include net        investment income or gains or losses on the Company’s investment portfolio. All        investment-related revenues are managed at the corporate level. Underwriting gain or loss        for the fleet trucking segment includes revenue and expense from the Company’s agency        operations since the agency operations serve as an exclusive direct marketing facility for        this segment. Underwriting gain or loss also includes fee income generated by each segment        in the course of its underwriting operations. Management does not identify or allocate        assets to reportable segments when evaluating segment performance and depreciation expense        is not material for any of the reportable segments. The accounting policies of each        reportable segment are the same as those described in the summary of significant accounting        policies.

- 53        -

----

**Note J -        Reportable Segments (continued)**

The        following table provides certain profit and loss information for each reportable segment        for the years ended

December        31:

|                                    |   |   |   |   |   | **2007**                                                                                                                                                            |   | 2006                                                                                                    |   | 2005                                                                                                    |
|-----------------------------------------|--------|--------|--------|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------|
| **Direct and assumed premium written:** |   |   |   |   |   |                                                                                                                                                                |   |                                                                                                    |   |                                                                                                    |
| Fleet trucking                          |   |   |   |   |   | **                         $**                                  **134,723**                                  |   | $              124,044            |   | $              155,201            |
| Private passenger automobile            |   |   |   |   |   | **23,603**                                                                                                                                                          |   | 33,964                                                                                                  |   | 38,498                                                                                                  |
| Small fleet trucking                    |   |   |   |   |   | **17,796**                                                                                                                                                          |   | 26,091                                                                                                  |   | 15,631                                                                                                  |
| Reinsurance assumed                     |   |   |   |   |   | **26,334**                                                                                                                                                          |   | 12,726                                                                                                  |   | 11,519                                                                                                  |
| All Other                               |   |   |   |   |   | **                                              111** |   | 239                                                                                                     |   | 1,597                                                                                                   |
|                                    |   |   |   | Totals |   | **                         $**          **202,567**                                                          |   | $              197,064            |   | $              222,446            |
|                                    |   |   |   |   |   |                                                                                                                                                                |   |                                                                                                    |   |                                                                                                    |
| **Net premium earned and fee income:**  |   |   |   |   |   |                                                                                                                                                                |   |                                                                                                    |   |                                                                                                    |
| Fleet trucking                          |   |   |   |   |   | **                         $**           **108,231**                                                    |   | $              107,021            |   | $              123,101            |
| Private passenger automobile            |   |   |   |   |   | **31,068**                                                                                                                                                          |   | 38,590                                                                                                  |   | 42,818                                                                                                  |
| Small fleet trucking                    |   |   |   |   |   | **15,568**                                                                                                                                                          |   | 14,711                                                                                                  |   | 9,362                                                                                                   |
| Reinsurance assumed                     |   |   |   |   |   | **28,578**                                                                                                                                                          |   | 15,009                                                                                                  |   | 13,144                                                                                                  |
| All Other                               |   |   |   |   |   | **220**                                                                                                                                                             |   | 530                                                                                                     |   | 4,175                                                                                                   |
|                                    |   |   |   | Totals |   | **                         $**           **183,665**                                                    |   | $              175,861            |   | $              192,600            |
|                                    |   |   |   |   |   |                                                                                                                                                                |   |                                                                                                    |   |                                                                                                    |
| **Underwriting gain (loss)**            |   |   |   |   |   |                                                                                                                                                                |   |                                                                                                    |   |                                                                                                    |
| Fleet trucking                          |   |   |   |   |   | **                         $**                                     **24,373**                 |   | $                17,754 |   | $                25,658 |
| Private passenger automobile            |   |   |   |   |   | **1,896**                                                                                                                                                           |   | 2,737                                                                                                   |   | 5,131                                                                                                   |
| Small fleet trucking                    |   |   |   |   |   | **220**                                                                                                                                                             |   | (402)                                                                                                   |   | 380                                                                                                     |
| Reinsurance assumed                     |   |   |   |   |   | **5,554**                                                                                                                                                           |   | 6,933                                                                                                   |   | (8,292)                                                                                                 |
| All Other                               |   |   |   |   |   | **165**                                                                                                                                                             |   | (637)                                                                                                   |   | (417)                                                                                                   |
|                                    |   |   |   | Totals |   | **                         $**                                     **32,208**                 |   | $                26,385 |   | $                22,460 |

 

The above        amounts for voluntary reinsurance assumed include certain intersegment reinsurance        agreements. Intersegment premiums earned during 2007, 2006 and 2005 were $2,314, $2,283 and        $1,570, respectively. Intersegment losses and loss expenses incurred during 2007, 2006 and        2005 were $2,994, $3,005 and $1,595, respectively. Reinsurance assumed premium written for        2007 is shown net of $4,800 representing the cost of a retrocession limiting the        Company’s probable maximum loss on its assumed book of business.

- 54        -

----

**Note J -        Reportable Segments (continued)**

The        following tables are reconciliations of reportable segment revenues and profits to the        Company’s consolidated revenue and income before federal income taxes,        respectively.

 

|                              |                               |                       |                                                                                                                        |                                                                                                       |                                                                                              | **2007**                                                                                                                    |                                                                                              | 2006                                                                                              |   | 2005                                                                                              |
|-----------------------------------|------------------------------------|----------------------------|-----------------------------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------|
| **Revenue:**                      |                               |                       |                                                                                                                        |                                                                                                       |                                                                                              |                                                                                                                        |                                                                                              |                                                                                              |   |                                                                                              |
| Net premium earned and fee income |                               |                       |                                                                                                                        |                                                                                                       |                                                                                              | **$**                                    **183,665**            |                                                                                              | $             175,861            |   | $             192,600            |
| Net investment income             |                               |                       |                                                                                                                        |                                                                                                       |                                                                                              | **19,595**                                                                                                                  |                                                                                              | 19,548                                                                                            |   | 14,840                                                                                            |
| Net gains on investments          |                               |                       |                                                                                                                        |                                                                                                       |                                                                                              | **40,096**                                                                                                                  |                                                                                              | 17,064                                                                                            |   | 22,981                                                                                            |
| Other income                      |                               |                       |                                                                                                                        |                                                                                                       |                                                                                              | **407**                                                                                                                     |                                                                                              | 596                                                                                               |   | 483                                                                                               |
|                              |                               | Total consolidated revenue |                                                                                                                        | **$**                                   **243,763** |                                                                                              | $             213,069                                      |                                                                                              | $             230,904            |
|                              |                               |                       |                                                                                                                        |                                                                                                       |                                                                                              |                                                                                                                        |                                                                                              |                                                                                              |   |                                                                                              |
| **Profit:**                       |                               |                       |                                                                                                                        |                                                                                                       |                                                                                              |                                                                                                                        |                                                                                              |                                                                                              |   |                                                                                              |
| Underwriting gain                 |                               |                       |                                                                                                                        |                                                                                                       |                                                                                              | **$**                                      **32,208** |                                                                                              | $               26,385 |   | $               22,460 |
| Net investment income             |                               |                       |                                                                                                                        |                                                                                                       |                                                                                              | **19,595**                                                                                                                  |                                                                                              | 19,548                                                                                            |   | 14,840                                                                                            |
| Net gains on investments          |                               |                       |                                                                                                                        |                                                                                                       |                                                                                              | **40,096**                                                                                                                  |                                                                                              | 17,064                                                                                            |   | 22,981                                                                                            |
| Corporate expenses                |                               |                       |                                                                                                                        |                                                                                                       |                                                                                              | **(12,247)**                                                                                                                |                                                                                              | (9,987)                                                                                           |   | (9,490)                                                                                           |
| Interest expense                  |                               |                       |                                                                                                                        |                                                                                                       |                                                                                              | **-**                                                                                                                       |                                                                                              | -                                                                                                 |   | (116)                                                                                             |
|                              | Income before federal income taxes |                       | **$**                                      **79,652** |                                                                                                       | $               53,010 |                                                                                                                        | $               50,675 |

 

The        Company, through its subsidiaries, is licensed to do business in all 50 states of the        United States, all Canadian provinces and Bermuda. Canadian and Bermuda operations are        currently not significant.

One        customer of the fleet trucking segment represents approximately $93,852, $69,636 and        $62,570 of the Company’s consolidated direct and assumed premium written in 2007,        2006 and 2005, respectively.

**Note K -        Earnings Per Share**

The        following is a reconciliation of the denominators used in the calculation of basic and        diluted earnings per share for the years ended December 31:

 

|                                                                             |           |           |       |       |       | **2007**   |   | 2006   |   | 2005    |
|----------------------------------------------------------------------------------|----------------|----------------|------------|------------|------------|------------|--------|--------|--------|---------|
|                                                                             |           |           |       |       |       |       |   |   |   |    |
| Average share outstanding for basic earnings per                        share    |           | **15,175,074** |       | 15,004,377 |       | 14,753,133 |
|                                                                             |           |           |       |       |       |       |   |   |   |    |
| Dilutive effect of options                                                       |           |           |       |       |       | **14,269** |   | 43,094 |   | 109,554 |
|                                                                             |           |           |       |       |       |       |   |   |   |    |
| Average shares outstanding for diluted earnings per                        share | **15,189,343** |           | 15,047,471 |       | 14,862,687 |

 

 

Options to        purchase 35,422 shares of the Company’s Class B common stock were excluded in 2005        from the above reconciliation in that inclusion would have an anti-dilutive        effect.

- 55        -

----

**Note L -        Concentrations of Credit Risk**

 

The        Company writes policies of excess insurance attaching above a self-insured retention        (“SIR”) and also writes policies that contain large, per-claim deductibles.        Those losses and claims that fall within the SIR or deductible are obligations of the        insured. The Company also writes surety bonds in favor of various regulatory agencies        guaranteeing the insured’s payment of claims within the SIR. Losses and claims under        a large deductible policy are payable by the Company with reimbursement due the Company        from the insured. The Company requires collateral from its insureds to serve as a source of        reimbursement if the Company is obligated to pay claims within the SIR by reason of an        insured’s default or if the insured fails to reimburse the Company for deductible        amounts paid by the Company.

Acceptable        collateral may be provided in the form of letters of credit on Company approved banks,        Company approved marketable securities or cash. At December 31, 2007, the Company held        collateral in the aggregate amount of $230,464.

The amount        of collateral required of an insured is determined by the financial condition of the        insured, the type of obligations guaranteed by the Company, estimated reserves for incurred        losses within the SIR or deductible that have been reported to the insured or the Company,        estimated incurred but not reported losses, and estimates for losses that are expected to        occur, within the SIR or deductible, prior to the next collateral adjustment date. In        general, the Company attempts to hold collateral equal to 100% of the ultimate losses that        would be paid by or due the Company in the event of the insured’s default. Periodic        audits are conducted by the Company to evaluate its exposure and the collateral required.        If a deficiency in collateral is noted as the result of an audit, additional collateral is        requested immediately. Because collateral amounts contain numerous estimates of the        Company’s exposure, are adjusted only periodically and are sometimes adjusted based        on the financial condition of the insured, the amount of collateral held by the Company at        a given point in time may not be sufficient to fully reimburse the Company for all of its        guarantees or amounts due in the event of an insured’s default. Further, the Company        is not fully collateralized for the guarantees made for, or the deductible amounts that may        be due from, the Company’s largest customer, and in the event of that        customer’s default, such default may have a material adverse impact on the Company.        The Company estimates its uncollateralized exposure related to this Fortune 500 company to        be as much as 27% of shareholders’ equity at December 31, 2007.

In        addition, the Company’s balance sheet includes paid and unpaid amounts recoverable        from reinsurers under various agreements totaling $132,812 at December 31, 2007, as more        fully discussed in Note D - Reinsurance. With minor exception, these recoverables are        uncollateralized. The largest estimated amount due from a single reinsurer totaled $19,857        at December 31, 2007. Included in the total recoverable amount are case basis and estimated        IBNR losses of approximately $8,016 due from Converium Insurance (North America) Inc. and        $2,682 due from PMA Re., each of which reported substantial reserve strengthening and/or        impairment of assets in 2005 which have negatively affected their reported financial        positions. All amounts due from these reinsurers on paid claims as of December 31, 2007 are        current and the Company has no information at this time to indicate that all obligations of        these reinsurers will not be met.

Investments in limited partnerships include an aggregate of $58,380 invested        in three related partnerships, New Vernon India Fund, New Vernon Global Opportunity Fund        and New Vernon North American Opportunity Fund.

**Note M -        New Accounting Pronouncements**

In September 2006, the Financial Accounting Standards Board issued Statement        No. 157, “Fair Value Measurements” (“SFAS No. 157”), which provides        a common definition of fair value and establishes a framework to make the measurement of        fair value more consistent and comparable. SFAS No. 157 also requires expanded disclosures        about (1) the extent to which companies measure assets and liabilities at fair value, (2)        the methods and assumptions used to measure fair value and (3) the effect of fair value        measures on earnings. SFAS 157 is effective for financial assets and liabilities on January        1, 2008. The FASB has deferred the implementation of the provisions of SFAS 157 relating to        certain nonfinancial assets and liabilities until January 1, 2009. SFAS 157 is not expected        to have a significant impact on the Company’s consolidated financial condition or        results of operations.

 

- 56        -

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**Note M -        New Accounting Pronouncements (continued)**

 

In February        2007, the Financial Accounting Standards Board issued Statement No. 159, “The Fair        Value Option for Financial Assets and Liabilities — Including an Amendment of FASB        Statement No. 115,” to permit an entity to choose to measure many financial        instruments and certain other items at fair value. Most of the provisions in SFAS 159 are        elective; however the amendment to SFAS 115, “Accounting for Certain Investments in        Debt and Equity Securities,” applies to all entities with available-for-sale and        trading securities. The fair value option permits all entities to choose to measure        eligible items at fair value at specified election dates. The fair value option may be        applied on an instrument-by-instrument basis, is irrevocable and is to be applied to entire        instruments and not portions thereof. SFAS 159 is not expected to have a significant impact        on the Company’s consolidated financial condition or results of        operations.

In        December 2007, Financial Accounting Standards Board issued Statement No. 141        (revised 2007), “Business Combinations” (“SFAS No. 141(R)”).        SFAS No. 141(R) changes the requirements for an acquirer’s recognition and        measurement of the assets acquired and the liabilities assumed in a business combination.        SFAS No. 141(R) is effective for annual periods beginning after December 15, 2008        and should be applied prospectively for all business combinations entered into after the        date of adoption. SFAS 141(R) is not expected to have a significant impact on the        Company’s consolidated financial condition or results of operations.

 

| **Note N - Quarterly Results of Operations                        (Unaudited)** |   |                                                               |   |                                                               |   |                                                               |   |                                                    |   |                                                       |   |
|---------------------------------------------------------------------------------|--------|--------------------------------------------------------------------|--------|--------------------------------------------------------------------|--------|--------------------------------------------------------------------|--------|---------------------------------------------------------|--------|------------------------------------------------------------|--------|
| Quarterly results of operations are as follows:                                 |   |                                                               |   |                                                               |   |                                                               |   |                                                    |   |                                                       |   |   |
|                                                                            |   |                                                               |   |                                                               |   |                                                               |   | Results by Quarter                                      |   |                                                       |   |   |   |   |
|                                                                            |   |                                                               |   | **2007**                                                           |   |                                                               |   |                                                    |   | 2006                                                       |   |   |
|                                                                            |   | **1st**                                                            |   | **2nd**                                                            |   | **3rd**                                                            |   | **4th**                                                 |   | 1st                                                        |   | 2nd |   | 3rd |   | 4th |
|                                                                            |   |                                                               |   |                                                               |   |                                                               |   |                                                    |   |                                                       |   |   |   |   |   |   |
| Net premiums earned                                                             |   | **$**   **44,175**                                  |   | **$**   **44,817**                                  |   | **$**   **44,601**                                  |   | **$**   **45,472**                       |   | $   43,218                                  |   | $   42,163 |   | $   42,333 |   | $   42,052 |
| Net investment income                                                           |   | **4,846**                                                          |   | **4,882**                                                          |   | **5,040**                                                          |   | **4,827**                                               |   | 4,559                                                      |   | 4,736 |   | 5,140 |   | 5,113 |
| Net gains (losses) on investments                                               |   | **474**                                                            |   | **8,772**                                                          |   | **6,421**                                                          |   | **24,429**                                              |   | 7,014                                                      |   | (1,135) |   | 2,958 |   | 8,227 |
| Losses and loss expenses incurred                                               |   | **26,892**                                                         |   | **24,493**                                                         |   | **24,949**                                                         |   | **31,447**                                              |   | 28,939                                                     |   | 27,717 |   | 25,837 |   | 30,111 |
|                                                                            |   |                                                               |   |                                                               |   |                                                               |   |                                                    |   |                                                       |   |   |   |   |   |   |
| Net income                                                                      |   | **8,211**                                                          |   | **14,792**                                                         |   | **11,714**                                                         |   | **20,414**                                              |   | 11,556                                                     |   | 5,427 |   | 9,879 |   | 11,323 |
|                                                                            |   |                                                               |   |                                                               |   |                                                               |   |                                                    |   |                                                       |   |   |   |   |   |   |
| Per share - diluted:                                                            |   |                                                               |   |                                                               |   |                                                               |   |                                                    |   |                                                       |   |   |   |   |   |   |
| Net income                                                                      |   | **$**         **.54** |   | **$**         **.98** |   | **$**         **.77** |   | **$**       **1.34** |   | $         .78 |   | $         .36 |   | $         .65 |   | $         .75 |

 

- 57        -

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**Item 9.        CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON**

|   | **ACCOUNTING AND FINANCIAL DISCLOSURE** |
|--------|-----------------------------------------|

 

No response        to this item is required.

 

**Item        9A.****CONTROLS AND PROCEDURES**

 

The        Company’s management, under the direction of our Chief Executive Officer        (“CEO”) and Chief Financial Officer (“CFO”), has performed an        evaluation of its disclosure controls and procedures (as defined by Exchange Act rules        13a-15(e) and 15d-15(e)) within 90 days of the date of the filing of this report. Based on        this evaluation, the Company’s CEO and CFO have concluded that the Company’s        disclosure controls and procedures were effective in ensuring that information required to        be disclosed by the company is recorded, processed, summarized, and reported within the        time periods specified in the SEC’s rules and forms. In addition, there have not been        any significant changes in internal controls or other factors that could significantly        affect internal controls subsequent to the date of the company’s most recent        evaluation.

 

***Management’s Responsibility For Financial        Statements***

Management        is responsible for the preparation of the Company’s consolidated financial statements        and related information appearing in this report. Management believes that the consolidated        financial statements fairly reflect the form and substance of transactions and that the        financial statements reasonably present the Company’s financial position and results        of operations in conformity with generally accepted accounting principles. Management has        included in the Company’s financial statements amounts that are based upon estimates        and judgments which it believes are reasonable under the circumstances.

Ernst &        Young LLP, an independent registered public accounting firm, audits the Company’s        consolidated financial statements in accordance with the standards of the Public Company        Accounting Oversight Board and provides an objective, independent review of the fairness of        reported operating results and financial position.

The Board        of Directors of the Company has an Audit Committee composed of three non-management        Directors. The committee meets periodically with financial management, the internal        auditors and the independent registered public accounting firm to review accounting,        control, auditing and financial reporting matters.

***Management’s Report on Internal Control Over Financial        Reporting***

The        Company’s management is responsible for establishing and maintaining adequate        internal control over financial reporting, as such term is defined in Exchange Act Rules        13a-15(f) and 15d-15(f). Under the supervision and with the participation of management,        including the chief executive officer and the chief financial officer, the Company        conducted an evaluation of the effectiveness of its internal control over financial        reporting based on the framework in Internal Control – Integrated Framework issued by        the Committee of Sponsoring Organizations of the Treadway Commission. Based on our        evaluation under this framework, management concluded that the Company’s internal        control over financial reporting was effective as of December 31, 2007. The effectiveness        of the Company’s internal control over financial reporting as of December 31, 2007        has been audited by Ernst & Young LLP, an independent registered public accounting        firm, as stated in their report which is included herein.

 

- 58        -

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***REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING        FIRM***

 

The Board        of Directors and Shareholders of

Baldwin        & Lyons, Inc.

We have        audited Baldwin & Lyons, Inc.’s internal control over financial reporting as of        December 31, 2007, based on criteria established in Internal Control – Integrated        Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission        (the “COSO criteria”). Baldwin & Lyons, Inc.’s management is        responsible for maintaining effective internal control over financial reporting, and for        its assessment of the effectiveness of internal control over financial reporting included        in the accompanying Management’s Report on Internal Control Over Financial Reporting.        Our responsibility is to express an opinion on the company’s internal control over        financial reporting based on our audit.

We        conducted our audit in accordance with the standards of the Public Company Accounting        Oversight Board (United States). Those standards require that we plan and perform the audit        to obtain reasonable assurance about whether effective internal control over financial        reporting was maintained in all material respects. Our audit included obtaining an        understanding of internal control over financial reporting, assessing the risk that a        material weakness exists, testing and evaluating the design and operating effectiveness of        internal control based on the assessed risk, and performing such other procedures as we        considered necessary in the circumstances. We believe that our audit provides a reasonable        basis for our opinion.

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 (1) pertain to the maintenance of records that, in        reasonable detail, accurately and fairly reflect the transactions and dispositions of the        assets of the company; (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 of the company are being        made only in accordance with authorizations of management and 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 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.

In our        opinion, Baldwin & Lyons, Inc. maintained, in all material respects, effective internal        control over financial reporting as of December 31, 2007, based on the COSO        criteria.

We also        have audited, in accordance with the standards of the Public Company Accounting Oversight        Board (United States), the consolidated balance sheets of Baldwin & Lyons, Inc. and        subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of        income, changes in equity other than capital, and cash flows for each of the three years in        the period ended December 31, 2007, and our report dated March 12, 2008 expressed an        unqualified opinion thereon.

 

/s/ ERNST        & YOUNG LLP

Indianapolis, Indiana

March 12,        2008

 

- 59        -

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**PART III**

 

**Item        10.****DIRECTORS AND EXECUTIVE OFFICERS OF THE        REGISTRANT**

 

The        information with respect to the directors of the Registrant to be provided under this item        is omitted from this Report because the Registrant will file with the Commission a        definitive proxy statement pursuant to Regulation 14A involving the election of directors        not later than 120 days after the close of its fiscal year.

 

The        information required by Item 10 of this Report with respect to directors which will appear        in the definitive proxy statement is incorporated by reference herein.

 

The        executive officers of the Company will serve until the next annual meeting of the Board of        Directors and until their respective successors are elected and qualified. Except as        otherwise indicated, the occupation of each officer during the past five years has been in        his current position with the Company.

 

The        following summary sets forth certain information concerning the Company’s executive        officers:

 

|   |   Served in |
|--------|------------------|

|   |    Such Capacity |
|--------|----------------------------|

|   | Name |        Age |                                      Title |    Since |
|--------|------|------------------------------------------|-------------------------------------------------------------------------------------------------------------|--------------------|

 

| Gary W. Miller | 67 | Chairman and CEO | 1997 |
|----------------|----|------------------|------|

| Joseph J. DeVito | 56 | President and COO | 2007 (1) |
|------------------|----|-------------------|----------|

| G. Patrick Corydon | 59 | Senior Vice President and CFO | 1979 (2) |
|--------------------|----|-------------------------------|----------|

| James E. Kirschner | 61 | Senior Vice President and Secretary | 1977 (2) (3) |
|--------------------|----|-------------------------------------|--------------|

| Mark L. Bonini | 49 | Vice President | 2001 |
|----------------|----|----------------|------|

 

(1)   Mr. DeVito was elected President and Chief Operating        Officer in February, 2007. He was elected Executive Vice President in 2001 and has served        in similar capacity since 1986.

(2)   Mr. Corydon and Mr. Kirschner were each elected        Senior Vice President in 2001.

|   | (3) | Mr. Kirschner was elected Secretary of the Company in                        1985. |
|--------|-----|-----------------------------------------------------------------------------------------|

 

**Item        11.****EXECUTIVE        COMPENSATION*******

 

**Item 12.        SECURITY OWNERSHIP OF CERTAIN BENEFICIAL**

|   | **OWNERS AND                        MANAGEMENT******* |
|--------|-------------------------------------------------------|

 

**Item        13.****CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS AND        DIRECTOR** 

|   | **INDEPENDENCE******* |
|--------|-----------------------|

 

**Item        14.****PRINCIPAL ACCOUNTANT FEES AND        SERVICES*******

 

*****The information to be provided under Items        11, 12, 13 and 14 is omitted from this Report because the Registrant will file with the        Commission a definitive proxy statement pursuant to Regulation 14A involving the election        of directors not later than 120 days after the close of its fiscal year. The information        required by these items of this Report which will appear in the definitive proxy statement        is incorporated by reference herein.

 

- 60        -

----

**PART IV**

 

**Item        15.****EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON        FORM 8-K**

 

| (a) | 1.                                    List                        of Financial Statements--The following consolidated financial statements of                        the registrant and its subsidiaries (including the Report of Independent                        Registered Public Accounting Firm) are submitted in Item 8 of this                        report. |
|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | Consolidated Balance Sheets - December 31, 2007 and                        2006 |
|--------|---------------------------------------------------------------------------------|

 

|   | Consolidated Statements of Income and Retained Earnings -                        Years ended |
|--------|----------------------------------------------------------------------------------------------|

|   | December 31, 2007, 2006 and 2005 |
|--------|----------------------------------|

 

|   | Consolidated Statements of Changes in Equity Other Than                        Capital - Years |
|--------|------------------------------------------------------------------------------------------------|

|   | ended December 31, 2007, 2006 and 2005 |
|--------|----------------------------------------|

 

|   | Consolidated Statements of Cash Flows - Years ended December                        31, |
|--------|-----------------------------------------------------------------------------------------|

|   | 2007, 2006 and 2005 |
|--------|---------------------|

 

|   | Notes to Consolidated Financial Statements |
|--------|--------------------------------------------|

 

|   | 2. | List of Financial Statement Schedules--The following                        consolidated financial statement |
|--------|----|--------------------------------------------------------------------------------------------------------------|

|   | schedules of Baldwin & Lyons, Inc. and subsidiaries are                        included in Item 15(d): |
|--------|------------------------------------------------------------------------------------------------------------|

 

|   | Pursuant to Article 7: |
|--------|------------------------|

 

|   | Schedule I--Summary of Investments--Other than                        Investments |
|--------|-----------------------------------------------------------------------------------|

|   | in Related Parties |
|--------|--------------------|

 

|   | Schedule II--Condensed Financial Information of the                        Registrant |
|--------|---------------------------------------------------------------------------------------|

 

|   | Schedule III--Supplementary Insurance Information |
|--------|---------------------------------------------------|

 

|   | Schedule IV--Reinsurance |
|--------|--------------------------|

 

|   | Schedule VI--Supplemental Information Concerning                        Property/Casualty |
|--------|-------------------------------------------------------------------------------------------|

|   | Insurance Operations |
|--------|----------------------|

 

All other        schedules to the consolidated financial statements required by Article 7 and Article 5 of        Regulation S-X are not required under the related instructions or are inapplicable and        therefore have been omitted.

 

- 61        -

----

 

3. Listing of Exhibits:

 

|   | Number & Caption |
|--------|----------------------|

   from Exhibit Table of

  Item 601 of Regulation

|   | S-K | Exhibit Number and Description |
|--------|-----|--------------------------------|

 

|   | (3) | EXHIBIT 3(i)-- |
|--------|-----|----------------|

|   | (Articles of Incorpor- | Articles of Incorporation of Baldwin & Lyons,                        Inc., |
|--------|------------------------|--------------------------------------------------------------------------------|

|   | ation & By Laws) | as amended (Incorporated as an exhibit by                        reference |
|--------|----------------------|----------------------------------------------------------------------------|

|   | to Exhibit 3(a) to the Company’s Annual Report                        on |
|--------|--------------------------------------------------------------------------------|

|   | Form 10-K for the year ended December 31, 1986) |
|--------|-------------------------------------------------|

 

 

|   | EXHIBIT 3(ii)-- |
|--------|-----------------|

|   | By-Laws of Baldwin & Lyons, Inc., as restated |
|--------|---------------------------------------------------|

|   | (Incorporated as an exhibit by reference to                        Exhibit |
|--------|----------------------------------------------------------------------------|

|   | 99.1 to the Company’s Current Report on Form                        8-K |
|--------|-------------------------------------------------------------------------------|

|   | dated May 4, 2004) |
|--------|--------------------|

 

 

|   | (10) | EXHIBIT 10(a)-- |
|--------|------|-----------------|

|   | (Material Contracts) | 1981 Employee Stock Purchase Plan (Incorporated |
|--------|----------------------|-------------------------------------------------|

|   | as an exhibit by reference to Exhibit A to the |
|--------|------------------------------------------------|

|   | Company’s definitive Proxy Statement for its                        Annual |
|--------|----------------------------------------------------------------------------------|

|   | Meeting held May 5, 1981) |
|--------|---------------------------|

 

 

|   | EXHIBIT 10(b)-- |
|--------|-----------------|

|   | Baldwin & Lyons, Inc. Employee Discounted                        Stock |
|--------|----------------------------------------------------------------------------|

|   | Option Plan (Incorporated as an exhibit by                        reference |
|--------|-----------------------------------------------------------------------------|

|   | to Appendix A to the Company’s definitive                        Proxy |
|--------|------------------------------------------------------------------------------|

|   | Statement for its Annual Meeting held May 2,                        1989) |
|--------|---------------------------------------------------------------------------|

|   | EXHIBIT 10(c)-- |
|--------|-----------------|

|   | Baldwin & Lyons, Inc. Deferred Directors Fee Option                            Plan(Incorporated as an                            exhibit by reference to Exhibit 10(f) to the                            Company’s AnnualReport on Form 10-K for the year endedDecember 31, 1989) |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

 

|   | EXHIBIT 10(d)-- |
|--------|-----------------|

|   | Baldwin & Lyons, Inc. Amended Employee                                Discounted Stock Option                                Plan (Incorporated as an exhibit by reference to Exhibit 10(f) to                                the Company’s Annual Report on Form 10-K for the year ended                                December 31, 1992) |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

----

|   | Number & Caption |
|--------|----------------------|

    from Exhibit Table of

   Item 601 of Regulation

|   | S-K | Exhibit Number and Description |
|--------|-----|--------------------------------|

 

| EXHIBIT 10(e)-- |
|-----------------|

|   | Baldwin & Lyons, Inc. Restated Employee Discounted Stock                        Option Plan. (Incorporated as an exhibit by reference to Exhibit 10(f) to                        the Company’s Annual Report on Form 10-K for the year ended December                        31, 1997) |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | (11) | EXHIBIT 11-- |
|--------|------|--------------|

|   |       (Statement                        regarding | Computation of Per Share Earnings |
|--------|----------------------------------------------------------------------------|-----------------------------------|

      computation of per

      share earnings)

 

|   | (14) |                                                                                 EXHIBIT 14— |
|--------|------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   |       (Code of                        ethics)  |                                          Code                        of Business Conduct of Baldwin & Lyons, Inc. (Incorporated                        as

                                                                an exhibit by reference to Exhibit 14 to the Company’s                        Annual Report   

                                         on                         Form 10-K for the year ended December 31,                        2005)                                                                              |
|--------|------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | (21) | EXHIBIT 21-- |
|--------|------|--------------|

|   | (Subsidiaries of the | Subsidiaries of Baldwin & Lyons, Inc. |
|--------|----------------------|-------------------------------------------|

     registrant)

 

|   | (23) | EXHIBIT 23-- |
|--------|------|--------------|

|   | (Consents of experts | Consent of Ernst & Young LLP |
|--------|----------------------|----------------------------------|

     and counsel)

 

|   | (24) | EXHIBIT 24-- |
|--------|------|--------------|

|   | (Powers of Attorney) | Powers of Attorney for certain Officers and                        Directors |
|--------|----------------------|------------------------------------------------------------------------------|

 

|   | (31) | EXHIBIT 31.1 |
|--------|------|--------------|

|   | (Certification) | Certification of CEO pursuant to Section 302 of the                        Sarbanes- |
|--------|-----------------|--------------------------------------------------------------------------------------|

|   | Oxley Act |
|--------|-----------|

 

|   | EXHIBIT 31.2 |
|--------|--------------|

|   | Certification of CFO pursuant to Section 302 of the                        Sarbanes- |
|--------|--------------------------------------------------------------------------------------|

|   | Oxley Act |
|--------|-----------|

 

 

|   | (32) | EXHIBIT 32.1 |
|--------|------|--------------|

|   | (Certification) | Certification of CEO pursuant to Section 906 of the                        Sarbanes- |
|--------|-----------------|--------------------------------------------------------------------------------------|

|   | Oxley Act and 18 U.S.C. 1350 |
|--------|------------------------------|

 

|   | EXHIBIT 32.2 |
|--------|--------------|

|   | Certification of CFO pursuant to Section 906 of the                        Sarbanes- |
|--------|--------------------------------------------------------------------------------------|

|   | Oxley Act and 18 U.S.C. 1350 |
|--------|------------------------------|

 

| (b) | A report on Form 8-K was filed by the Company in the fourth                        quarter of 2007 to announce its third quarter earnings press                        release. |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

 

- 63        -

----

| (c) | Exhibits. The response to this portion of Item 15 is                        submitted as a separate section of this report. |
|-----|-----------------------------------------------------------------------------------------------------------------------------|

 

| (d) | Financial Statement Schedules. The response to this portion                        of Item 15 is submitted on pages 65 through 71 of this report. |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------|

 

- 64        -

----

 

| **SCHEDULE I -- SUMMARY OF INVESTMENTS-**      |
|------------------------------------------------|
| **OTHER THAN INVESTMENTS IN RELATED PARTIES**  |
|                                           |   |   |   |   |   |   |
| **Form 10-K - Year Ended December 31, 2007**   |
| **Baldwin & Lyons, Inc. and Subsidiaries** |
|                                           |   |   |   |   |   |   |
| Column A                                       |   | Column B |   | Column C |   | Column D |
| *(Dollars in thousands)*                       |   |   |   |   |   |   |
|                                           |   |   |   |   |   | Amount At |
|                                           |   |   |   |   |   | Which Shown |
|                                           |   |   |   | Fair |   | In The Balance |
| Type of Investment                             |   | Cost |   | Value |   | Sheet (A) |
|                                           |   |   |   |   |   |   |
| Fixed Maturities:                              |   |   |   |   |   |   |
| Bonds:                                         |   |   |   |   |   |   |
| United States government and                   |   |   |   |   |   |   |
| government agencies and                        |   |   |   |   |   |   |
| authorities                                    |   | $    27,222 |   | $    27,484 |   | $    27,484 |
| Mortgage backed securities                     |   | 16,226 |   | 16,153 |   | 16,153 |
| States, municipalities and                     |   |   |   |   |   |   |
| political subdivisions                         |   | 278,752 |   | 280,665 |   | 280,665 |
| Foreign governments                            |   | 7,868 |   | 7,918 |   | 7,918 |
| Public utilities                               |   | 250 |   | 250 |   | 250 |
| All other corporate bonds                      |   | 5,446 |   | 5,541 |   | 5,541 |
| Total fixed maturities                         |   | 335,764 |   | 338,011 |   | 338,011 |
|                                           |   |   |   |   |   |   |
| Equity Securities:                             |   |   |   |   |   |   |
| Common Stocks:                                 |   |   |   |   |   |   |
| Banks, trust and insurance                     |   |   |   |   |   |   |
| companies                                      |   | 5,876 |   | 17,387 |   | 17,387 |
| Industrial, miscellaneous                      |   |   |   |   |   |   |
| and all other                                  |   | 39,375 |   | 82,349 |   | 82,349 |
| Total equity securities                        |   | 45,251 |   | 99,736 |   | 99,736 |
|                                           |   |   |   |   |   |   |
| Limited partnerships                           |   | 80,884 |   | 80,884 |   | 80,884 |
|                                           |   |   |   |   |   |   |
| Short-term:                                    |   |   |   |   |   |   |
| Certificates of deposit                        |   | 2,871 |   | 2,871 |   | 2,871 |
| Commercial paper                               |   | 41,897 |   | 41,897 |   | 41,897 |
| Total short-term and other                     |   | 44,768 |   | 44,768 |   | 44,768 |
| Total investments                              |   | $ 506,667 |   | $ 563,399 |   | $  563,399 |
|                                           |   |   |   |   |   |   |

(A) All securities listed are considered available-for-sale and,        accordingly, are presented at fair value in the financial statements.

Investments presented above do not include $87,140 of money market funds        classified with cash and cash equivalents in the balance sheet.

 

- 65        -

----

 

| **SCHEDULE II**                                                          |
|--------------------------------------------------------------------------|
| **CONDENSED FINANCIAL INFORMATION OF                        REGISTRANT** |
|                                                                     |   |   |   |   |
| **Form 10-K - Year Ended December 31, 2007**                             |
| **Baldwin & Lyons, Inc.**                                            |
|                                                                     |   |   |   |   |
| **Condensed Balance Sheet**                                              |   |   |   |   |
|                                                                     |   | December 31 |
|                                                                     |   | **2007** |   | 2006 |
| **Assets**                                                               |   |   |   |   |
| Investment in subsidiaries                                               |   | **$**         **370,371** |   | $          345,963 |
| Due from affiliates                                                      |   | **3,798** |   | 3,041 |
| Investments other than subsidiaries:                                     |   |   |   |   |
| Fixed maturities                                                         |   | **10,116** |   | 9,594 |
| Limited partnerships                                                     |   | **1,267** |   | 2,020 |
| Short-term                                                               |   | **-** |   | 9,890 |
|                                                                     |   | **11,383** |   | 21,504 |
| Cash and cash equivalents                                                |   | **11,514** |   | 16,110 |
| Accounts receivable                                                      |   | **7,280** |   | 12,248 |
| Notes receivable from employees                                          |   | **2,228** |   | 2,343 |
| Other assets                                                             |   | **6,198** |   | 3,596 |
| **Total assets**                                                         |   | **$**         **412,772** |   | $          404,805 |
|                                                                     |   |   |   |   |
| **Liabilities and shareholders' equity**                                 |   |   |   |   |
| *Liabilities:*                                                           |   |   |   |   |
| Premiums payable                                                         |   | **$**            **15,202** |   | $             29,453 |
| Deposits from insureds                                                   |   | **11,677** |   | 13,359 |
| Current payable federal income taxes                                     |   | **-** |   | 62 |
| Other liabilities                                                        |   | **5,175** |   | 4,304 |
|                                                                     |   | **32,054** |   | 47,178 |
|                                                                     |   |   |   |   |
| *Shareholders' equity:*                                                  |   |   |   |   |
| Common stock:                                                            |   |   |   |   |
| Class A                                                                  |   | **113** |   | 113 |
| Class B                                                                  |   | **537** |   | 533 |
| Additional paid-in capital                                               |   | **47,899** |   | 45,692 |
| Unrealized net gains on investments                                      |   | **36,876** |   | 47,229 |
| Retained earnings                                                        |   | **295,293** |   | 264,060 |
|                                                                     |   | **380,718** |   | 357,627 |
| **Total liabilities and shareholders' equity**                           |   | **$**         **412,772** |   | $          404,805 |
|                                                                     |   |   |   |   |
| *See notes to condensed financial                        statements*     |   |   |   |   |

 

- 66        -

----

 

| **SCHEDULE II**                                                          |
|--------------------------------------------------------------------------|
| **CONDENSED FINANCIAL INFORMATION OF                        REGISTRANT** |
|                                                                     |   |   |   |   |   |   |
| **Form 10-K - Year Ended December 31, 2007**                             |
| **Baldwin & Lyons, Inc.**                                            |
|                                                                     |   |   |   |   |   |   |
| **Condensed Statements of Income**                                       |   |   |   |   |   |   |
|                                                                     |   | Year Ended December 31 |
|                                                                     |   | **2007** |   | 2006 |   | 2005 |
| **Revenue:**                                                             |   |   |   |   |   |   |
| Commissions and service fees                                             |   | **$**            **16,514** |   | $             15,024 |   | $             18,640 |
| Dividends from subsidiaries                                              |   | **20,000** |   | 32,500 |   | 10,000 |
| Net investment income                                                    |   | **1,082** |   | 1,741 |   | 1,339 |
| Net gains (losses) on investments                                        |   | **(58)** |   | 278 |   | 5,632 |
| Other                                                                    |   | **1,576** |   | 135 |   | 103 |
|                                                                     |   | **39,114** |   | 49,678 |   | 35,714 |
|                                                                     |   |   |   |   |   |   |
| **Expenses:**                                                            |   |   |   |   |   |   |
| Salary and related items                                                 |   | **13,337** |   | 11,426 |   | 10,672 |
| Other                                                                    |   | **3,632** |   | 3,810 |   | 4,683 |
|                                                                     |   | **16,969** |   | 15,236 |   | 15,355 |
| **Income before federal income taxes**                                   |   |   |   |   |   |   |
| **and equity in undistributed**                                          |   |   |   |   |   |   |
| **income of subsidiaries**                                               |   | **22,145** |   | 34,442 |   | 20,359 |
| Federal income taxes                                                     |   | **687** |   | 95 |   | 3,551 |
|                                                                     |   | **21,458** |   | 34,347 |   | 16,808 |
| Equity in undistributed income                                           |   |   |   |   |   |   |
| of subsidiaries                                                          |   | **33,673** |   | 3,838 |   | 17,415 |
| **Net income**                                                           |   | **$**            **55,131** |   | $             38,185 |   | $             34,223 |
|                                                                     |   |   |   |   |   |   |
| *See notes to condensed financial                        statements*     |   |   |   |   |   |   |

 

- 67        -

----

 

| **SCHEDULE II**                                                                |
|--------------------------------------------------------------------------------|
| **CONDENSED FINANCIAL INFORMATION OF                        REGISTRANT**       |
|                                                                           |   |   |   |   |   |   |
| **Form 10-K - Year Ended December 31, 2007**                                   |
| **Baldwin & Lyons, Inc.**                                                  |
|                                                                           |   |   |   |   |   |   |
| **Condensed Statements of Cash Flows**                                         |   |   |   |   |   |   |
|                                                                           |   | Year Ended December 31 |
|                                                                           |   | **2007** |   | 2006 |   | 2005 |
|                                                                           |   |   |   |   |   |   |
| **Net cash provided by (used in) operating                        activities** |   | **$**              **9,371** |   | $             21,299 |   | ($ 493) |
|                                                                           |   |   |   |   |   |   |
| **Investing activities:**                                                      |   |   |   |   |   |   |
| Purchases of long-term investments                                             |   | **(9,781)** |   | (16,184) |   | (3,047) |
| Sales or maturities of long-term investments                                   |   | **9,331** |   | 13,298 |   | 9,965 |
| Net sales of short-term investments                                            |   | **9,890** |   | 4,975 |   | 5,096 |
| Decrease in notes receivable from employees                                    |   | **110** |   | 15 |   | 169 |
| Distributions from limited partnerships                                        |   | **683** |   | 2,599 |   | 1,633 |
| Net purchases of property and equipment                                        |   | **(2,274)** |   | (824) |   | (544) |
| Other                                                                          |   | **925** |   | 111 |   | 199 |
| **Net cash provided by investing activities**                                  |   | **8,884** |   | 3,990 |   | 13,471 |
|                                                                           |   |   |   |   |   |   |
| **Financing activities:**                                                      |   |   |   |   |   |   |
| Dividends paid to shareholders                                                 |   | **(25,062)** |   | (38,435) |   | (14,029) |
| Repayment on line of credit                                                    |   | **-** |   | - |   | (6,000) |
| Stock option exercises and other                                               |   | **2,211** |   | 6,804 |   | 1,618 |
| Cost of treasury shares                                                        |   | - |   | (401) |   | - |
| **Net cash used in financing activities**                                      |   | **(22,851)** |   | (32,032) |   | (18,411) |
| **Increase (decrease) in cash and cash                        equivalents**    |   | **(4,596)** |   | (6,743) |   | (5,433) |
| Cash and cash equivalents at beginning of year                                 |   | **16,110** |   | 22,853 |   | 28,286 |
| **Cash and cash equivalents at end of year**                                   |   | **$**            **11,514** |   | $             16,110 |   | $               22,853 |
|                                                                           |   |   |   |   |   |   |
| *See notes to condensed financial                        statements*           |   |   |   |   |   |   |

 

- 68        -

----

 

|                                                                                                                                                                                                                 |   |               |   |                    |   |     |   |       |   |     |   |       |   |       |   |         |   |      |   |     |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|--------|-------------------------|--------|----------|--------|------------|--------|----------|--------|------------|--------|------------|--------|--------------|--------|-----------|--------|----------|
| **SCHEDULE III -- SUPPLEMENTARY INSURANCE                        INFORMATION**                                                                                                                                       |
|                                                                                                                                                                                                                 |   |               |   |                    |   |     |   |       |   |     |   |       |   |       |   |         |   |      |   |     |
| **Form 10-K - Year Ended December 31, 2007**                                                                                                                                                                         |
| **Baldwin & Lyons, Inc. and Subsidiaries**                                                                                                                                                                       |
|                                                                                                                                                                                                                 |   |               |   |                    |   |     |   |       |   |     |   |       |   |       |   |         |   |      |   |     |
| (Dollars in thousands)                                                                                                                                                                                               |
|                                                                                                                                                                                                                 |   |               |   |                    |   |     |   |       |   |     |   |       |   |       |   |         |   |      |   |     |
| Column A                                                                                                                                                                                                             |   | Column B           |   | Column C                |   | Column D |   | Column E   |   | Column F |   | Column G   |   | Column H   |   | Column I     |   | Column J  |   | Column K |
|                                                                                                                                                                                                                 |   |               |   |                    |   |     |   |       |   |     |   |       |   |       |   |         |   |      |   |     |
|                                                                                                                                                                                                                 |   |               |   |                    |   |     |   |       |   |     |   |       |   |       |   |         |   |      |   |     |
|                                                                                                                                                                                                                 |   | As of December 31, |   | Year Ended December 31, |
|                                                                                                                                                                                                                 |   |               |   | Reserves                |   |     |   |       |   |     |   |       |   |       |   |         |   |      |   |     |
|                                                                                                                                                                                                                 |   |               |   | for Unpaid              |   |     |   | Other      |   |     |   |       |   | Benefits,  |   | Amortization |   |      |   |     |
|                                                                                                                                                                                                                 |   | Deferred           |   | Claims                  |   |     |   | Policy     |   |     |   |       |   | Claims,    |   | of Deferred  |   |      |   |     |
|                                                                                                                                                                                                                 |   | Policy             |   | and Claim               |   |     |   | Claims and |   | Net      |   | Net        |   | Losses and |   | Policy       |   | Other     |   | Net      |
|                                                                                                                                                                                                                 |   | Acquisition        |   | Adjustment              |   | Unearned |   | Benefits   |   | Premium  |   | Investment |   | Settlement |   | Acquisition  |   | Operating |   | Premiums |
| Segment                                                                                                                                                                                                              |   | Costs              |   | Expenses                |   | Premiums |   | Payable    |   | Earned   |   | Income     |   | Expenses   |   | Costs        |   | Expenses  |   | Written  |
|                                                                                                                                                                                                                 |   |               |   |                    |   |     |   |       |   |     |   | (A)        |   | (A)        |   |         |   | (A) (B)   |   |     |
| Property/Casualty                                                                                                                                                                                                    |   |               |   |                    |   |     |   |       |   |     |   |       |   |       |   |         |   |      |   |     |
| Insurance                                                                                                                                                                                                            |   |               |   |                    |   |     |   |       |   |     |   |       |   |       |   |         |   |      |   |     |
|                                                                                                                                                                                                                 |   |               |   |                    |   |     |   |       |   |     |   |       |   |       |   |         |   |      |   |     |
| 2007                                                                                                                                                                                                                 |   | 3,193              |   | 378,616                 |   | 22,678   |   | ---        |   | 179,065  |   | 19,595     |   | 107,781    |   | 20,985       |   | 19,644    |   | 169,587  |
|                                                                                                                                                                                                                 |   |               |   |                    |   |     |   |       |   |     |   |       |   |       |   |         |   |      |   |     |
| 2006                                                                                                                                                                                                                 |   | 4,742              |   | 409,412                 |   | 32,145   |   | ---        |   | 169,766  |   | 19,548     |   | 112,604    |   | 14,155       |   | 17,584    |   | 172,228  |
|                                                                                                                                                                                                                 |   |               |   |                    |   |     |   |       |   |     |   |       |   |       |   |         |   |      |   |     |
| 2005                                                                                                                                                                                                                 |   | 4,376              |   | 430,273                 |   | 29,688   |   | ---        |   | 186,165  |   | 14,840     |   | 140,622    |   | 14,066       |   | 9,850     |   | 182,793  |
|                                                                                                                                                                                                                 |   |               |   |                    |   |     |   |       |   |     |   |       |   |       |   |         |   |      |   |     |
| (A) Allocations of certain expenses have been made to                        investment income, settlement expenses and other operating expenses and are                        based on a number of assumptions and |
| estimates. Results among these catagories would change if                        different methods were applied.                                                                                                     |   |               |   |                    |   |     |   |       |   |     |
| (B) Commissions paid to the Parent Company have been                        eliminated for this presentation. Commission allowances relating to                        reinsurance ceded are offset against          |   |               |
| other operating expenses.                                                                                                                                                                                            |   |               |   |                    |   |     |   |       |   |     |   |       |   |       |   |         |   |      |

 

- 69        -

----

 

| **SCHEDULE IV -- REINSURANCE**                 |
|------------------------------------------------|
|                                           |   |   |   |   |   |   |   |   |   |   |
| **Form 10-K - Year Ended December 31, 2007**   |
| **Baldwin & Lyons, Inc. and Subsidiaries** |
|                                           |   |   |   |   |   |   |   |   |   |   |
| *(Dollars in thousands)*                       |
|                                           |   |   |   |   |   |   |   |   |   |   |
| Column A                                       |   | Column B |   | Column C |   | Column D |   | Column E |   | Column F |
|                                           |   |   |   |   |   |   |   |   |   | % of |
|                                           |   |   |   | Ceded |   | Assumed |   |   |   | Amount |
|                                           |   | Direct |   | to Other |   | from Other |   | Net |   | Assumed to |
|                                           |   | Premiums |   | Companies |   | Companies |   | Amount |   | Net |
| Premiums Earned -                              |   |   |   |   |   |   |   |   |   |   |
| Property/casualty insurance:                   |   |   |   |   |   |   |   |   |   |   |
|                                           |   |   |   |   |   |   |   |   |   |   |
| Years Ended December 31:                       |   |   |   |   |   |   |   |   |   |   |
|                                           |   |   |   |   |   |   |   |   |   |   |
| 2007                                           |   | 185,566 |   | 32,974 |   | 26,473 |   | 179,065 |   | 15.4 |
|                                           |   |   |   |   |   |   |   |   |   |   |
| 2006                                           |   | 181,491 |   | 24,841 |   | 13,116 |   | 169,766 |   | 7.7 |
|                                           |   |   |   |   |   |   |   |   |   |   |
| 2005                                           |   | 212,997 |   | 39,825 |   | 12,993 |   | 186,165 |   | 7.0 |

 

- 70        -

----

 

| **SCHEDULE VI--SUPPLEMENTAL INFORMATION**                                    |
|------------------------------------------------------------------------------|
| **CONCERNING PROPERTY/CASUALTY INSURANCE                        OPERATIONS** |
|                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Form 10-K - Year Ended December 31, 2007**                                 |
| **Baldwin & Lyons, Inc. and Subsidiaries**                               |
|                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| *(Dollars in thousands)*                                                     |
|                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Column A                                                                     |   | Column B |   | Column C |   | Column D |   | Column E |   | Column F |   | Column G |   | Column H |   |   |   | Column I |   | Column J |   | Column K |
|                                                                         |   | As of December 31, |   | Year Ended December 31, |
|                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                         |   |   |   | Reserves |   |   |   |   |   |   |   |   |   | Claims and Claim

Adjustment Expenses

Incurred Related to

                         

                          |   | Amortiza- |   |   |   |   |
|                                                                         |   |   |   | for Unpaid |   | Discount, |   |   |   |   |   |   |   |   | tion of |   |   |   |   |
|                                                                         |   | Deferred |   | Claims |   | if any |   |   |   |   |   |   |   |   | Deferred |   | Paid Claims |   |   |
| AFFILIATION                                                                  |   | Policy |   | and Claim |   | Deducted |   |   |   |   |   | Net |   | (1) |   | (2) |   | Policy |   | and Claim |   | Net |
| WITH                                                                         |   | Acquisi- |   | Adjustment |   | in |   | Unearned |   | Earned |   | Investment |   | Current |   | Prior |   | Acquisition |   | Adjustment |   | Premiums |
| REGISTRANT                                                                   |   | tion Costs |   | Expenses |   | Column C |   | Premiums |   | Premiums |   | Income |   | Year |   | Years |   | Costs |   | Expenses |   | Written |
| Consolidated Property/Casualty Subsidiaries:                                 |   |   |   | (A) |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 2007                                                                         |   | $       3,193 |   | $    378,616 |   | $      5,591 |   | $    22,678 |   | $    179,065 |   | $      19,595 |   | $    129,065 |   | ($21,284) |   | $       20,985 |   | $    112,776 |   | $    169,587 |
| 2006                                                                         |   |        4,742 |   |   409,412 |   |      4,883 |   |  32,145 |   |  169,766 |   | 19,548 |   |     129,551 |   | (16,947) |   |        14,155 |   |     105,239 |   |     172,228 |
| 2005                                                                         |   | 4,376 |   | 430,273 |   | 4,476 |   | 29,688 |   | 186,165 |   | 14,840 |   | 154,314 |   | (13,692) |   | 14,066 |   | 105,629 |   | 182,793 |

 

(A) Loss        reserves on certain reinsurance assumed and permanent total disability workers'        compensation claims have been discounted to present value using pretax interest rates not        exceeding 3.5%.

- 71        -

----

**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.

 

|   | **    BALDWIN& LYONS,INC.** |
|--------|------------------------------------------------|

 

 

| March 14, 2008 | By | */s/ Gary W. Miller* |
|----------------|----|----------------------|

|   | Gary W. Miller, Chairman and CEO |
|--------|----------------------------------|

|   | (Chief Executive Officer) |
|--------|--------------------------------|

 

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

 

| March 14, 2008 | By | */s/ Gary W. Miller* |
|----------------|----|----------------------|

|   | Gary W. Miller, Chairman and |
|--------|------------------------------|

|   | CEO; Director |
|--------|---------------|

 

 

March 14,        2008                                                                       By           */s/ G. Patrick Corydon*

*                                                                                                   *        G. Patrick Corydon, Senior Vice

|   | President - Finance and CFO (Principal |
|--------|----------------------------------------|

|   | Financial and Accounting Officer) |
|--------|-----------------------------------|

 

                                                                                          

 

| March 14, 2008 | By | */s/ Joseph DeVito* |
|----------------|----|---------------------|

|   | Joseph DeVito, Director, President |
|--------|------------------------------------|

|   | and Chief Operating Officer |
|--------|-----------------------------|

 

                                                                                          

 

March 14,        2008                                                                By           */s/ Stuart D. Bilton*(*)

                                                                                                     Stuart        D. Bilton, Director

 

 

| March 14, 2008 | By | */s/ Otto N. Frenzel III*(*) |
|----------------|----|------------------------------|

|   | Otto N. Frenzel III, Director |
|--------|-------------------------------|

 

 

| March 14, 2008 | By | */s/ John M. O’Mara*(*) |
|----------------|----|-------------------------------|

|   | John M. O’Mara, Director |
|--------|--------------------------------|

 

 

- 72        -

----

 

**SIGNATURES (CONTINUED)**

 

 

| March 14, 2008 |  By | * /s/ Thomas H. Patrick*(*) |
|----------------|----------|----------------------------------|

|   | Thomas H. Patrick, Director |
|--------|-----------------------------|

 

 

| March 14, 2008 |  By | * /s/ John Pigott*(*) |
|----------------|----------|----------------------------|

|   | John Pigott, Director |
|--------|-----------------------|

 

March 14,        2008                                                                       By           */s/ Kenneth D. Sacks*(*)

                                                                                                           Kenneth D. Sacks, Director

 

March 14,        2008                                                                       By         */s/ Nathan Shapiro*(*)

                                                                                                           Nathan Shapiro, Director

 

March 14,        2008                                                                       By         */s/ Norton Shapiro*(*)

                                                                                                           Norton Shapiro, Director

 

                                                                                          

March 14,        2008                                                                       By          */s/ Robert Shapiro*(*)

                                                                                                            Robert Shapiro, Director

 

March 14,        2008                                                                       By                  */s/ Steven A. Shapiro*(*)

                                                                                                           Steven A. Shapiro, Director

 

March 14,        2008                                                                       By                 */s/ John D. Weil*(*)

                                                                                                          John D. Weil, Director

 

(*) By Gary        W. Miller, Attorney-in-Fact

 

- 73        -

----

ANNUAL REPORT        ON FORM 10-K

 

 

         

**ITEM 15(c)--CERTAIN EXHIBITS**

         

 

YEAR        ENDED DECEMBER 31, 2007

 

BALDWIN        & LYONS, INC.

 

INDIANAPOLIS, INDIANA

 

- 74        -

----

BALDWIN        & LYONS, INC.

Form 10-K        for the Fiscal Year

Ended        December 31, 2007

 

**INDEX TO EXHIBITS**

 

 

|   | Begins on sequential page |
|--------|---------------------------|

| Exhibit No. | number of Form 10-K |
|-------------|---------------------|

 

EXHIBIT        3(i)--

Articles of        Incorporation of

Baldwin        & Lyons, Inc. as amended

(Incorporated as an exhibit by

reference        to Exhibit 3(a) to the

Company’s Annual Report on Form

10-K for        the year ended December

| 31, 1986) | N/A |
|-----------|-----|

 

EXHIBIT        3(ii)--

By-Laws of        Baldwin & Lyons, Inc.,

as restated        (Incorporated as an exhibit by

reference        to Exhibit 99.1 to the

Company’s Current Report on Form

| 8-K dated May 4, 2004) | N/A |
|------------------------|-----|

 

EXHIBIT        10(a)--

1981        Employees Stock Purchase Plan

(Incorporated as an exhibit by

reference        to Exhibit A to the

Company’s definitive Proxy

Statement        for its Annual Meeting

| held May 5, 1981) | N/A |
|-------------------|-----|

 

EXHIBIT        10(b)--

Baldwin        & Lyons, Inc. Employee

Discounted        Stock Option Plan

(Incorporated as an exhibit by reference

to Appendix        A to the Company’s definitive

Proxy        Statement for its Annual Meeting

| held May 2, 1989) | N/A |
|-------------------|-----|

 

EXHIBIT        10(c)--

Baldwin        & Lyons, Inc. Deferred Directors

Fee Option        Plan (Incorporated as an

exhibit by        reference to Exhibit 10(f) to the

Company’s Annual Report on Form 10-K

| for the year ended December 31, 1989) | N/A |
|---------------------------------------|-----|

 

- 75        -

----

**INDEX TO        EXHIBITS (CONTINUED)**

 

 

|   |     Begins on sequential page |
|--------|----------------------------------------------|

| Exhibit No. |      number of Form                        10-K |
|-------------|---------------------------------------------------------------------|

 

EXHIBIT        10(d)--

Baldwin        & Lyons, Inc. Amended Employee

Discounted        Stock Option Plan (Incorporated

as an        exhibit by reference to Exhibit 10(f) to

the        Company’s Annual Report on Form 10-K

| for the year ended December 31, 1989) | N/A |
|---------------------------------------|-----|

 

EXHIBIT        10(e)--

Baldwin        & Lyons, Inc. Restated Employee

Discounted        Stock Option Plan (Incorporated

as an        exhibit by reference to Exhibit 10(f) to

the        Company’s Annual Report on Form 10-K

| for the year ended December 31, 1997) | N/A |
|---------------------------------------|-----|

 

EXHIBIT        11--

| Computation of Per Share Earnings | filed herewith electronically |
|-----------------------------------|-------------------------------|

 

EXHIBIT        14--

Code of        Business Conduct, as amended

May 3, 2005        (Incorporated as an exhibit by

reference        to Exhibit 14 to the Company’s

Annual        Report on Form 10-K for the year

| ended December 31, 2005) | N/A |
|--------------------------|-----|

 

EXHIBIT        21--

| Subsidiaries of Baldwin & Lyons, Inc. | filed herewith                        electronically |
|-------------------------------------------|------------------------------------------------------|

 

EXHIBIT        23--

| Consent of Ernst & Young LLP | filed herewith electronically |
|----------------------------------|-------------------------------|

 

EXHIBIT        24--

Powers of        Attorney for certain

| Officers and Directors | filed herewith electronically |
|------------------------|-------------------------------|

 

EXHIBIT        31.1--

Certification of CEO pursuant to Section

| 302 of the Sarbanes-Oxley Act of 2002. | filed herewith electronically |
|----------------------------------------|-------------------------------|

 

EXHIBIT        31.2--

Certification of CFO pursuant to Section

| 302 of the Sarbanes-Oxley Act of 2002. | filed herewith electronically |
|----------------------------------------|-------------------------------|

 

EXHIBIT        32.1--

Certification of CEO pursuant to 18 U.S.C.

Section        1350, as adopted pursuant to Section

| 906 of the Sarbanes-Oxley Act of 2002. | filed herewith electronically |
|----------------------------------------|-------------------------------|

 

- 76        -

----

**INDEX TO EXHIBITS (CONTINUED)**

 

 

|   |     Begins on sequential page |
|--------|----------------------------------------------|

| Exhibit No. |  number of Form 10-K |
|-------------|---------------------------|

 

EXHIBIT        32.2--

Certification of CFO pursuant to 18 U.S.C.

Section        1350, as adopted pursuant to Section

| 906 of the Sarbanes-Oxley Act of 2002. | filed herewith electronically |
|----------------------------------------|-------------------------------|

 

- 77        -

----