American Physicians Capital (ACAP) 10-Q 2006 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

þ	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended September 30, 2006
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from           to

Commission File Number:000-32057

American Physicians Capital, Inc.

(Exact name of registrant as specified in its charter)

Michigan	38-3543910
(State or other jurisdiction of incorporation or organization)	(IRS employer identification number)

1301 North Hagadorn Road, East Lansing, Michigan 48823

(Address of principal executive offices, including zip code)

Registrant’s telephone number, including area code:

(517) 351-1150

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

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” inRule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o     Accelerated Filer þ     Non-accelerated filer o

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

The number of shares outstanding of the registrant’s common stock, no par value per share, as of November 3, 2006 was 11,654,704.

TABLE OF CONTENTS

PART I.  FINANCIAL INFORMATION
Item 1.	Financial Statements	3
	Condensed Consolidated Balance Sheets	3
	Condensed Consolidated Statements of Income	4
	Condensed Consolidated Statements of Comprehensive Income	5
	Condensed Consolidated Statements of Cash Flows	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	28
Item 4	Controls and Procedures	29
PART II.  OTHER INFORMATION
Item 1A.	Risk Factors	30
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	30
Item 6.	Exhibits	31
Signatures		32
Exhibit Index		33
Certificate of the Chief Executive Officer to Section 302
Certificate of the Chief Financial Officer to Section 302
Section 906 Certification of CEO and CFO

2

PART I.  FINANCIAL INFORMATION

ITEM 1.   FINANCIAL STATEMENTS

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

	September 30,		December 31,
	2006		2005
	(Unaudited)
	(In thousands, except
	share data)
ASSETS
Investments:
Fixed-income securities
Available-for-sale, at fair value	$	292,977	$	224,101
Held-to-maturity		509,905		345,702
Other investments		16,664		11,568
Total investments		819,546		581,371
Cash and cash equivalents		50,435		272,988
Premiums receivable		48,581		50,729
Reinsurance recoverable		106,988		109,368
Deferred federal income taxes		34,458		44,039
Property and equipment, net of accumulated depreciation		10,094		11,157
Other assets		29,947		39,676
Total assets	$	1,100,049	$	1,109,328
LIABILITIES
Unpaid losses and loss adjustment expenses	$	689,126	$	689,857
Unearned premiums		79,543		82,098
Federal income taxes payable		1,309		762
Long-term debt		30,928		30,928
Other liabilities		33,361		41,830
Total liabilities		834,267		845,475
Minority Interest in Consolidated Subsidiary		—		2,641
Shareholders’ Equity
Common stock, no par value, 50,000,000 shares authorized: 11,684,973 and 12,500,126 shares outstanding at September 30, 2006 and December 31, 2005, respectively		—		—
Additionalpaid-in-capital		48,262		74,360
Retained earnings		210,348		179,748
Accumulated other comprehensive income:
Net unrealized appreciation on investments, net of deferred federal income taxes		7,172		7,104
Total shareholders’ equity		265,782		261,212
Total liabilities and shareholders’ equity	$	1,100,049	$	1,109,328

The accompanying notes are an integral part of the condensed consolidated financial statements.

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AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Income

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006			2005			2006			2005
	(Unaudited)
	(In thousands, except per share data)
Net premiums written	$	48,304		$	52,991		$	117,351		$	123,414
Change in net unearned premiums		(10,532	)		(12,820	)		(4,716	)		330
Net premiums earned		37,772			40,171			112,635			123,744
Investment income		11,338			10,752			34,010			33,582
Net realized gains (losses)		100			(428	)		1,448			(750	)
Other income		198			222			825			687
Total revenues and other income		49,408			50,717			148,918			157,263
Losses and loss adjustment expenses		24,547			30,794			77,220			97,844
Underwriting expenses		7,373			7,538			22,784			25,247
Investment expenses		205			540			602			1,216
Interest expense		786			646			2,258			1,818
Amortization expense		—			157			—			470
General and administrative expenses		302			433			988			2,269
Other expenses		8			48			90			480
Total expenses		33,221			40,156			103,942			129,344
Income before federal income taxes and minority interest		16,187			10,561			44,976			27,919
Federal income tax expense (benefit)		5,162			3,705			14,376			(34,393	)
Income before minority interest		11,025			6,856			30,600			62,312
Minority interest in net income of consolidated subsidiary		—			(31	)		—			(373	)
Net income	$	11,025		$	6,825		$	30,600		$	61,939
Net income — per common share
Basic	$	0.93		$	0.54		$	2.52		$	4.82
Diluted	$	0.91		$	0.53		$	2.47		$	4.72

The accompanying notes are an integral part of the condensed consolidated financial statements.

4

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006			2005			2006			2005
	(Unaudited)
	(In thousands)
Net income	$	11,025		$	6,825		$	30,600		$	61,939
Other comprehensive income (loss):
Unrealized appreciation (depreciation) onavailable-for-sale investment securities arising during the period		5,826			(3,524	)		1,082			(9,869	)
Amortization of net unrealized appreciation onheld-to-maturity investment securities since the date of transfer from theavailable-for-sale category		(272	)		(440	)		(829	)		(696	)
Adjustment for realized (gains) losses on investment securities included in net income		—			(26	)		(148	)		42
Other comprehensive income (loss) before tax and minority interests		5,554			(3,990	)		105			(10,523	)
Deferred federal income tax expense (benefit)		1,944			(1,396	)		37			(3,683	)
Change in deferred tax valuation allowance		—			—			—			(7,512	)
Other comprehensive income (loss) before minority interest		3,610			(2,594	)		68			672
Minority interest in unrealized depreciation		—			6			—			3
Other comprehensive income (loss)		3,610			(2,588	)		68			675
Comprehensive income	$	14,635		$	4,237		$	30,668		$	62,614

The accompanying notes are an integral part of the condensed consolidated financial statements.

5

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

	Nine Months Ended
	September 30,
	2006			2005
	(Unaudited)
	(In thousands)
Cash flows from (for) operating activities
Net income	$	30,600		$	61,939
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization		2,240			4,119
Net realized (gains) losses		(1,448	)		750
Change in fair value of derivatives		—			1,050
Deferred federal income taxes		9,259			(35,572	)
Share-based compensation		459			291
Income on equity method investee		(1,001	)		—
Minority interest in net income of consolidated subsidiary		—			373
Changes in:
Unpaid loss and loss adjustment expenses		3,412			(5,690	)
Unearned premiums		1,909			1,117
Other assets and liabilities		(4,285	)		(5,787	)
Net cash from operating activities		41,145			22,590
Cash flows from (for) investing activities
Purchases
Available-for-sale — fixed income		(126,979	)		(3,752	)
Held-to-maturity — fixed income		(188,188	)		(112,912	)
Other investments		(386	)		(8,186	)
Property and equipment		(216	)		(670	)
Proceeds from sales and maturities
Available-for-sale — fixed income		50,938			100,836
Held-to-maturity — fixed income		22,514			52,513
Other investments		2,485			2,835
Property and equipment		6			30
Deconsolidation of PIC-Florida		(2,941	)		—
Pending securities transactions		5,285			(7,934	)
Net cash (for) from investing activities		(237,482	)		22,760
Cash flows from (for) financing activities
Common stock repurchased		(27,701	)		(9,399	)
Federal income tax effect of share based awards		700			727
Payable for shares repurchased		295			—
Proceeds from stock options exercised		490			1,709
Net cash for financing activities		(26,216	)		(6,963	)
Net (decrease) increase in cash and cash equivalents		(222,553	)		38,387
Cash and cash equivalents, beginning of period		272,988			190,936
Cash and cash equivalents, end of period	$	50,435		$	229,323

The accompanying notes are an integral part of the condensed consolidated financial statements.

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AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements — (Unaudited)

1.   Significant Accounting Policies

Basis of Consolidation and Reporting

The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of American Physicians Capital, Inc. (“APCapital”) and its wholly owned subsidiaries, Insurance Corporation of America (“ICA”), APSpecialty Insurance Corporation (“APS”), Alpha Advisors, Inc., APIndemnity (Bermuda) Ltd., APManagement Ltd. and American Physicians Assurance Corporation (“American Physicians”). Effective February 28, 2006, APManagement Ltd was liquidated. Effective May 10, 2006, APIndemnity (Bermuda) Ltd. was liquidated. APCapital and its consolidated subsidiaries are referred to collectively herein as the Company. All significant intercompany accounts and transactions are eliminated in consolidation.

The accounts of Physicians Insurance Company, a Florida domiciled insurance company (“PIC-Florida”), were consolidated in the accompanying unaudited Condensed Consolidated Financial Statements during 2005. However, as described under the heading “Minority Interests” below, in 2006 PIC-Florida is no longer being consolidated, but rather is accounted for using the equity method of accounting.

The accompanying unaudited Condensed Consolidated Financial Statements of the Company have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and with the instructions forForm 10-Q andRule 10-01 ofRegulation S-X as they apply to interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The December 31, 2005 Condensed Consolidated Balance Sheet of the Company presented in this Report onForm 10-Q was derived from audited financial statements.

In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The operating results for the three-month and nine-month periods ended September 30, 2006 are not necessarily indicative of the results to be expected for the year ending December 31, 2006. The accompanying unaudited Condensed Consolidated Financial Statements should be read in conjunction with the annual consolidated financial statements and notes contained in the Company’s Annual Report onForm 10-K for the year ended December 31, 2005.

Use of Estimates

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

The most significant estimates that are susceptible to significant change in the near-term relate to the determination of the liability for unpaid losses and loss adjustment expenses, value of investments, income taxes, reinsurance, the reserve for extended reporting period claims and deferred policy acquisition costs. Although considerable judgment is inherent in these estimates, management believes that the current estimates are reasonable in all material respects. The estimates are reviewed regularly and adjusted as necessary. Adjustments related to changes in estimates are reflected in the Company’s results of operations, or other comprehensive income, in the period in which those estimates changed.

Nature of Business and Segment Reporting

The Company is principally engaged in the business of providing medical professional liability insurance to physicians and other health care providers, with an emphasis on markets in the Midwest. While the Company had historically provided workers’ compensation and health insurance, in 2003 the Company initiated plans to exit these lines and in the second quarter of 2005, the last health and workers’ compensation policies expired. In 2005, the health and workers’ compensation lines of business were included in the Company’s other insurance lines segment

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AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements — (Continued)

along with the results of the Company’s personal and commercial insurance business, which it discontinued writing in 2001. With the expiration of all other insurance lines policies in 2005, and the diminished financial significance of these lines, the Company, in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 131, “Disclosures about Segments of an Enterprise and Related Information,” has determined that effective January 1, 2006 it has a single reportable segment, which includes all of the Company’s operations.

Share-Based Compensation

On January 1, 2006, the Company adopted SFAS No. 123(R), “Share-Based Payment.” The adoption and its impact on amounts reported in the accompanying unaudited Condensed Consolidated Financial Statements is more fully described in Note 5.

Minority Interests

Minority interest in the accompanying Condensed Consolidated Financial Statements at December 31, 2005 represents the 51% ownership interest of other investors in PIC-Florida. PIC-Florida was included in the Company’s Consolidated Financial Statements at and for the year ended December 31, 2005, as it had been determined to be a variable interest entity and the Company’s subsidiary, American Physicians, had been determined to be the primary beneficiary in accordance with the guidance given in Financial Accounting Standards Board Interpretation (“FIN”) 46(R), “Consolidation of Variable Interest Entities.”

On December 31, 2004, the Company consummated a transaction in which PIC-Florida’s other investor assumed ownership of 100% of PIC-Florida’s outstanding common stock. In exchange for its 49% ownership interest, American Physicians received a $3 million note that bears interest at a rate of eight percent. The note is collateralized by 100% of the outstanding common stock of PIC-Florida. As the note received in exchange for American Physicians ownership interest is collateralized by the common stock of PIC-Florida, the exchange was deemed not to be a sale in accordance with SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities a replacement of FASB Statement 125,” but was rather accounted for as a secured borrowing with pledge of collateral.

During 2005, monthly interest-only payments were made on the note. Principal payments on the note began in January 2006, and will continue every month through December 2012 unless earlier prepaid. The principal payments that began in January 2006 resulted in deemed partial sales of the Company’s investment in PIC-Florida in accordance with SFAS No. 140. As a result of these deemed partial sales, and the resulting change in circumstance, the Company re-evaluated the appropriateness of continuing to consolidate PIC-Florida in accordance with the guidance in FIN 46(R) and determined that the Company was no longer the primary beneficiary as it was no longer at risk for a majority of PIC-Florida’s potential losses. Accordingly, the Company determined that as of January 1, 2006, that its investment in PIC-Florida should be accounted for under the equity method of accounting and no longer consolidated.

The balance of the Company’s investment in PIC-Florida was approximately $2.8 million at September 30, 2006 and is included in the accompanying unaudited Condensed Consolidated Balance Sheet in other investments. The Company’s share of PIC-Florida’s reported net income for the three and nine months ended September 30, 2006 was approximately $294,000 and $583,000, respectively, and is included in investment income in the accompanying unaudited Condensed Consolidated Statements of Income.

Reclassification

Certain prior year amounts have been reclassified to conform to the current year presentation.

8

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements — (Continued)

2.   Stock Split

On September 25, 2006, the Company’s Board of Directors declared athree-for-two stock split of its common shares to shareholders of record as of the close of business on October 11, 2006. Shares resulting from the stock split were distributed to shareholders on November 1, 2006. Share, per share and option exercise price data in the unaudited Condensed Consolidated Financial Statements and Notes thereto have been retroactively adjusted to reflect the stock split.

3.   Effects of New Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109, Accounting for Income Taxes,” which clarifies the accounting for uncertainty in income taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation requires that the Company recognize in the financial statements, the impact of a tax position, if that position is more likely than not to be sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006 with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations. However, additional disclosures will be required in the notes to future consolidated financial statements.

SFAS No. 157, “Fair Value Measurements,” which was issued in September 2006, defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, SFAS No. 157 does not require any new fair value measurements. However, for some entities, the application of this Statement will change current practice. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Based on assets held and liabilities carried as of this reporting date, the adoption of SFAS No. 157 is not expected to have a material impact on the Company’s consolidated financial position or results of operations. However, assets acquired or liabilities assumed in periods prior to the adoption of SFAS No. 157 may result in a different assessment of the impact of adoption.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides guidance to registrants on how prior year misstatements should be taken into consideration when quantifying misstatements in current year financial statements for purposes of determining whether the current year’s financial statements are materially misstated. SAB 108 is effective for fiscal years ending after November 15, 2006. The Company does not expect that the adoption of SAB 108 will have a material impact on its results of operations or financial position.

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AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements — (Continued)

4.   Income Per Share

The following table sets forth the details regarding the computation of basic and diluted net income per common share for each period presented:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2006		2005		2006		2005
	(In thousands, except per share data)
Numerator for basic and diluted income per common share:
Net income	$	11,025	$	6,825	$	30,600	$	61,939
Denominator:
Denominator for basic income per common share — weighted average shares outstanding		11,796		12,667		12,123		12,858
Effect of dilutive stock options and awards		266		312		267		273
Denominator for diluted income per common share — adjusted weighted average shares outstanding		12,062		12,979		12,390		13,131
Net income — basic	$	0.93	$	0.54	$	2.52	$	4.82
Net income — diluted	$	0.91	$	0.53	$	2.47	$	4.72

In accordance with SFAS No. 128, “Earnings per Share,” the diluted weighted average number of shares outstanding includes an incremental adjustment for the assumed exercise of dilutive stock options and non-vested share awards. Stock options are considered dilutive when the exercise price exceeds the average stock price during the period and the assumed conversion of the options, using the treasury stock method as required by SFAS No. 128, produces an increased number of shares. Stock options with an exercise price that is higher than the average stock price during the period are excluded from the computation as their impact would be anti-dilutive. During the three months and nine months ended September 30, 2006 and 2005, there were no stock options that were considered to be anti-dilutive. Share amounts and net income per share amounts have been retroactively adjusted to reflect the stock split described in Note 2.

5.   Share-Based Compensation

Equity Compensation Plans

The Board of Directors and shareholders have authorized the American Physicians Capital, Inc. Stock Compensation Plan (the “Plan”). The Plan provides for the award of stock options and other share-based awards for officers, directors and employees of the Company.

These awards must be approved by the compensation committee of the board of directors. The total number of shares of the Company’s common stock authorized for issuance under the Plan is 1,800,000 shares, of which only 6,540 remain available for future grants.

Certain executive officers, board members and employees have been granted options to purchase shares of APCapital common stock. All outstanding options vest in annual installments of 33%, 33%, and 34% on the first through the third anniversaries, respectively, of the date of grant. All options expire on the tenth anniversary of the grant date.

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AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements — (Continued)

The following table summarizes activity in the Company’s equity compensation plans for stock options awards for the nine months ended September 30, 2006:

	For the Nine Months Ended September 30, 2006
						Weighted
	Number			Weighted		Average		Aggregate
	of			Average		Remaining		Intrinsic
	Options			Exercise Price		Term		Value
						(In years)		(In thousands)
Options outstanding at January 1, 2006		776,100		$	15.20
Granted during the period		—			—
Exercised during the period		(78,600	)	$	9.67
Canceled during the period		(1,500	)	$	26.50
Options outstanding at September 30, 2006		696,000		$	15.80		6.34	$	11,453
Options exercisable at September 30, 2006		550,253		$	12.93		5.80	$	10,634

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted market price (adjusted for the effect of the stock split described in Note 2) of the Company’s common stock for the options that werein-the-money at September 30, 2006. During the nine months ended September 30, 2006, the total intrinsic value of options exercised under the stock option plan was $1.8 million. For the years ended December 31, 2005 and 2004, the total intrinsic value of options exercised was $2.1 million and $4.8 million, respectively, determined as of the date of option exercise.

In January 2004, the Company issued 45,000 shares of non-vested stock under the Plan to certain employees with a market price at the date of grant of $11.47 per share. The shares granted in 2004 vest annually at a rate of 33%, 33% and 34% in January 2005, 2006 and 2007, respectively, as long as the grantees remain employed by the Company.

A summary of the status and changes of nonvested shares issued under the Plan as of and during the nine months ended September 30, 2006 is presented below:

				Weighted
	Number of			Average
	Non-vested			Grant Date
	Shares			Fair Value
Non-vested shares outstanding at January 1, 2006		24,119		$	11.47
Granted during the period		—			—
Vested during the period		(11,882	)	$	11.47
Forfeited during the period		(765	)	$	11.47
Non-vested shares outstanding at September 30, 2006		11,472		$	11.47

The total fair value, at the date of vesting, of stock options and non-vested share awards vested during the nine months ended September 30, 2006 was $3.5 million. For the years ended December 31, 2005 and 2004, the total fair value of stock options and non-vested share awards vested was $5.7 million and $8.5 million, respectively.

As of September 30, 2006, the Company had $303,000 of unrecognized compensation costs related to non-vested share-based payment awards that are expected to be recognized over a weighted average period of seven months.

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AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements — (Continued)

Impact of the Adoption of SFAS No. 123(R)

The Company adopted SFAS No. 123(R), “Share-Based Payment,” beginning January 1, 2006 using the modified prospective transition method. Accordingly, during the three-month and nine-month periods ended September 30, 2006, the Company recorded share-based compensation expense for awards granted prior to, but not yet vested, as of January 1, 2006, adjusted for estimated forfeitures, using the fair value method. Share-based compensation for option awards is being recognized on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award were, in substance, multiple awards. Compensation expense for restricted shares granted is being recognized on a straight-line basis over the requisite service period for the entire award, or three years. The impact on our results of operations of recording share-based compensation for the three and nine months ended September 30, 2006 was as a pre-tax charge to underwriting expense of $122,000 and $459,000, respectively. Net of taxes, the effect on net income was $79,000, or $0.01, per basic and diluted share for the three months ended September 30, 2006 and $298,000, or $0.02, per basic and diluted share for the nine months ended September 30, 2006.

SFAS No. 123(R) also requires that the cash flows resulting from the excess tax benefits associated with the share-based compensation be classified as cash flows from financing activities. Accordingly, the Company has reported excess tax benefits of $700,000 and $727,000 as cash inflows in the financing activities section of the statement of cash flows for the nine-month periods ended September 30, 2006 and 2005, respectively. These incremental tax benefits are also credited to additionalpaid-in-capital.

Prior to the adoption of SFAS No. 123(R), the unrecognized portion of share-based compensation, based on the APB No. 25 intrinsic value method, was reported as a contra account in the shareholders’ equity section of the balance sheet, net of deferred taxes. Upon the adoption of SFAS No. 123(R) in January 2006, the unearned share-based compensation balance of approximately $84,000 was reclassified toadditional-paid-in-capital and subsequently reduced to zero.

Employee share-based compensation expense recognized under SFAS No. 123(R)was not reflected in our results of operations for the three and nine-month periods ended September 30, 2005 for employee stock option awards as all options were granted with an exercise price equal to the market value of the underlying common stock on the date of grant. However, the Company has historically provided the required pro forma disclosures under SFAS No. 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosures.” The originally disclosed pro forma effects of share-based compensation expense have been included here for purposes of comparison to the results of operations for the three and nine months ended September 30, 2006. In accordance with adoption pursuant to the modified-prospective method, previously reported amounts in the income statement have not been changed.

12

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements — (Continued)

The pro forma information for the three and nine months ended September 30, 2005 was as follows:

	Three Months Ended			Nine Months Ended
	September 30, 2005			September 30, 2005
	(In thousands, except per share data)
Net income as reported	$	6,825		$	61,939
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects		63			190
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards granted since 2000, net of related tax effects		(160	)		(405	)
Pro forma net income	$	6,728		$	61,724
Basic income per share
As reported	$	0.54		$	4.82
Pro forma	$	0.53		$	4.80
Diluted income per share
As reported	$	0.53		$	4.72
Pro forma	$	0.52		$	4.70

Valuation Assumptions

There were no stock options or other share-based awards granted during the nine months ended September 30, 2006. The grant date fair value of stock options for award grants made in 2005 was estimated using a binomial lattice model. Prior to 2005, the Company used a Black-Scholes option pricing model to estimate the fair value of option grants at the date of grant. The following table indicates the assumptions used, or in the case of the binomial lattice model the range of assumptions, in estimating the grant date fair value for options granted during the years ended December 31, 2005 and 2004.

	2005			2004
	(Binomial Lattice)			(Black-Scholes)
Risk-free interest rate		4.44	%		3.12	%
Dividend yield		0	%		0	%
Expected volatility		10% - 25	%		40	%
Weighted average volatility		20	%		40	%
Expected term (years)		4.0			5.0
Weighted average estimated grant date fair value	$	4.85		$	5.70

Expected volatility is based on historical volatility for the Black-Scholes valuation model. Under the binomial lattice model, expected volatility is based on a number of factors, including historical volatility, return on equity, price to book value ratios and trends impacting the medical professional liability insurance industry. The Company uses historical data to estimate option exercise and employee termination behavior within both valuation models. Employee groups and option characteristics are considered separately for valuation purposes. The expected term represents an estimate of the period of time options are expected to remain outstanding based on the past exercise behavior of employees in relation to the Company’s current stock price. The risk-free interest rate is based on the yield of a zero coupon U.S. Treasury security with a remaining term to maturity equal to the contractual term of the option, in the case of the binomial lattice model, and over the expected term for the Black-Scholes model.

13

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements — (Continued)

6.   Investments

The composition of the Company’savailable-for-sale investment security portfolio, including unrealized gains and losses at September 30, 2006 and December 31, 2005 was as follows:

	September 30, 2006
			Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost/Cost		Gains		Losses			Fair Value
	(In thousands)
Available-for-sale
U.S. government obligations	$	2,499	$	27	$	(2	)	$	2,524
States and political subdivisions		79,618		465		—			80,083
Corporate securities		205,904		4,482		(242	)		210,144
Mortgage-backed securities		191		35		—			226
Totalavailable-for-sale securities	$	288,212	$	5,009	$	(244	)	$	292,977

	December 31, 2005
			Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost/Cost		Gains		Losses			Fair Value
	(In thousands)
Available-for-sale
U.S. government obligations	$	3,752	$	55	$	(19	)	$	3,788
States and political subdivisions		16,106		145		—			16,251
Corporate securities		197,926		6,028		(230	)		203,724
Mortgage-backed securities		287		57		(6	)		338
Totalavailable-for-sale securities	$	218,071	$	6,285	$	(255	)	$	224,101

The following table shows the carrying value, gross unrecognized holding gains and losses, as well as the estimated fair value of the Company’sheld-to-maturity fixed-income security portfolio as of September 30, 2006 and December 31, 2005:

	September 30, 2006
			Gross		Gross
			Unrecognized		Unrecognized
	Carrying		Holding		Holding			Estimated
	Value(1)		Gains		Losses			Fair Value
	(In thousands)
Held-to-maturity
U.S. government obligations	$	142,580	$	288	$	(1,763	)	$	141,105
States and political subdivisions		130,265		549		(33	)		130,781
Corporate securities		69,230		114		(2,567	)		66,777
Mortgage-backed securities		167,830		19		(4,211	)		163,638
Totalheld-to-maturity fixed-income securities	$	509,905	$	970	$	(8,574	)	$	502,301

(1) Carrying value includes $4.0 million of unamortized net unrealized appreciation.

14

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements — (Continued)

	December 31, 2005
			Gross		Gross
			Unrecognized		Unrecognized
	Carrying		Holding		Holding			Estimated
	Value(2)		Gains		Losses			Fair Value
	(In thousands)
Held-to-maturity
U.S. government obligations	$	82,628	$	—	$	(1,638	)	$	80,990
States and political subdivisions		2,879		—		(28	)		2,851
Corporate securities		69,681		173		(1,572	)		68,282
Mortgage-backed securities		190,514		51		(3,753	)		186,812
Totalheld-to-maturity fixed-income securities	$	345,702	$	224	$	(6,991	)	$	338,935

(2) Carrying value includes $4.9 million of unamortized net unrealized appreciation.

At September 30, 2006, approximately 99% of the Company’s fixed-income portfolio, bothavailable-for-sale andheld-to-maturity (excluding approximately $13.3 million of private placement issues) was considered investment grade. The Company defines investment grade securities as those that have a Standard & Poors’ credit rating of BBB and above. The increase in the gross unrecognized holding losses from December 31, 2005 to September 30, 2006 is due to an increase in prevailing interest rates. The Company has evaluated each fixed-income security in an unrealized or unrecognized loss position and has concluded that the declines in market value are temporary in nature due to interest rate increases. The Company has determined that there is no impairment based on the Company’s ability and intent to hold these securities to maturity.

During the three and nine months ended September 30, 2006, the Company recognized impairments totaling $0 and $153,000, respectively, for other than temporary declines in the market value of unaffiliated equity securities, which are included in other investments in the accompanying unaudited Condensed Consolidated Balance Sheets.

7.   Income Taxes

In the second quarter of 2005, the Company reversed the entire deferred tax asset valuation allowance as it had concluded that it was more likely than not that sufficient taxable income would exist in future periods when the deductible temporary differences were expected to reverse. As a result of the reversal, income taxes incurred do not bear the usual relationship to income before federal income taxes for the nine months ended September 30, 2005, while a more customary relationship was present for the three months ended September 30, 2005 and the three and nine months ended September 30, 2006, as shown in the table below.

	Three Months Ended September 30,										Nine Months Ended September 30,
	2006					2005					2006					2005
	(Dollars in thousands)
Income before taxes	$	16,187				$	10,561				$	44,976				$	27,919
Tax at statutory rate		5,665		35.0	%		3,689		34.9	%		15,742		35.0	%		9,764		35.0	%
Tax effect of:
Tax exempt interest		(599	)	(3.7	)%		(39	)	(0.4	)%		(1,492	)	(3.3	)%		(142	)	(0.5	)%
Other items, net		96		0.6	%		55		0.5	%		126		0.3	%		36		0.1	%
Valuation allowance		—		0.0	%		—		0.0	%		—		0.0	%		(44,051	)	(157.8	)%
	$	5,162		31.9	%	$	3,705		35.1	%	$	14,376		32.0	%	$	(34,393	)	(123.2	)%

15

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements — (Continued)

For additional information regarding the Company’s accounting for the deferred tax valuation allowance and its reversal during 2005, see Note 11 of the Notes to Consolidated Financial Statements in the Company’s annual report onForm 10-K for the year ended December 31, 2005.

8.   Shareholders Equity

The Board of Directors has authorized the Company to purchase shares of its outstanding common stock under two separate plans. In November 2005, the Board of Directors authorized the purchase of approximately 637,500 additional shares at the discretion of management (referred to as the “discretionary plan”). This most recent authorization brings the total number of shares authorized to be repurchased under the discretionary plan to 6,060,659. At September 30, 2006, 404,804 shares remained available for repurchase under the discretionary plan, subject to limitations that may be imposed by applicable laws and regulations and the rules of the Nasdaq Stock Market. The timing of the purchases and the number of shares to be bought at any one time depend on market conditions and the Company’s capital resources and requirements. Shares repurchased under this authorization during the three-month and nine-month periods ended September 30, 2006, as well as the total number of shares repurchased pursuant to prior authorizations under the discretionary plan are shown in the table below.

	Discretionary Plan
	Total
	Number of				Average
	Shares		Total		Price Paid
	Purchased		Cost		per Share
			(In thousands)
Three months ended March 31, 2006		191,250	$	6,110	$	31.95
Three months ended June 30, 2006		18,750		594		31.69
Three months ended September 30, 2006		—		—		—
Nine months ended September 30, 2006		210,000	$	6,704	$	31.92
Inception to date as of September 30, 2006		5,655,855	$	84,144	$	14.88

In April 2006, the Company announced that its Board of Directors had authorized a share repurchase of $20 million of its common shares pursuant to a plan adopted underRule 10b5-1 of the Securities Exchange Act of 1934. In August 2006, the Board of Directors authorized an additional share repurchase of $10 million of its common shares under this plan. Shares repurchased under aRule 10b5-1 plan may be repurchased at times when the Company otherwise might be prevented from doing so under insider trading laws or because of self-imposed trading blackout periods. A broker selected by the Company has the authority under the terms and limitations specified in the plan to repurchase shares on the Company’s behalf.

	Rule 10b5-1 Plan
	Total
	Number of				Average
	Shares		Total		Price Paid
	Purchased		Cost		per Share
			(In thousands)
Three months ended March 31, 2006		—	$	—	$	—
Three months ended June 30, 2006		420,900		12,916		30.69
Three months ended September 30, 2006		253,800		8,081		31.84
Nine months ended September 30, 2006		674,700	$	20,997	$	31.12
Inception to date as of September 30, 2006		674,700	$	20,997	$	31.12

At September 30, 2006, there was $9.0 million remaining to be purchased under theRule 10b5-1 plan. On October 27, 2006, the Company’s Board of Directors adopted a new stock repurchase plan for 2007 under

16

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements — (Continued)

Rule 10b5-1 and authorized an additional share repurchase of $32 million of its common shares. In addition, the Board authorized the rollover into the 2007 plan of any unused dollars allocated to the 2006 10b5-1 plan. TheRule 10b5-1 plan share repurchases are expected to continue until the authorizations are fully utilized, subject to conditions specified in theRule 10b5-1 plan. However, the Company may terminate the plan at any time.

9.   Subsequent Event

On July 26, 2006, ProAssurance Corporation (“ProAssurance”) and Physicians Insurance Company of Wisconsin, Inc. (“PIC-Wisconsin”) announced that PIC-Wisconsin shareholders had approved PIC-Wisconsin’s merger into ProAssurance effective on August 1, 2006. Under the terms of the merger, each share of PIC-Wisconsin common stock was converted to shares of ProAssurance common stock having a value of approximately $5,000. Accordingly, the Company received ProAssurance common stock, having a total value of approximately $9.7 million in exchange for the 1,942 shares of PIC-Wisconsin common stock the Company owned. The carrying value of the Company’s PIC-Wisconsin common stock was $7.6 million. In October 2006, the Company sold its shares of ProAssurance common stock and realized a gain of $2.1 million in connection with the sale.

17

Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and the Notes thereto included elsewhere in this report and our Annual Report onForm 10-K for the year ended December 31, 2005, particularly “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

The following discussion of our financial condition and results of operations contains certain forward-looking statements related to our anticipated future financial condition and operating results and our current business plans. When we use words such as “will,” “should,” “likely,” “believe,” “expect,” “anticipate,” “estimate” or similar expressions, we are making forward-looking statements. These forward-looking statements represent our outlook only as of the date of this report.

We claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 for all of our forward-looking statements. While we believe that our forward-looking statements are reasonable, you should not place undue reliance on any such forward-looking statements, which speak only as of the date made. Because these forward-looking statements are based on estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond our control or are subject to change, actual results could be materially different. Factors that might cause such a difference include, without limitation, the risks and uncertainties discussed from time to time in our reports filed with the Securities and Exchange Commission, including those listed in our Annual Report onForm 10-K under ��Item 1A — Risk Factors,” as modified in “Part II, Item 1A — Risk Factors” in this report, and the following.

•  Increased competition could adversely affect our ability to sell our products at premium rates we deem adequate, which may result in a decrease in premium volume, a decrease in our profitability, or both.

•  Our reserves for unpaid losses and loss adjustment expenses are based on estimates that may prove to be inadequate to cover our losses.

•  Our exit from various markets and lines of business may prove more costly than originally anticipated.

•  Legislative or judicial changes in the tort system may have adverse or unintended consequences that could materially and adversely affect our results of operations and financial condition.

•  If we are unable to obtain or collect on ceded reinsurance, our results of operations and financial condition may be adversely affected.

•  The insurance industry is subject to regulatory oversight that may impact the manner in which we operate our business, our ability to obtain future premium rate increases, the type and amount of our investments, the levels of capital and surplus deemed adequate to protect policyholder interests, or the ability of our insurance subsidiaries to pay dividends to the holding company.

•  Our geographic concentration in certain Midwestern states and New Mexico ties our performance to the business, economic, regulatory and legislative conditions in those states.

•  An interruption or change in current marketing and agency relationships could reduce the amount of premium we are able to write.

•  A downgrade in the A.M. Best Company rating of our insurance subsidiaries could reduce the amount of business we are able to write.

•  Changes in interest rates could adversely impact our results of operation, cash flows and financial condition.

•  Our status as an insurance holding company with no direct operations could adversely affect our ability to meet our debt obligations and fund future share repurchases.

Other factors not currently anticipated by management may also materially and adversely affect our financial position and results of operations. We do not undertake, and expressly disclaim, any obligation to update or alter our statements, whether as a result of new information, future events or otherwise, except as required by applicable law.

18

Overview of APCapital’s Operations

We are a leading provider of medical professional liability insurance coverage, which protects physicians and other health providers from claims filed against them for alleged acts of medical malpractice. We currently write medical professional liability coverage in seven states, with a concentration in our core Midwestern states of Michigan, Illinois and Ohio as well as Kentucky and New Mexico.

We previously offered workers’ compensation insurance and health insurance products. However, we discontinued writing these products starting in 2004 and the last of these policies expired in the second quarter of 2005. As workers’ compensation is a long-tailed line of business, we will continue to settle and pay these claims for a number of years.

Historically, we have reported three segments: Medical Professional Liability, Other Insurance and Corporate and Other. However, with the diminished significance of the lines of business previously reported in the Other Insurance Lines segment, the Company has discontinued segment reporting and now reports its results of operations on a consolidated basis. Accordingly, the discussion that follows focuses on the Company’s consolidated results of operations.

On September 25, 2006, the Company’s Board of Directors declared athree-for-two stock split of its common shares to shareholders of record as of the close of business on October 11, 2006. Shares resulting from the stock split were distributed to shareholders on November 1, 2006. Share, per share and option exercise price data in this report have been retroactively adjusted to reflect the stock split.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, or GAAP, requires us to make estimates and assumptions that affect amounts reported in the accompanying unaudited Condensed Consolidated Financial Statements and Notes thereto. These estimates and assumptions are evaluated on an on-going basis based on historical developments, market conditions, industry trends and other information we believe to be reasonable under the circumstances. There can be no assurance that actual results will conform to our estimates and assumptions, or that reported results of operations will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. Adjustments related to changes in estimates are reflected in our results of operations in the period in which those estimates changed.

Our “critical” accounting policies are those policies that we believe to be most sensitive to estimates and judgments. These policies are more fully described in “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations, Significant Accounting Policies” of our Annual Report onForm 10-K for the year ended December 31, 2005, and in Note 1 to our Consolidated Financial Statements contained in that report. Except as noted below, there have been no material changes to these policies since the most recent year end.

Share-Based Compensation

Beginning on January 1, 2006, we began accounting for stock options and non-vested stock awards under the provisions of Statement of Financial Accounting Standard No. 123 (revised 2004), “Share-Based Payment”, or SFAS No. 123(R), which requires the recognition of share-based compensation expense based on the fair value of the awards granted. Prior to the adoption of SFAS No. 123(R), we had accounted for stock options using the intrinsic value method, which resulted in no compensation expense for stock option awards as the option exercise prices were equal to the market price of the Company’s stock at the respective dates of grant. Under both the intrinsic value and fair value models, compensation expense for non-vested share awards is based on the market price of the Company’s stock at the date of grant.

Details regarding the adoption of SFAS No. 123(R), and our equity compensation plans, including the assumptions utilized in estimating the fair value of option awards, are more fully described in Note 5 of the Notes to Condensed Consolidated Financial Statements. If different assumptions were used in the option valuation models, share-based compensation expense would differ from that recorded in the current period, and from that which is

19

expected to be recorded in future periods. Pre-tax share-based compensation expense for the three and nine months ended September 30, 2006 was approximately $122,000 and $459,000, respectively. As of September 30, 2006, the Company had $303,000 of unrecognized compensation costs related to non-vested share-based payment awards that are expected to be recognized over a weighted average period of seven months.

Description of Ratios Analyzed

In the analysis of our operating results that follows, we refer to various financial ratios and other measures that management uses to analyze and compare the underwriting results of our insurance operations.

GAAP Ratios and Other GAAP Financial Measures

We calculate loss ratio, underwriting expense ratio and combined ratio on a GAAP basis. There have been no material changes to the calculation and use of these ratios during the most recent quarter. We also calculate underwriting gain (loss) on a GAAP basis. This measure equals the net premiums earned less loss and loss adjustment expenses and underwriting expenses. It is another measure used by management and others in the industry to evaluate the underwriting performance of our insurance operations in relation to peer companies.

Accident Year Loss Ratio

In addition to our reported GAAP loss ratios, we also report accident year loss ratios. The accident year loss ratio excludes the effect of development on prior year loss reserves. We believe this ratio is useful in evaluating our current underwriting performance, as it focuses on the relationships between current premiums earned and losses incurred related to the current year. Considerable variability is inherent in the establishment of loss reserves related to the current accident year. While management believes that its estimate is reasonable, there can be no assurance that these loss reserves will develop as expected. Our method of calculating accident year loss ratios may differ from the method used by other companies and, therefore, comparability may be limited.

Results of Operations — Three and Nine Months Ended September 30, 2006 Compared to Three and Nine Months Ended September 30, 2005

The discussion that follows should be read in connection with the unaudited Condensed Consolidated Financial Statements and Notes thereto included elsewhere in this report.

20

The following tables show our underwriting results, as well as other revenue and expense items included in our unaudited Condensed Consolidated Statements of Income, for the three and nine-month period ended September 30, 2006 and 2005.

	For the Three Months Ended September 30,												For the Nine Months Ended September 30,
							Change												Change
	2006			2005			Dollar			Percentage			2006			2005			Dollar			Percentage
	(Dollars in thousands)												(Dollars in thousands)
Direct premiums written	$	51,819		$	61,841		$	(10,022	)		(16.2	)%	$	125,742		$	147,739		$	(21,997	)		(14.9	)%
Net premiums written	$	48,304		$	52,991		$	(4,687	)		(8.8	)%	$	117,351		$	123,414		$	(6,063	)		(4.9	)%
Net earned premium	$	37,772		$	40,171		$	(2,399	)		(6.0	)%	$	112,635		$	123,744		$	(11,109	)		(9.0	)%
Losses and loss adjustment expenses Current year losses		27,693			32,055			(4,362	)		(13.6	)%		85,352			99,960			(14,608	)		(14.6	)%
Prior year losses		(3,146	)		(1,261	)		(1,885	)		(149.5	)%		(8,132	)		(2,116	)		(6,016	)		(284.3	)%
Total		24,547			30,794			(6,247	)		(20.3	)%		77,220			97,844			(20,624	)		(21.1	)%
Underwriting expenses		7,373			7,538			(165	)		(2.2	)%		22,784			25,247			(2,463	)		(9.8	)%
Total underwriting gain		5,852			1,839			4,013			218.2	%		12,631			653			11,978			1834.3	%
Other revenue (expense) items
Investment income		11,338			10,752			586			5.5	%		34,010			33,582			428			1.3	%
Net realized gains (losses)		100			(428	)		528			123.4	%		1,448			(750	)		2,198			293.1	%
Other income		198			222			(24	)		(10.8	)%		825			687			138			20.1	%
Other expenses(1)		(1,301	)		(1,824	)		523			28.7	%		(3,938	)		(6,253	)		2,315			37.0	%
Total other revenue and expenses items		10,335			8,722			1,613			18.5	%		32,345			27,266			5,079			18.6	%
Income before federal income taxes and minority interest		16,187			10,561			5,626			53.3	%		44,976			27,919			17,057			61.1	%
Federal in come tax expense (benefit)		5,162			3,705			1,457			(39.3	)%		14,376			(34,393	)		48,769			141.8	%
Income before minority interest		11,025			6,856			4,169			60.8	%		30,600			62,312			(31,712	)		(50.9	)%
Minority interest in income of consolidated subsidiary		—			(31	)		31			(100.0	)%		—			(373	)		373			(100.0	)%
Net income	$	11,025		$	6,825		$	4,200			61.5	%	$	30,600		$	61,939		$	(31,339	)		(50.6	)%
Loss Ratio:
Accident year		73.3	%		79.8	%					6.5	%		75.8	%		80.8	%					5.0	%
Priory ears		(8.3	)%		(3.1	)%					5.2	%		(7.2	)%		(1.7	)%					5.5	%
Calendar year		65.0	%		76.7	%					11.7	%		68.6	%		79.1	%					10.5	%
Underwriting expense ratio		19.5	%		18.8	%					(0.7	)%		20.2	%		20.4	%					0.2	%
Combined ratio		84.5	%		95.5	%					11.0	%		88.8	%		99.5	%					10.7	%

(1) Other expenses includes investment expenses, interest expense, amortization expense, general and administrative expenses and other expenses as reported in the unaudited Condensed Consolidated Statements of Income included elsewhere in this report.

21

The increase in net income for the three months ended September 30, 2006 compared to the same period in 2005 is primarily the result of improved underwriting results. Increases in investment income and realized gains, as well as a decrease in other expenses, also contributed to the increase in reported net income. Net income for the nine months ended September 30, 2006 compared to 2005 decreased $31.3 million. This decrease is primarily attributable to the reversal of the deferred tax valuation allowance in the second quarter of 2005, which contributed $44.1 million to net income in the form of a federal income tax benefit for the nine months ended September 30, 2005. Income before federal income taxes and minority interests, or pre-tax income, for the nine months ended September 30, 2006 increased $17.1 million to $45.0 million when compared to the nine months ended September 30, 2005. This increase in pre-tax income was the result of the same factors that contributed to the increase in net income for the three months ended September 30, 2006.

The following table shows our direct premiums written by major geographical market for the three months and nine months ended September 30, 2006 and 2005.

	For the Three Months Ended September 30,										For the Nine Months Ended September 30,
					Change										Change
	2006		2005		Dollar			Percentage			2006		2005		Dollar			Percentage
	(Dollars in thousands)										(Dollars in thousands)
Direct premiums written
Michigan	$	17,411	$	18,216	$	(805	)		(4.4	)%	$	36,739	$	39,275	$	(2,536	)		(6.5	)%
Illinois		17,379		21,067		(3,688	)		(17.5	)%		42,185		47,915		(5,730	)		(12.0	)%
Ohio		7,887		8,887		(1,000	)		(11.3	)%		22,965		25,119		(2,154	)		(8.6	)%
New Mexico		6,124		6,882		(758	)		(11.0	)%		15,903		16,929		(1,026	)		(6.1	)%
Other		1,712		1,730		(18	)		(1.0	)%		2,859		3,018		(159	)		(5.3	)%
Kentucky		1,306		1,836		(530	)		(28.9	)%		5,091		8,191		(3,100	)		(37.8	)%
PIC-Florida		—		3,223		(3,223	)		(100.0	)%		—		7,292		(7,292	)		(100.0	)%
Total	$	51,819	$	61,841	$	(10,022	)		(16.2	)%	$	125,742	$	147,739	$	(21,997	)		(14.9	)%

As seen above, direct premiums written for the three months and nine months ended September 30, 2006 decreased $10.0 million and $22.0 million, respectively, compared to the same periods in 2005. The deconsolidation of PIC-Florida accounted for $3.2 million and $7.3 million, respectively, of these decreases. The deconsolidation of PIC-Florida is described more fully in Note 1 of the Notes to unaudited Condensed Consolidated Financial Statements included elsewhere in this report. In addition, the exit from our health line of business in Michigan accounted for an additional $2.3 million of the decrease in the nine month period. The remainder of the decreases were the result of price competition in our core medical professional liability markets, primarily in our Illinois, Ohio and Kentucky markets. Although the medical professional liability market continues to be competitive, we remain committed to our strategy of adequate pricing and strict underwriting. This strategy may result in the loss of additional policyholders and further decreases in direct premiums written. Our insured physician count at September 30, 2006 was 9,495, a decrease of 324, or 3.3% compared to September 30, 2005. However, the count dropped less than 1% compared to December 31, 2005.

Effective January 1, 2006, we began retaining a 50% participation in our excess of loss reinsurance layer, which is all losses in excess of $500,000, compared to a 20% participation in 2005. In addition to the increase in retention, our 2006 reinsurance treaty is no longer swing-rated. These changes in reinsurance are the primary reason that the decreases in net premiums written do not correlate with the decreases in direct premiums written, as the effect of the increased participation has reduced our ceded premium writings. Ceded premiums written for our core medical professional liability business, excluding amounts attributable to PIC-Florida for comparative reasons due to its deconsolidation in 2006, were 6.6% and 12.9% of direct premiums written during the nine months ended September 30, 2006 and 2005, respectively. While we anticipate that the changes in our reinsurance treaties from 2005 to 2006 will continue to result in an increase in our net premiums written and earned, the ultimate impact of these changes in our reinsurance treaties on net income will depend upon future underwriting results.

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The effects of the changes in our reinsurance program did not have as dramatic an effect on net premiums earned as it did on net premiums written for the nine months ended September 30, 2006 compared to 2005, as in 2006 we continue to earn in some of the premiums written under the 2005 treaty. This impact was minimized for the quarter, as a substantially larger percentage of the premiums earned during the three months ended September 30, 2006 and 2005 were written and earned in the same year.

The decreases in our incurred loss and loss adjustment expenses were partially attributable to decreases in exposure as a result of the 6.0% and 9.0% decreases in net premiums earned for the three and nine months ended September 30, 2006. We also continue to benefit from the enhancements we have made in our underwriting processes and claims processes over the last several years. The changes in our underwriting processes have resulted in a more stable book of insured accounts, which has resulted in a steady decline in the number of claims reported to us each quarter. Reported claims for the three months ended September 30, 2006 totaled 297, compared to 361 in the third quarter of 2005. As the number of claims reported to us has been decreasing, our average net paid loss has remained relatively consistent. While we anticipate that the benefits of the changes in our underwriting and claims handling practices will continue to result in decreases in the number of claims reported, we anticipate that the rate of decrease will be slower than the current rate.

The loss ratios for the three and nine months ended September 30, 2006 were 65.0% and 68.6%, respectively, compared with loss ratios of 76.7% and 79.1% for the three and nine months ended September 30, 2005, respectively. The decreases in the loss ratios are the result of the factors described above, as well as the rate increases we have taken over the last two to three years, which are now being fully earned. Favorable development on prior years’ loss reserves was $3.1 million and $8.1 million for the three and nine months ended September 30, 2006, respectively. Incurred losses and loss adjustment expenses for the three and nine months ended September 30, 2005 included approximately $1.3 million and $2.1 million of favorable prior year development. The favorable development on prior years’ loss reserves experienced in 2006 was primarily attributable to the emergence of lower frequency and severity trends than originally projected, especially related to accident years 2003 through 2005 in our Michigan and Ohio medical professional liability markets. These positive factors were partially offset by an increase in prior year reserves in our Florida market.

For the nine months ended September 30, 2006, the decrease in underwriting expense, compared to the nine months ended September 30, 2005, correlates with the decrease in net premiums earned for the same periods, as demonstrated by the approximately equivalent underwriting ratios of 20.2% for 2006 and 20.4% for 2005. The decrease in underwriting expenses for the three months ended September 30, 2006 was not as dramatic as the decrease in the nine-month period, primarily as a result of lower expenses during the three months ended September 30, 2005 due to a reduction of liabilities of approximately $500,000 recorded in the third quarter of 2005 related to an information technology implementation settlement.

Investment income was $11.3 million for the three months ended September 30, 2006 compared to $10.8 million for the same period in 2005. The overall investment yield for the three months ended September 30, 2006 was 5.29% compared to 5.18% for the same period in 2005. The increased investment yield was the result of higher short-term rates and the improved performance of certain collateralized mortgage obligations and equity investments in the third quarter. Investment income was $34.0 million for the nine months ended September 30, 2006 compared to $33.6 million for the same period in 2005. The overall annual yield on our investment portfolio decreased to 5.33% for the nine months ended September 30, 2006 compared to 5.40% for the nine months ended September 30, 2005. Investment income increased for the nine months ended September 30, 2006 primarily as a result of an increase in the overall average size of our investment portfolio. However, the nine month yield decreased as a result of the increased allocation in our portfolio to tax-exempt securities compared to 2005. In the first quarter of 2006, we purchased $193.0 million of tax-exempt securities. We now have a 24.2% allocation of our cash and investment portfolio in tax-exempt securities. The average annual yield on these securities is expected to be approximately 3.8%. Although we anticipate our annual gross investment returns to decrease in the future as a result of this allocation decision, we expect that the overall impact on net income of the purchase of these securities will be positive because of the associated tax savings.

Net realized gains reported for the nine months ended September 30, 2006 were primarily the result of the sale of investment real estate in the second quarter of 2006. This sale resulted in a realized gain of $1.4 million. Net

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realized losses for the three and nine months ended September 30, 2005 were the result of write-downs of the value of investment real estate holdings in Western Michigan. The last of these Western Michigan investment real estate properties was sold in the fourth quarter of 2005.

Other expenses consist primarily of investment expenses, interest expense, amortization expense, general and administrative expenses as shown below.

	For the Three Months Ended September 30,										For the Nine Months Ended September 30,
					Change										Change
	2006		2005		Dollar			Percentage			2006		2005		Dollar			Percentage
	(Dollars in thousands)										(Dollars in thousands)
Other expenses
Investment expenses		205		540		(335	)		(62.0	)%		602		1,216		(614	)		(50.5	)%
Interest expense		786		646		140			21.7	%		2,258		1,818		440			24.2	%
Amortization expense		—		157		(157	)		(100.0	)%		—		470		(470	)		(100.0	)%
General and administrative expenses		302		433		(131	)		(30.3	)%		988		2,269		(1,281	)		(56.5	)%
Other		8		48		(40	)		(83.3	)%		90		480		(390	)		(81.3	)%
Total		1,301		1,824		(523	)		(28.7	)%		3,938		6,253		(2,315	)		(37.0	)%

The decreases in other expenses for the three months and nine months ended September 30, 2006 were primarily the result of decreased depreciation expense related to investment real estate properties (investment expenses), the elimination of amortization expense as all intangible assets were fully amortized as of December 31, 2005, reduced professional service fees and other expenses following the initial year implementation in 2005 of the Securities and Exchange Commission requirements relating to certification of our internal control over financial reporting (general and administrative expenses), and reduced exit costs activities (“other” expenses).

Partially offsetting these decreases in other expenses were increases in interest expense as a result of increases in short-term interest rates. Our long-term debt of $30.9 million bears interest at 4.15% plus the three-month London Inter Bank Offered Rate (“LIBOR”). The weighted average annual interest rate for this debt was 9.65% and 9.20% for the three and nine months ended September 30, 2006, compared to 7.86% and 7.29% for the same periods in 2005. If the three-month LIBOR continues to increase, our interest expense will also increase. However, the annual rate of interest on this debt is capped at 12.5%. We currently anticipate that we will reduce or eliminate this debt in 2008. However, any such debt reduction is subject to cash flow and other liquidity factors as discussed in “— Liquidity and Capital Resources” below.

The effective tax rate for the three and nine months ended September 30, 2006 was 31.9% and 32.0%, respectively, compared with 35.1% and (123.2)% for the three and nine months ended September 30, 2005, respectively. The 2006 rates differ from the statutory rate of 35% primarily as a result of tax exempt investment income. Federal income taxes do not bear the usual relationship to pre-tax income for the nine-month period ended September 30, 2005 as a result of the effects of the reversal of the deferred tax asset valuation allowance, which created a $44.1 million tax benefit during the nine months ended September 30, 2005.

Liquidity and Capital Resources

The primary sources of our liquidity, on both a short- and long-term basis, are funds provided by insurance premiums collected, net investment income, recoveries from reinsurers and proceeds from the maturity or sale of invested assets and principal receipts from our mortgage-backed securities. The primary uses of cash, on both a short- and long-term basis, are losses, loss adjustment expenses, operating expenses, the acquisition of invested assets and fixed assets, reinsurance premiums, interest payments, taxes, the repayment of long-term debt, and the purchase of shares of APCapital’s outstanding common stock.

APCapital’s only material assets are cash and the capital stock of American Physicians and its other subsidiaries. APCapital’s cash flow consists primarily of dividends and other permissible payments from its subsidiaries and investment earnings on funds held. The payment of dividends to APCapital by its insurance

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subsidiaries is subject to limitations imposed by applicable law. Through September 30, 2006, American Physicians had paid APCapital $32 million in dividends, which was the maximum amount of dividends that could be paid without prior approval by the State of Michigan Office of Financial and Insurance Services. These dividends are being used to fund APCapital’s debt service and other operating costs, as well as the purchase of shares of APCapital’s outstanding common stock. At September 30, 2006, APCapital’s net cash and cash equivalent resources totaled approximately $13.9 million.

We continue to repurchase shares of our outstanding common stock, including 884,700 shares for $27.7 million in the first nine months of 2006. See Note 8 of the Notes to Condensed Consolidated Financial Statements for details of our share repurchase plans.

Our net cash flow from operations was $41.1 million for the nine months ended September 30, 2006, compared to $22.6 million for the same period of 2005. The increase in cash provided by operations was primarily the result of a $34.3 million decrease in paid loss and loss adjustment expenses, partially offset by a reduction in cash premium receipts of $7.7 million, a $3.7 million reduction in investment income collected and an increase in operating expenses paid of $4.4 million.

At September 30, 2006, the Company had $50.4 million of cash and cash equivalents and $49.2 million of fixed-income securities that mature in the next year that are available to meet short-term cash flow needs. On a long-term basis, fixed-income securities are purchased with the intent to provide adequate cash flows from maturities to meet future policyholder obligations and ongoing operational expenses. As of September 30, 2006, we had approximately $197.4 million, $300.9 million and $87.3 million ofavailable-for-sale andheld-to-maturity fixed-income securities that mature in the next one to five years, five to ten years and more than ten years, respectively. We also have approximately $168.1 million of mortgage-backed securities that provide periodic principal repayments.

On July 26, 2006, ProAssurance Corporation (“ProAssurance”) and Physicians Insurance Company of Wisconsin, Inc. (“PIC-Wisconsin”) announced that PIC-Wisconsin shareholders had approved PIC-Wisconsin’s merger into ProAssurance effective on August 1, 2006. Under the terms of the merger, each share of PIC-Wisconsin common stock was converted to shares of ProAssurance common stock having a value of approximately $5,000. Accordingly, we received ProAssurance common stock, having a total value of approximately $9.7 million in exchange for the 1,942 shares of PIC-Wisconsin common stock we owned. The carrying value of ourPIC-Wisconsin common stock was $7.6 million. In October 2006, we sold our shares of ProAssurance common stock and realized a gain of $2.1 million in connection with the sale during the fourth quarter of 2006.

Based on historical trends, economic, market and regulatory conditions and our current business plans, we believe that our existing resources and sources of funds, including possible dividend payments from our insurance subsidiaries to APCapital, will be sufficient to meet our short- and long-term liquidity needs. However, these trends, conditions and plans are subject to change, and there can be no assurance that our funds will be sufficient to meet our liquidity needs.

Financial Condition

In evaluating our financial condition, two factors are the most critical: first, the availability of adequate statutory capital and surplus to satisfy state regulatory requirements and support our current A.M. Best Company (“A.M. Best”) rating and second, the adequacy of our reserves for unpaid loss and loss adjustment expenses.

Statutory Capital and Surplus

Our statutory capital and surplus (collectively referred to herein as “surplus”) at September 30, 2006 was approximately $245.7 million. The $245.7 million of surplus results in a net premiums written to surplus ratio of 0.61:1. Surplus at December 31, 2005 was approximately $240.1 million, yielding a net premiums written to surplus ratio of 0.64:1. The increase in statutory surplus from December 31, 2005 to September 30, 2006 is the result of net income of $38.0 million, partially offset by $32 million of dividend payments by American Physicians to its parent company, APCapital. In general, A.M. Best and state insurance regulators prefer to see a net written premiums to surplus ratio for medical professional liability insurance companies of 1:1 or lower.

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During the second quarter of 2006, our primary insurance subsidiary, American Physicians received an upgrade in its A.M. Best rating from B+ to B++. Both the B++ and B+ ratings are considered “Very Good” by A.M. Best.

Reserves for Unpaid Losses and Loss Adjustment Expenses

Medical professional liability insurance is a “long-tailed” line of business, which means that claims may take several years from the date they are reported to us until the time at which they are either settled or closed. In addition, we also offer occurrence-based coverage in select markets, primarily Michigan and New Mexico. Occurrence-based policies offer coverage for insured events that occurred during the dates that a policy was in-force. This means that claims that have been incurred may not be reported to us until several years after the insured event has occurred. These claims, and their associated reserves, are referred to as incurred but not reported, or IBNR. IBNR reserves may also be recorded as part of the actuarial estimation of total reserves to cover any deficiency or redundancy in case reserves that may be indicated by the actuary’s analyses.

As previously mentioned in our discussion of incurred losses in the “— Results of Operations” section of this report, the number of claims reported to us has been steadily decreasing over the last two to three years. As a result, our open claim count has also been decreasing as we settle and close claims.

The table below shows the net case reserves, open claim counts, average net case reserves per open claim, net IBNR reserve and total net reserves for our medical professional liability line of business as of September 30, 2006 and December 31, 2005. Net reserves include direct and assumed reserves, the amount reported as unpaid loss and loss adjustment expenses in the accompanying unaudited Condensed Consolidated Balance Sheet, included elsewhere in this report, reduced by the amount of ceded reserves, which are reported as a component of reinsurance recoverables in the balance sheet. Data in the table does not include PIC-Florida counts or reserves, as claim count data has historically not been available to us.

	September 30,		December 31,
	2006		2005		Change			% Change
	(In thousands, except claim and per claim data)
Net case reserves	$	325,708	$	366,138	$	(40,430	)		(11.0	)%
Number of open claims		2,347		2,991		(644	)		(21.5	)%
Average net case reserve per open claim	$	138,776	$	122,413	$	16,363			13.4	%
Net IBNR reserves	$	228,298	$	178,123	$	50,175			28.2	%
Total net reserves	$	554,006	$	544,261	$	9,745			1.8	%

Workers’ compensation is also a long-tailed line of business, and as a result, even though all workers’ compensation policies expired in the second quarter of 2005, it will be several years until we settle all workers’ compensation claims. Our open number of workers’ compensation claims has decreased from 585 at December 31, 2005 to 410 at September 30, 2006. Workers’ compensation net reserves at September 30, 2006 were $29.0 million compared with $34.8 million at December 31, 2005. As the remaining open claims age, the ultimate amount of claim settlement should become more evident. As a result, volatility inherent in the actuarial projection of ultimate losses begins to stabilize, reducing the need to adjust loss reserves for previous accident years. We believe that the reserve we have established for workers’ compensation unpaid loss and loss adjustment expenses as of September 30, 2006 is adequate. However, due to the uncertainty inherent in such estimates, there can be no assurance that the ultimate cost of claims settlement will not exceed the reserves we have established, as future claims patterns may emerge differently than the assumptions utilized in our estimates.

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Activity in the liability for unpaid loss and loss adjustment expenses for the nine months ended September 30, 2006 and the year ended December 31, 2005 was as follows:

	Nine Months Ended			Year Ended
	September 30, 2006			December 31, 2005
Beginning balance, gross	$	689,857		$	693,630
Less, reinsurance recoverables		107,692			101,791
Net reserves, beginning balance		582,165			591,839
Deconsolidation of PIC-FL		(2,418	)		—
Incurred related to
Current year		85,352			131,496
Prior years		(8,132	)		(4,372	)
		77,220			127,124
Paid related to
Current year		1,731			5,054
Prior years		71,389			131,744
		73,120			136,798
Net reserves, ending balance		583,847			582,165
Plus, reinsurance recoverables		105,279			107,692
Ending balance, gross	$	689,126		$	689,857
Development as a % of beginning net reserves		(1.4	)%		(0.7	)%

While we believe that our estimate for ultimate projected losses related to our medical professional liability segment is adequate based on our open and reported claim counts and paid loss history, there can be no assurance that additional significant reserve enhancements will not be necessary in the future given the many variables inherent in such estimates and the extended period of time it can take for claim patterns to emerge.

Other Significant Balance Sheet Items

Our invested assets at September 30, 2006 consist primarily of fixed-income securities (92.3%) and cash and cash equivalents (5.8%). In addition we hold a small amount of strategic equity security investments, investment real estate and investment real estate limited partnerships (1.9%). Approximately 63.5% of our fixed-income securities were classified asheld-to-maturity at September 30, 2006. For more information on our fixed-income security portfolio and the risks inherent to such a portfolio, see “Item 3 — Quantitative and Qualitative Disclosures About Market and Credit Risk,” included elsewhere in this report.

At September 30, 2006, we had $50.4 million of cash and cash equivalents compared to $273.0 million at December 31, 2005. In the first quarter of 2006, we purchased $193.0 million of tax-exempt securities in anticipation of the utilization of the majority of our federal income tax net operating loss carryforwards sometime during 2006.

Our deferred income tax assets decreased approximately $9.6 million almost exclusively as a result of utilizing the remaining net operating loss carryforwards from the 2003 tax year. We still have approximately $3.5 million of net operating loss carryforwards. However these carryforwards are limited to an annual use of about $914,000 per year. In addition, we have approximately $6.5 million of minimum tax credits, which can be carried forward indefinitely and used to reduce our regular tax liability to the alternative minimum tax amount, if that amount is lower.

Other assets decreased $9.7 million to $29.9 million at September 30, 2006. The decrease was primarily the result of a $5.3 million decrease in the prepaid reinsurance premium, also known as ceded unearned premium. This decrease was largely attributable to the changes in our reinsurance treaties, discussed elsewhere in this report.

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However, approximately $2.5 million of the $5.3 million decrease in prepaid reinsurance premiums was the result of the deconsolidation of PIC-Florida. In addition to the decrease in prepaid reinsurance premiums, receivables for securities decreased $5.4 million as a result of the timing of investment transactions near each respective period end. These decreases were partially offset by an increase in accrued investment income of $3.6 million related to a higher invested asset base and a shift in our portfolio from cash and cash equivalents, which pay interest monthly, to tax-exempt securities, which typically pay interest semi-annually.

Other liabilities decreased $8.5 million to $33.4 million at September 30, 2006. In addition to accounts payable and other accruals, other liabilities included ceded reinsurance premium payable, advanced premiums and a liability account for pending security transactions. The $8.5 million decrease was partially the result of a $3.3 million decrease in ceded reinsurance payable, attributable to the settlement of prior year “swing-rated” treaties ($4.8 million) and the deconsolidation of PIC-Florida ($1.6 million), partially offset by adjustments made to deposit premiums paid in prior years ($3.2 million). In addition, there was a $3.1 million decrease in premiums received in advance, primarily due to the significant balance at December 31, 2005, which is the result of premiums received in advance of a large January 1 renewal date. Finally, there was a decrease in accrued expenses and other liabilities of approximately $2.2 million primarily due to the payment of a large unpaid corporate insurance invoice at December 31, 2005 and a decrease in our payables due to certain state patient compensation funds.

Shareholders’ equity at September 30, 2006 was $265.8 million, an increase of $4.6 million from $261.2 million at December 31, 2005. The increase was primarily attributable to reported net income of $30.6 million for the nine months ended September 30, 2006, as well as an increase inadditional-paid-in-capital of approximately $1.6 million attributable to our equity compensation plans. These increases were partially offset by the repurchase of $27.7 million of the Company’s outstanding common stock in the first nine months of 2006. The Company’s book value per common share outstanding at September 30, 2006 was $22.75, based on 11,684,973 shares outstanding, compared to $20.90 per common share outstanding at December 31, 2005. Total shares outstanding at December 31, 2005 were 12,500,125.

Contractual Obligations and Off-Balance Sheet Arrangements

Our contractual obligations and off-balance sheet arrangements are described in “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report onForm 10-K for the year ended December 31, 2005. Except as described elsewhere in this report onForm 10-Q, there have been no material changes to those obligations or arrangements outside of the ordinary course of business since the most recent fiscal year end.

Effects of New Accounting Pronouncements

The effects of new accounting pronouncements are described in Note 3 of the Notes to unaudited Condensed Consolidated Financial Statements included elsewhere in this report. Such information is incorporated herein by reference.

Item 3.   Quantitative and Qualitative Disclosures About Market Risk

General

Market risk is the risk of loss due to adverse changes in market rates and prices. We invest primarily in fixed-income securities, which are interest-sensitive assets. Accordingly, our primary market risk is exposure to changes in interest rates.

In addition, our fixed-income securities, bothavailable-for-sale andheld-to-maturity, are subject to a degree of credit risk. Credit risk is the risk that the issuer will default on interest or principal payments, or both, which could prohibit us from recovering a portion or all of our original investment.

As of September 30, 2006, the majority of our investment portfolio was invested in fixed-income security investments, as well as cash and cash equivalents. The fixed-income securities consisted primarily of U.S. government and agency bonds, high-quality corporate bonds, mortgage-backed securities and tax-exempt U.S. municipal bonds.

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Qualitative Information About Market Risk

At September 30, 2006, 99% of our fixed-income portfolio, bothavailable-for-sale andheld-to-maturity, (excluding approximately $13.3 million of private placement issues, which constitutes 1.7% of our portfolio) was considered investment grade. We define investment grade securities as those that have a Standard & Poor’s credit rating of BBB and above. The weighted average credit quality of our fixed-income security portfolio (again, excluding private placement issues) on the Standard & Poor’s credit rating scale was AA+ at September 30, 2006. Non-investment grade securities typically bear more credit risk than those of investment grade quality. In addition, we try to limit credit risk by not maintaining fixed-income security investments pertaining to any one issuer, with the exception of U.S. Government and agency backed securities, in excess of $6 million. We also diversify our holdings so that there is not a significant concentration in any one industry or geographical region. We periodically review our investment portfolio for any potential credit quality or collection issues and for any securities with respect to which we consider any decline in market value to be other than temporary.

Ourheld-to-maturity portfolio is not carried at estimated fair value. As a result, changes in interest rates do not affect the carrying amount of these securities. However, ourheld-to-maturity investment security portfolio includes approximately $167.8 million, or 32.9%, of mortgage-backed securities. While the carrying value of these securities is not subject to fluctuations as a result of changes in interest rates, changes in interest rates could impact our cash flows as an increase in interest rates will slow principal payments, and a decrease in interest rates will accelerate principal payments.

Quantitative Information About Market Risk

At September 30, 2006, ouravailable-for-sale fixed-income security portfolio was valued at $293.0 million and had an average modified duration of 2.84 years, compared to a portfolio valued at $224.1 million with an average modified duration of 2.27 years at December 31, 2005. The following tables show the effects of a change in interest rates on the fair value and duration of ouravailable-for-sale fixed-income security portfolio at September 30, 2006 and December 31, 2005. We have assumed an immediate increase or decrease of 1% or 2% in interest rate for illustrative purposes. You should not consider this assumption or the values shown in the table to be a prediction of actual future results.

	September 30, 2006							December 31, 2005
	Portfolio		Change in			Modified		Portfolio		Change in			Modified
Change in Rates	Value		Value			Duration		Value		Value			Duration
	(Dollars in thousands)							(Dollars in thousands)
+2%	$	277,589	$	(15,388	)		2.53	$	215,014	$	(9,087	)		1.89
+1%		284,902		(8,075	)		2.59		219,173		(4,928	)		2.16
0		292,977					2.84		224,101					2.27
−1%		301,586		8,609			2.92		228,991		4,890			2.36
−2%		310,691		17,714			3.01		234,917		10,816			2.50

Item 4.   Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure material information required to be disclosed in our reports that we file or submit under the Securities Exchange Act of 1934 (“Exchange Act”) is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required financial disclosures. In designing and evaluating the disclosure controls and procedures, we recognized that a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can

29

provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our Disclosure Committee and management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange ActRule 13a-15(b). Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of September 30, 2006.

Changes in Internal Control Over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1A.   Risk Factors

An investment in our common stock involves numerous risks and uncertainties. The first risk factor in Item 1A of the Company’sForm 10-K for the year ended December 31, 2005 has been amended and restated in its entirety as set forth in theForm 10-Q for the period ended March 31, 2006. There have been no other material changes from the risk factors contained in Item 1A of thatForm 10-K.

Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds.

The following table sets forth the repurchases of common stock for the quarter ended September 30, 2006:

					Total Number
	Total				of Shares		Maximum Number (or Approximate Dollar
	Number of		Average		Purchased as		Value) of Shares That May Yet be
	Shares		Price Paid		Part of Publicly		Purchased Under the Plans or Programs
	Purchased		per Share		Announced Plans		Discretionary Plan(a)		Rule 10b5-1 Plan(b)
For the month ended July 31, 2006		68,250	$	32.25		68,250		404,804	$	4,883,124
For the month ended August 31, 2006		120,300	$	31.21		120,300		404,804	$	11,128,374
For the month ended September 30, 2006		65,250	$	32.57		65,250		404,804	$	9,002,752
For the three months ended September 30, 2006		253,800	$	31.84		253,800		404,804	$	9,002,752

(a)

In November 2005, the Board of Directors authorized the purchase of an additional five percent of the Company’s outstanding common shares, which represents approximately 637,500 shares, at the discretion of management as part of a repurchase program that began March 30, 2001 (referred to as the “discretionary plan”). This most recent authorization brings the total number of shares authorized to be repurchased under the discretionary plan to 6,060,659. The timing of the purchases and the number of shares to be bought at any time depend on market conditions and the Company’s capital resources and requirements. The discretionary plan has no expiration date and may be terminated at any time.

(b)

In April 2006, the Company announced that its Board of Directors authorized an additional share repurchase of $20 million of its common shares, which would be repurchased under a newly adopted plan under

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Rule 10b5-1 of the Securities Exchange Act of 1934. In August 2006, the Board of Directors authorized an additional share repurchase of $10 million of its common shares under theRule 10b5-1 plan. TheRule 10b5-1 plan share repurchases are made pursuant to a formula in the plan and are expected to continue until the entire authorizations are utilized, subject to conditions specified in the plan, but not later than December 31, 2006. The Company may terminate the plan at any time. On October 27, 2006, the Company’s Board of Directors adopted a new stock repurchase plan for 2007 underRule 10b5-1 and authorized an additional share repurchase of $32 million of its common shares. In addition, the Board authorized the rollover into the 2007 plan of any unused dollars allocated to the 2006 10b5-1 plan.

Item 6.   Exhibits

Exhibits.

The Exhibits included as part of this report are listed in the attached Exhibit Index, which is incorporated herein by reference.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

AMERICAN PHYSICIANS CAPITAL, INC.

By:  /s/  R. Kevin Clinton

R. Kevin Clinton

Its: President and Chief Executive Officer

By:  /s/  Frank H. Freund

Frank H. Freund

Its: Executive Vice President, Treasurer and

Chief Financial Officer

Date: November 9, 2006

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EXHIBIT INDEX

Exhibit No.			Exhibit Description
	31	.1	Certification of Chief Executive Officer pursuant toRule 13a-14(a) under the Securities Exchange Act of 1934.
	31	.2	Certification of Chief Financial Officer pursuant toRule 13a-14(a) under the Securities Exchange Act of 1934.
	32		Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 andRule 13a-14(b) under the Securities Exchange Act of 1934.

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