American Physicians Capital (ACAP) 10-Q 2007 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, 2007
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
(State or other jurisdiction of
incorporation or organization) 38-3543910
(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 October 31, 2007 was 10,566,661.

TABLE OF CONTENTS

PART I.  FINANCIAL INFORMATION
	Item 1	.	Financial Statements
			Condensed Consolidated Balance Sheets	3
			Condensed Consolidated Statements of Income	4
			Condensed Consolidated Statements of Shareholders’ Equity	5
			Condensed Consolidated Statements of Comprehensive Income	6
			Condensed Consolidated Statements of Cash Flows	7
			Notes to Condensed Consolidated Financial Statements	8
	Item 2	.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
	Item 3	.	Quantitative and Qualitative Disclosures About Market Risk	22
	Item 4	.	Controls and Procedures	23
PART II.  OTHER INFORMATION
	Item 1A	.	Risk Factors	24
	Item 2	.	Unregistered Sales of Equity Securities and Use of Proceeds	24
	Item 5	.	Other Information	25
	Item 6	.	Exhibits	25
Signatures				26
Exhibit Index				27
Amendment No.2 to Stock Compensation Plan, dated October 25, 2007
Form of Amendment No.1 to Form of Executive Employment Agreement
Amendment No.1 to Incentive Compensation Plan
Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
Certification of Chief Executive Officer and Chief Financial Officer pusuant to U.S.C. Section 1350

2

PART I. FINANCIAL INFORMATION

ITEM 1.   FINANCIAL STATEMENTS

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

	September 30,		December 31,
	2007		2006
	(Unaudited)
	(In thousands, except
	share data)
ASSETS
Investments:
Fixed-income securities
Available-for-sale, at fair value	$	279,066	$	255,001
Held-to-maturity, at amortized cost		498,940		505,572
Other investments		12,180		6,476
Total investments		790,186		767,049
Cash and cash equivalents		81,525		108,227
Premiums receivable		41,342		43,068
Reinsurance recoverable		111,573		109,013
Deferred federal income taxes		26,643		32,795
Property and equipment, net of accumulated depreciation		11,950		9,775
Other assets		24,327		25,888
Total assets	$	1,087,546	$	1,095,815
LIABILITIES
Unpaid losses and loss adjustment expenses	$	680,096	$	688,031
Unearned premiums		68,744		70,744
Long-term debt		30,928		30,928
Federal income taxes payable		2,737		189
Other liabilities		34,202		37,113
Total liabilities		816,707		827,005
Commitments & Contingencies
Shareholders’ Equity
Common stock, no par value, 50,000,000 shares authorized: 10,575,799 and 11,556,575 shares outstanding at September 30, 2007 and December 31, 2006, respectively		—		—
Additionalpaid-in-capital		4,348		41,106
Retained earnings		261,992		222,935
Accumulated other comprehensive income:
Net unrealized appreciation on investments, net of deferred federal income taxes		4,499		4,769
Total shareholders’ equity		270,839		268,810
Total liabilities and shareholders’ equity	$	1,087,546	$	1,095,815

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,
	2007			2006			2007			2006
	(Unaudited)
	(In thousands, except per share data)
Net premiums written	$	43,626		$	48,304		$	105,487		$	117,351
Change in net unearned premiums		(8,110	)		(10,532	)		(43	)		(4,716	)
Net premiums earned		35,516			37,772			105,444			112,635
Investment income		10,737			11,338			33,066			34,010
Net realized (losses) gains		(73	)		100			(139	)		1,448
Other income		186			198			574			825
Total revenues and other income		46,366			49,408			138,945			148,918
Losses and loss adjustment expenses		18,233			24,547			53,511			77,220
Underwriting expenses		7,275			7,373			22,202			22,784
Investment expenses		231			205			648			602
Interest expense		796			786			2,351			2,258
General and administrative expenses		333			302			1,028			988
Other expenses		1			8			3			90
Total expenses		26,869			33,221			79,743			103,942
Income before federal income taxes		19,497			16,187			59,202			44,976
Federal income tax expense		6,216			5,162			19,083			14,376
Net income	$	13,281		$	11,025		$	40,119		$	30,600
Net income — per common share
Basic	$	1.23		$	0.93		$	3.61		$	2.52
Diluted	$	1.21		$	0.91		$	3.54		$	2.47
Cash dividends declared per common share	$	0.10		$	—		$	0.10		$	—

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 Shareholders’ Equity

										Accumulated
				Additional						Other
	Shares			Paid-in			Retained			Comprehensive
	Outstanding			Capital			Earnings			Income			Total
	(Unaudited)
	(In thousands, except share data)
Balance, December 31, 2006		11,556,575		$	41,106		$	222,935		$	4,769		$	268,810
Comprehensive income:
Net income					—			40,119			—			40,119
Other comprehensive loss					—			—			(270	)		(270	)
Total comprehensive income, net of taxes														39,849
Options exercised		18,025			215			—			—			215
Shares tendered/netted in connection with option exercise		(3,201	)		(122	)		—			—			(122	)
Cash dividends to shareholders, $0.10 per share								(1,062	)					(1,062	)
Excess tax benefits from share-based awards					320			—			—			320
Fair value compensation of share-based awards					142			—			—			142
Purchase and retirement of common stock		(995,600	)		(37,313	)		—			—			(37,313	)
Balance, September 30, 2007		10,575,799		$	4,348		$	261,992		$	4,499		$	270,839

									Accumulated
				Additional					Other
	Shares			Paid-in			Retained		Comprehensive
	Outstanding(1)			Capital			Earnings		Income		Total
	(Unaudited)
	(In thousands, except share data)
Balance, December 31, 2005		12,500,126		$	74,360		$	179,748	$	7,104	$	261,212
Comprehensive income:
Net income					—			30,600		—		30,600
Other comprehensive income					—			—		68		68
Total comprehensive income, net of taxes												30,668
Options exercised		78,600			760			—		—		760
Shares tendered/netted in connection with option exercise		(8,289	)		(270	)		—		—		(270	)
Excess tax benefits from share-based awards					700			—		—		700
SFAS No. 123R adoption					(46	)		—		—		(46	)
Fair value compensation of share-based awards					459			—		—		459
Purchase and retirement of common stock		(884,700	)		(27,701	)		—		—		(27,701	)
Forfeiture of restricted stock		(764	)		—			—		—		—
Balance, September 30, 2006		11,684,973		$	48,262		$	210,348	$	7,172	$	265,782

(1) Share amounts have been retroactively adjusted to reflect a three-for-two stock split effective November 1, 2006. See Note 2.

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 Comprehensive Income

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2007			2006			2007			2006
	(Unaudited)
	(In thousands)
Net income	$	13,281		$	11,025		$	40,119		$	30,600
Other comprehensive income (loss):
Unrealized appreciation on available-for-sale investment securities arising during the period		2,920			5,826			361			1,082
Amortization of net unrealized appreciation on held-to-maturity investment securities since the date of transfer from the available-for-sale category		(234	)		(272	)		(716	)		(829	)
Adjustment for realized losses on investment securities included in net income		—			—			(60	)		(148	)
Other comprehensive income (loss) before tax		2,686			5,554			(415	)		105
Deferred federal income tax expense (benefit)		941			1,944			(145	)		37
Other comprehensive income (loss)		1,745			3,610			(270	)		68
Comprehensive income	$	15,026		$	14,635		$	39,849		$	30,668

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 Cash Flows

	Nine Months Ended
	September 30,
	2007			2006
	(Unaudited)
	(In thousands)
Cash flows from (for) operating activities
Net income	$	40,119		$	30,600
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization		2,256			2,240
Net realized losses (gains)		139			(1,448	)
Deferred federal income taxes		6,297			9,259
Excess tax benefits from share-based awards		(320	)		(700	)
Share-based compensation		142			459
Income on equity method investees		(101	)		(1,001	)
Changes in:
Unpaid loss and loss adjustment expenses		(7,935	)		3,412
Unearned premiums		(2,000	)		1,909
Other assets and liabilities		836			(3,585	)
Net cash from operating activities		39,433			41,145
Cash flows from (for) investing activities
Purchases
Available-for-sale — fixed income		(56,234	)		(126,979	)
Held-to-maturity — fixed income		(5,312	)		(188,188	)
Other investments		(5,901	)		(386	)
Property and equipment		(2,981	)		(216	)
Proceeds from sales and maturities
Available-for-sale — fixed income		31,685			50,938
Held-to-maturity — fixed income		10,325			22,514
Other investments		375			2,485
Property and equipment		22			6
Deconsolidation of PIC-Florida		—			(2,941	)
Pending securities transactions		—			5,285
Net cash for investing activities		(28,021	)		(237,482	)
Cash flows from (for) financing activities
Common stock repurchased		(37,313	)		(27,701	)
Excess tax benefits from share-based awards		320			700
Change in payable for shares repurchased		(152	)		295
Cash dividends paid		(1,062	)		—
Proceeds from stock options exercised		93			490
Net cash for financing activities		(38,114	)		(26,216	)
Net decrease in cash and cash equivalents		(26,702	)		(222,553	)
Cash and cash equivalents, beginning of period		108,227			272,988
Cash and cash equivalents, end of period	$	81,525		$	50,435

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 and May 10, 2006, APManagement Ltd. and APIndemnity (Bermuda) Ltd., respectively, were 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 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, 2006 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 and nine-month periods ended September 30, 2007 are not necessarily indicative of the results to be expected for the year ending December 31, 2007. 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, 2006.

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, the fair 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.

Software for Internal Use

Certain costs incurred related to software developed for internal use are accounted for in accordance with the American Institute of Certified Public Accountants’ Statement of PositionNo. 98-1(“SOP 98-1”),Accounting for Costs of Computer Software Developed or Obtained for Internal Use.In accordance withSOP 98-1, costs incurred in the planning and post-implementation stages are expensed as incurred, while costs relating to application development are capitalized. Qualifying software and development costs are included as an element of property and equipment in the unaudited Condensed Consolidated Balance Sheet at September 30, 2007. Once the software is placed into production, the Company will amortize such software costs over the shorter of the estimated useful life of the software or five years.

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AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements — (Continued)

Nature of Business

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.

Reclassification

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

2.   Stock Split

On September 25, 2006, the Company’s Board of Directors declared a three-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

Effective January 1, 2007, the Company adopted Financial Accounting Standards Board (“FASB”) 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 adoption of this statement did not have a material impact on the Company’s consolidated financial position or results of operations. The Company determined that there were no material liabilities for uncertain tax positions; therefore, the disclosures required by FIN 48 were not made.

Statement of Financial Accounting Standards (“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 September 30, 2007, 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 future periods prior to the adoption of SFAS No. 157 may result in a different assessment of the impact of adoption.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment of FAS 115,” which permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of this statement is to provide entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The provisions of SFAS No. 159 are effective for fiscal years beginning after November 15, 2007. The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

9

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 September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
	(In thousands, except per share data)
Numerator for basic and diluted income per common share:
Net income	$	13,281	$	11,025	$	40,119	$	30,600
Denominator:
Denominator for basic income per common share — weighted average shares outstanding		10,801		11,796		11,124		12,123
Effect of dilutive stock options and awards		214		266		215		267
Denominator for diluted income per common share — adjusted weighted average shares outstanding		11,015		12,062		11,339		12,390
Net income — basic	$	1.23	$	0.93	$	3.61	$	2.52
Net income — diluted	$	1.21	$	0.91	$	3.54	$	2.47

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 average stock price during the period exceeds the exercise price 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 and nine months ended September 30, 2007 and 2006, there were no stock options that were considered to be anti-dilutive.

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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, 2006, 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 this report and our other reports filed with the Securities and Exchange Commission, including those listed in our Annual Report onForm 10-K under “Item 1A — Risk Factors,” 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.

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

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

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

•  A downgrade in the A.M. Best Company rating of our primary 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.

•  The unpredictability of court decisions could have a material impact on our operations.

•  Our business could be adversely affected by the loss of one or more key employees.

•  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 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.

•  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.

•  Applicable law and various provisions in our articles and bylaws may prevent and discourage unsolicited attempts to acquire APCapital that you may believe are in your best interests or that might result in a substantial profit to you.

11

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.

Overview of the Company’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 focus on writing physician medical professional liability coverage in five core states: Michigan, Illinois, Ohio, New Mexico and Kentucky. We also write a small amount of business in contiguous states.

We previously offered workers’ compensation insurance and health insurance products. 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. Health insurance is a much shorter-tailed line of business, and as such, we have no material reserves remaining related to our health insurance programs.

On September 25, 2006, the Company’s Board of Directors declared a three-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.

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, 2006, and in Note 1 to our Consolidated Financial Statements contained in that report. The only material changes to these policies since the most recent year end is the addition of a new policy with respect to software developed for internal use, described below.

Software for Internal Use

Certain costs incurred related to software developed for internal use are accounted for in accordance with the American Institute of Certified Public Accountants’ Statement of PositionNo. 98-1(“SOP 98-1”),Accounting for Costs of Computer Software Developed or Obtained for Internal Use.In accordance withSOP 98-1, costs incurred in the planning and post-implementation stages are expensed as incurred, while costs relating to application development are capitalized.

One of the components of the cost of application development is salary and benefit expense related to employees who work on the development project. We determine salary expense based on an estimated percentage of an individual employee’s time spent working on the project. Benefit expenses are allocated to the development project by applying the ratio of benefit costs to salary expense for all employees to the salary expense allocated to the project. From the start of the project in mid-March 2007 through September 30, 2007, we have capitalized approximately $994,000 of employee salary and benefit costs in connection with internally developed software projects.

12

Qualifying software and development costs are included as an element of property and equipment in the unaudited consolidated balance sheet. Once the software is placed into production, the Company will amortize such software costs over the shorter of the estimated useful life of the software or five years.

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 our 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 presented here because 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.

13

Results of Operations — Three and Nine Months Ended September 30, 2007 Compared to Three and Nine Months Ended September 30, 2006

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

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 periods ended September 30, 2007 and 2006.

	For the Three Months Ended September 30,
							Change
	2007			2006			Dollar			Percentage
	(Dollars in thousands)
Direct premiums written	$	45,213		$	51,819		$	(6,606	)		(12.7	)%
Net premiums written	$	43,626		$	48,304		$	(4,678	)		(9.7	)%
Net premiums earned	$	35,516		$	37,772		$	(2,256	)		(6.0	)%
Losses and loss adjustment expenses
Current year losses		26,191			27,693			(1,502	)		(5.4	)%
Prior year losses		(7,958	)		(3,146	)		(4,812	)		153.0	%
Total		18,233			24,547			(6,314	)		(25.7	)%
Underwriting expenses		7,275			7,373			(98	)		(1.3	)%
Total underwriting gain		10,008			5,852			4,156			71.0	%
Other revenue (expense) items
Investment income		10,737			11,338			(601	)		(5.3	)%
Net realized (losses) gains		(73	)		100			(173	)		(173.0	)%
Other income		186			198			(12	)		(6.1	)%
Other expenses(1)		(1,361	)		(1,301	)		(60	)		4.6	%
Total other revenue and expense items		9,489			10,335			(846	)		(8.2	)%
Income before federal income taxes		19,497			16,187			3,310			20.4	%
Federal income tax expense		6,216			5,162			1,054			20.4	%
Net income	$	13,281		$	11,025		$	2,256			20.5	%
Loss Ratio:
Accident year		73.7	%		73.3	%					0.4	%
Prior years		(22.4	)%		(8.3	)%					(14.1	)%
Calendar year		51.3	%		65.0	%					(13.7	)%
Underwriting expense ratio		20.5	%		19.5	%					1.0	%
Combined ratio		71.8	%		84.5	%					(12.7	)%

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

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	For the Nine Months Ended September 30,
							Change
	2007			2006			Dollar			Percentage
	(Dollars in thousands)
Direct premiums written	$	109,362		$	125,742		$	(16,380	)		(13.0	)%
Net premiums written	$	105,487		$	117,351		$	(11,864	)		(10.1	)%
Net premiums earned	$	105,444		$	112,635		$	(7,191	)		(6.4	)%
Losses and loss adjustment expenses
Current year losses		78,632			85,352			(6,720	)		(7.9	)%
Prior year losses		(25,121	)		(8,132	)		(16,989	)		208.9	%
Total		53,511			77,220			(23,709	)		(30.7	)%
Underwriting expenses		22,202			22,784			(582	)		(2.6	)%
Total underwriting gain		29,731			12,631			17,100			135.4	%
Other revenue (expense) items
Investment income		33,066			34,010			(944	)		(2.8	)%
Net realized (losses) gains		(139	)		1,448			(1,587	)		(109.6	)%
Other income		574			825			(251	)		(30.4	)%
Other expenses(1)		(4,030	)		(3,938	)		(92	)		2.3	%
Total other revenue and expense items		29,471			32,345			(2,874	)		(8.9	)%
Income before federal income taxes		59,202			44,976			14,226			31.6	%
Federal income tax expense		19,083			14,376			4,707			32.7	%
Net income	$	40,119		$	30,600		$	9,519			31.1	%
Loss Ratio:
Accident year		74.5	%		75.8	%					(1.3	)%
Prior years		(23.8	)%		(7.2	)%					(16.6	)%
Calendar year		50.7	%		68.6	%					(17.9	)%
Underwriting expense ratio		21.1	%		20.2	%					0.9	%
Combined ratio		71.8	%		88.8	%					(17.0	)%

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

The increases in net income were primarily the result of an increase in favorable development on prior years’ loss reserves, partially offset by an increase in the associated federal income tax expense. The favorable development on prior years’ loss reserves is discussed in more detail in the section entitled “Loss and Loss Adjustment Expenses” below.

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Premiums Written and Earned

The following table shows our direct premiums written by major geographical market for the three and nine months ended September 30, 2007 and 2006.

	For the Three Months Ended September 30,										For the Nine Months Ended September 30,
					Change											Change
	2007		2006		Dollar			Percentage			2007		2006			Dollar			Percentage
	(Dollars in thousands)							(Dollars in thousands)
Direct premiums written
Michigan	$	16,898	$	17,411	$	(513	)		(2.9	)%	$	36,312	$	36,739		$	(427	)		(1.2	)%
Illinois		12,944		17,379		(4,435	)		(25.5	)%		30,281		42,190			(11,909	)		(28.2	)%
Ohio		7,087		7,887		(800	)		(10.1	)%		21,138		22,965			(1,827	)		(8.0	)%
New Mexico		5,842		6,124		(282	)		(4.6	)%		14,794		15,903			(1,109	)		(7.0	)%
Kentucky		987		1,306		(319	)		(24.4	)%		4,343		5,091			(748	)		(14.7	)%
Other		1,455		1,712		(257	)		(15.0	)%		2,494		2,868			(374	)		(13.0	)%
Subtotal		45,213		51,819		(6,606	)		(12.7	)%		109,362		125,756			(16,394	)		(13.0	)%
Exited lines of business		—		—		—						—		(14	)		14			(100.0	)%
Total	$	45,213	$	51,819	$	(6,606	)		(12.7	)%	$	109,362	$	125,742		$	(16,380	)		(13.0	)%

Even though the medical malpractice insurance market has become highly competitive, we have been successful in retaining most of our insured physicians. Our average retention ratio, which is the number of policies that we renew in a given period as a percentage of the number of policies that expire during the same period, has increased from 82% for the nine months ended September 30, 2006 and year ended December 31, 2006, to 86% for the nine months ended September 30, 2007. Competition has been increasing in Illinois, where our 81% retention ratio for the nine months ended September 30, 2007, was below our Company-wide average. Our insured physician count at September 30, 2007 was 9,313, down 1.9% compared to September 30, 2006, and 1.5% compared to December 31, 2006.

Due to improving loss experience and competitive pressures, we have reduced premium rates in most markets and increased the use of schedule rate credits. As a result, the average premium per policy decreased approximately 9.8% to $14,621 at September 30, 2007, from $16,215 at September 30, 2006, and 8.4% compared to the average premium per policy of $15,967 at December 31, 2006.

We anticipate that the medical malpractice insurance pricing environment will remain competitive in the near future. However, we remain committed to our philosophy of underwriting discipline and adequate pricing.

Net premiums written for the third quarter of 2007, as a percentage of direct premiums written, increased to 96.5% from 93.2% in the third quarter of 2006 and to 96.5% from 93.3% when comparing the nine months ended September 30, 2007, to the same period in 2006. The increase in the percentage of premium we are retaining is primarily related to changes in our reinsurance program for the 2007 policy year. Effective January 1, 2007, we began retaining the first $1.0 million of loss exposure in all states. This compares with retaining the first $500,000 of loss exposure in 2006 and then a 50% participation in our excess of loss reinsurance layer, which are all losses in excess of $500,000. We anticipate that the changes in our reinsurance treaties from 2006 to 2007 will continue to result in a net premiums written to direct premiums written ratio of approximately 96.5% for the remainder of 2007. However, the ultimate impact of these changes in our reinsurance treaties on net income will depend upon future loss frequency and severity.

Net premiums earned did not decrease as much as net premiums written, as in 2007 we continue to earn in the higher premium volume written in 2006.

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Loss and Loss Adjustment Expenses

The decreases in incurred loss and loss adjustment expenses, which we refer to collectively as losses, and the calendar year loss ratios were primarily attributable to increases in the favorable development on prior years’ loss reserves, as our current accident year loss ratios in 2007 remain relatively consistent with those for the same periods of 2006.

The increases in favorable development on prior years’ loss reserves were attributable primarily to three factors. The most significant factor was a decline in the frequency of reported claims. Medical professional liability claims reported to us during the most recent quarter were down 35.7% from the third quarter of 2006. Year-to-date through September 30, 2007, claims reported to us were down 21.5% compared with the first nine months of 2006. Another factor was that paid severity has remained relatively stable over the past several quarters. While the average paid loss per closed claim will often fluctuate from quarter to quarter, it has remained relatively stable over the past three years. The third contributing factor is the amount of savings we have had upon claim closure. Savings on closed claims occurs when the claim is ultimately settled or closed at less than the recorded case reserve. This factor was especially significant in the second quarter of 2007 when we had several potentially high severity claims that were closed with no indemnity payment.

We have remained cautious regarding the impact of loss trends noted in 2007 on the actuarially projected ultimate net losses. Accordingly, we continue to reserve the current accident year at what we deem to be prudent levels to guard against future increases in claims frequency or severity as we remain uncertain that the trends indicated in 2007 will continue in future periods.

During the third quarter of 2007, we recovered substantially all of the outstanding amounts from a reinsurer that had fallen behind in its payments due to the Company. As a result, we reversed the $928,000 allowance that we had established in the second quarter of 2007 related to recoverable amounts from this reinsurer, which in effect reduced net incurred losses and loss adjustment expense in the third quarter of 2007 by that amount. For the nine months ended September 30, 2007, the establishment and subsequent reversal of the allowance had no impact on incurred losses.

Underwriting Expenses

Underwriting expenses decreased slightly as a result of our decreasing premium volume. However, as a percentage of net premiums earned, underwriting expenses increased to 20.5% and 21.1% for the three and nine months ended September 30, 2007, from 19.5% and 20.2%, respectively, for the same period of 2006. As our premium volume has declined, the fixed cost portion of our underwriting expenses represents a relatively greater proportion of overall underwriting expenses, thereby resulting in an increase in the underwriting expense ratio. If our premium volume continues to decline, we anticipate that our underwriting expense ratio may continue to increase in the future.

Investment Income

Investment income decreased slightly for the three and nine months ended September 30, 2007 compared to the same periods in 2006. The overall investment yields for the three and nine months ended September 30, 2007 were 4.93% and 5.05%, compared to 5.29% and 5.33%, respectively, for the same periods in 2006. Investment income decreased primarily as a result of the increased allocation in our portfolio to tax-exempt securities and the maturity in 2006 and 2007 of a few older corporate bonds, that had a higher yield than is currently available in the market for similar securities. In June 2007 we purchased an additional $61.5 million of tax-exempt securities, increasing the percentage of our total cash and investment portfolio allocated to tax-exempt securities to 31.5% at September 30, 2007, from 23.8% at December 31, 2006. While this increase in tax-exempt securities will likely decrease investment income and the overall investment yield in future periods, we expect that the impact on net income of the purchase of these securities will be positive because of the associated tax savings.

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Income Taxes

The effective tax rates for the three and nine months ended September 30, 2007 were 31.9%, and 32.2%, compared with 31.9% and 32.0%, respectively, for the same periods in 2006. The rates differ from the statutory rate of 35% primarily as a result of tax exempt investment income. While our tax-exempt interest income in 2007 has increased compared to 2006, the pre-tax income increased (the denominator in the effective tax rate calculation) more than the impact of the tax-exempt interest income, thereby increasing the effective tax rate for the nine months ended September 30, 2007 compared to the same period in 2006.

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 repurchase of shares of APCapital’s outstanding common stock.

In addition, we paid a cash dividend of $0.10 per common share on September 28, 2007 to shareholders of record as of September 12, 2007. The dividend resulted in a payout of approximately $1.1 million, based on a total of 10.6 million shares outstanding. On October 25, 2007, the Board of Directors declared a fourth-quarter cash dividend of $0.10 per common share payable on December 31, 2007 to shareholders of record on December 13, 2007, which is expected to result in a payout of approximately $1.0 million.

The Board’s current intention is to pay a comparable cash dividend on a quarterly basis for the foreseeable future. However, the payment of future dividends will depend upon the availability of cash resources at APCapital, the financial condition and results of operations of the Company and such other factors as are deemed relevant by the Board of Directors.

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 subsidiaries is subject to limitations imposed by applicable law. In accordance with these limits, $49.2 million of dividends could be paid to APCapital during calendar year 2007 without prior approval from the State of Michigan Office of Financial and Insurance Services, or OFIS. However, in August 2007, the Company obtained permission from OFIS to pay extraordinary dividends, which are dividends in excess of the normal limits as described above, of $40 million from American Physicians and $2.25 million from Insurance Corporation of America. Thus, through September 30, 2007, APCapital has received dividend payments from its subsidiaries totaling approximately $81.9 million. Because dividend limitations are also subject to the timing of the payments, we do not anticipate that any additional dividends will be paid to APCapital by its subsidiaries until at least the third quarter of 2008. At September 30, 2007, APCapital’s net cash and cash equivalent resources totaled approximately $61.2 million.

We continue to repurchase shares of our outstanding common stock, including 506,400 shares during the third quarter of 2007 at a cost of $18.8 million. Year to date through September 30, 2007, we have repurchased 995,600 shares at a cost of $37.3 million. See Part II, Item 2. “Unregistered Sales of Equity Securities and Use of Proceeds” for details of our share repurchase plans.

Our net cash flow from operations was $39.4 million for the nine months ended September 30, 2007, compared to $41.1 million for the same period of 2006. The decrease in cash provided by operations was primarily the result of a decrease in cash premium receipts of $5.5 million, an increase in income taxes paid of $6.3 million, and an increase in operating expenses paid of $2.6 million, partially offset by a $9.3 million decrease in paid loss and loss adjustment expenses and a $3.4 million increase in investment income collected.

At September 30, 2007, the Company had $81.5 million of cash and cash equivalents and $279.1 million of available-for-sale fixed-income securities 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, 2007, we had approximately $89.7 million,

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$177.3 million and $78.4 million of held-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 $153.5 million of mortgage-backed securities, classified as held-to-maturity, which provide periodic principal repayments.

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 in the future. In addition, any acquisition or transaction APCapital may pursue, outside of the ordinary course of business, could require that we raise additional capital.

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 (B++) 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, 2007 was approximately $205.8 million. This results in a net premiums written to surplus ratio of 0.66:1 based on $134.9 million of net premiums written over the last 12 months. Statutory surplus at December 31, 2006 was approximately $248.9 million, yielding a net premiums written to surplus ratio of 0.59:1. 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. Statutory surplus from December 31, 2006 to September 30, 2007, decreased as a result of the $81.9 million in dividend payments by American Physicians and Insurance Corporation of America to its parent company, APCapital. This decrease was partially offset by $46.8 million of statutory net income.

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. Case reserves are established for open claims and represent management’s estimate of the ultimate net settlement cost of a claim, and the costs to investigate, defend and settle the claim, based on the information available about a given claim at a point in time.

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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, 2007, December 31, 2006 and September 30, 2006. 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.

							September 30, 2007 versus						September 30, 2007 versus
	September 30,		December 31,		September 30,		December 31, 2006						September 30, 2006
	2007		2006		2006		Change			% Change			Change			% Change
	(In thousands, except claim and per claim data)
Net case reserves	$	275,836	$	311,142	$	325,708	$	(35,306	)		(11.3	)%	$	(49,872	)		(15.3	)%
Number of open claims		1,913		2,256		2,347		(343	)		(15.2	)%		(434	)		(18.5	)%
Average net case reserve per open claim	$	144,190	$	137,918	$	138,776	$	6,272			4.5	%	$	5,414			3.9	%
Net IBNR reserves	$	268,945	$	241,068	$	228,298	$	27,877			11.6	%	$	40,647			17.8	%
Total net reserves	$	544,781	$	552,210	$	554,006	$	(7,429	)		(1.3	)%	$	(9,225	)		(1.7	)%

Medical professional liability total net reserves decreased compared to December 31, 2006 and September 30, 2006 primarily due to the settlement of several claims during the second quarter of 2007 for significantly less than recorded case reserves, as well as continued decreases in the number of claims reported to us throughout 2007. The number of reported claims in the third quarter of 2007 was 191, a decrease of 35.7% from the same period in 2006. For the nine months ended September 30, 2007, there were 707 claims reported in 2007 as compared to 901 claims through September 30, 2006, a decrease of 21.5%. This trend in decreasing claim frequency has been ongoing for several years. We believe the decrease in claims frequency is primarily attributable to our underwriting efforts and the emphasis we have placed on underwriting good accounts, as well as the overall declining frequency trend in our industry sector.

As a result of decreases in reported claims, our open claims count has also decreased as we continue to settle and close claims reported to us in previous periods. As a result of the decrease in the number of open claims, net case reserves have also been decreasing over the past 12 quarters, though at a lesser rate. Open claim counts have decreased 49.7% since September 30, 2004, while net case reserves have decreased at a 29.8% rate. However, this discrepancy is to be expected as higher severity claims typically take longer to settle and our projection of ultimate net losses includes assumptions for loss cost inflation. Both of these factors have contributed to the increase in our average net case reserve per open claim over time.

While net case reserves have been decreasing, net IBNR reserves have increased approximately 90.8% over the same period, from $140.9 million at September 30, 2004 to $268.9 million at September 30, 2007. The estimation of total net reserves is based on the actuarially projected ultimate cost to settle, defend and handle both claims reported to us, as well as those that have been incurred, but not yet reported. As such, the distinction between case and IBNR reserves is less important than the overall adequacy of our total reserves.

Although considerable judgment is inherent in the estimation of net loss and loss adjustment expense reserves, we believe that our net reserves for medical professional liability claims are adequate. However, there can be no assurance that losses will not exceed the reserves we have recorded or that we will not later determine that our reserve estimates were inadequate, as future trends related to the frequency and severity of claims, and other factors may develop differently than management has projected. The assumptions and methodologies used in estimating and establishing reserves for unpaid loss and loss adjustment expenses are continually reviewed and any adjustments are reflected as income or expense in the period in which the adjustment is made. Historically, such adjustments have not exceeded eight-percent (8%) of our recorded net reserves as of the beginning of the period, but such adjustments can materially and adversely affect our results of operations when they are made.

Workers’ compensation is also a long-tailed line of business, and as a result, it will be several years until we settle all workers’ compensation claims. Our open number of workers’ compensation claims has decreased from

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357 at December 31, 2006 to 273 at September 30, 2007. It is important to note, however, that workers’ compensation insurance is written on an occurrence basis, and as such, claims may have been incurred in prior periods when we actively provided coverage that have not been reported to us yet. Workers’ compensation net reserves at September 30, 2007 were $24.4 million compared with $27.1 million at December 31, 2006. 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, 2007, 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 or that we will not later determine that our reserve estimates were inadequate, as future claims patterns may emerge differently than the assumptions utilized in our estimates.

Activity in the liability for unpaid loss and loss adjustment expenses for the nine months ended September 30, 2007 and the year ended December 31, 2006, was as follows (dollars in thousands):

	Nine Months Ended			Year Ended
	September 30,			December 31, 2006
Beginning balance, gross	$	688,031		$	689,857
Less, reinsurance recoverables		107,965			107,692
Net reserves, beginning balance		580,066			582,165
Deconsolidation of PIC-FL		—			(2,418	)
Incurred related to
Current year		78,632			113,338
Prior years		(25,121	)		(12,880	)
		53,511			100,458
Paid related to
Current year		1,474			3,168
Prior years		62,345			96,971
		63,819			100,139
Net reserves, ending balance		569,758			580,066
Plus, reinsurance recoverables		110,338			107,965
Ending balance, gross	$	680,096		$	688,031
Development as a% of beginning net reserves		(4.3	)%		(2.2	)%

Other Significant Balance Sheet Items

Our invested assets at September 30, 2007 consist primarily of fixed-income securities (89.2%) and cash and cash equivalents (9.4%). In addition we hold a small amount of investment real estate and investment real estate limited partnerships (0.4%), as well as a limited number of equity security investments (1.0%). Approximately 64.1% of our fixed-income securities were classified as held-to-maturity at September 30, 2007, with the remainder being classified as available-for-sale. In June 2007, we purchased an additional $61.5 million of tax-exempt securities. At September 30, 2007, approximately 31.5% of our total cash and investment portfolio was allocated to tax-exempt securities. For more information on our investment portfolio see Item 3, Quantitative and Qualitative Disclosures About Market Risk.

Our deferred income tax assets decreased approximately $6.2 million, primarily as a result of utilizing minimum tax credits to reduce our regular federal income tax liability to the alternative minimum tax amount. We still have approximately $2.5 million ($889,000 at the anticipated tax rate of 35%) of net operating loss carryforwards. However these carryforwards are limited to an annual use of about $915,000 per year.

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Property & equipment increased $2.2 million to $11.9 million at September 30, 2007. The increase is due to capitalization of costs related to the implementation of a new policy administration software system.

Unpaid loss and loss adjustment expenses decreased $7.9 million as a result of the favorable development on prior years’ loss reserves. See the discussion of reserves for unpaid loss and loss adjustment expenses above for further details regarding our reserve adequacy.

Shareholders’ equity at September 30, 2007 was $270.8 million, an increase of $2.0 million from $268.8 million at December 31, 2006. The increase is primarily attributable to reported net income of $40.1 million for the nine months ended September 30, 2007, partially offset by a decrease in additional-paid-in-capital due to the use of $37.3 million to repurchase shares of the Company’s outstanding common stock in the first nine months of 2007. The Company’s book value per common share outstanding at September 30, 2007 was $25.61, based on 10,575,799 shares outstanding, compared to $23.26 per common share outstanding at December 31, 2006. Total shares outstanding at December 31, 2006 were 11,556,575.

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, 2006. 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.

In February 2007, we entered into a contract with a vendor to provide us with, and assist in the implementation of, a new policy administration software system. The total cash outflow of the project is anticipated to be approximately $6 million over the total project life, which is expected to be 12 to 15 months. As of September 30, 2007, approximately $2.5 million of this amount had been spent.

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, both available-for-sale and held-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, 2007, 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.

Qualitative Information About Market Risk

At September 30, 2007, our entire fixed-income portfolio, both available-for-sale and held-to-maturity, excluding approximately $13.2 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, 2007. Non-investment grade securities typically bear more credit risk than those of investment grade quality. In addition,

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we try to limit credit risk by not maintaining fixed-income security investments pertaining to any one issuer, other than 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.

Our held-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, 30.8%, or $153.6 million, of our held-to-maturity investment security portfolio consists 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, 2007, our available-for-sale fixed-income security portfolio was valued at $279.1 million and had an average modified duration of 3.06 years, compared to a portfolio valued at $255.0 million with an average modified duration of 3.16 years at December 31, 2006. The following tables show the effects of a change in interest rates on the fair value and duration of our available-for-sale fixed-income security portfolio at September 30, 2007 and December 31, 2006. 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, 2007							December 31, 2006
	Portfolio		Change in			Modified		Portfolio		Change in			Modified
Change in Rates	Value		Value			Duration		Value		Value			Duration
	(Dollars in thousands)							(Dollars in thousands)
+2%	$	264,118	$	(14,948	)		2.78	$	239,943	$	(15,058	)		2.88
+1%		271,525		(7,541	)		2.83		247,111		(7,890	)		2.89
0		279,066					3.06		255,001					3.16
-1%		288,246		9,180			3.14		263,350		8,349			3.23
-2%		297,431		18,365			3.21		272,152		17,151			3.33

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 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, 2007.

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.

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PART II. OTHER INFORMATION

Item 1A.   Risk Factors

In 2001, we discontinued writing personal and commercial lines insurance and in 2003 we announced our exit from the workers’ compensation and health insurance lines of business. Our last workers’ compensation and health policies expired on June 30, 2005, putting all three of these insurance lines effectively into run-off. Although the long-tailed nature of workers’ compensation claims makes the projection of ultimate losses inherently less certain, the uncertainty regarding the ultimate number of claims and their severity diminishes as time passes, thus decreasing the volatility inherent in reserve estimates. In light of the amount of time that has passed since we exited these insurance lines, we believe that the risks described in the risk factor in Part I, Item 1A of ourForm 10-K for the year ended December 31, 2006 captioned “Our exit from various markets and lines of business may prove more costly than originally anticipated” are no longer material and that such risk factor is no longer applicable.

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, 2007:

					Total Number
	Total				of Shares		Maximum Number (or Approximate Dollar Value) of Shares That May Yet Be
	Number of		Average		Purchased as		Purchased Under the Plans or Programs
	Shares		Price Paid		Part of Publicly		Discretionary		Discretionary		Rule 10b5-1
	Purchased		per Share		Announced Plans		Plan(a)		Plan(b)		Plan(c)
For the month ended July 31, 2007		100,300	$	38.26		100,300		604		15,000,000		26,793,663
For the month ended August 31, 2007		360,100	$	36.69		360,100		—		25,458,932		23,146,059
For the month ended September 30, 2007		46,000	$	38.02		46,000		—		25,458,932		21,397,077
For the three months ended September 30, 2007		506,400	$	37.12		506,400		—		25,458,932		21,397,077

(a)	In November 2005, the Board of Directors authorized the purchase of an additional five percent of the Company’s outstanding common shares, which represented approximately 637,500 shares, at the discretion of management as part of a repurchase program that began March 30, 2001. This authorization brought the total number of shares authorized to be repurchased under the discretionary plan to 6,060,659. The remaining shares to be purchased under this authorization were repurchased in July 2007.
(b)	On May 22, 2007, the Board of Directors authorized management to repurchase, at management’s discretion, additional common shares with a cost of up to $15 million in the open market or in privately negotiated transactions during the Company’s normal trading windows. On August 16, 2007, the Board of Directors authorized the repurchase of an additional $20 million under the discretionary plan. 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 or discontinued at any time or from time to time.
(c)	On October 27, 2006, the Company’s Board of Directors adopted an additional 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 200610b5-1 plan, which equaled $6.4 million at December 31, 2006. The 2007Rule 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, 2007. The Company may terminate the plan at any time. On October 29, 2007, the Company’s Board of Directors authorized the repurchase of an additional $20 million of its common shares in 2008 pursuant to a plan underRule 10b5-1. In addition, the Board authorized the rollover into the 2008Rule 10b5-1 plan of any unused dollars allocated to the 2007Rule 10b5-1 plan adopted by the Board in October 2006.

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Item 5.   Other Information

On October 25, 2007, the Company adopted amendments to the Stock Compensation Plan, the 2007 Bonus Program and its employment agreements with R. Kevin Clinton — President and Chief Executive Officer, Annette E. Flood — Executive Vice President and Chief Operating Officer and Frank H. Freund — Executive Vice President, Treasurer and Chief Financial Officer. These amendments modify various definitions and payment timing provisions to comply with the requirements of Section 409A of the Internal Revenue Code of 1986 relating to deferred compensation. The amendments are filed as exhibits to this Report onForm 10-Q and are incorporated herein by reference.

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, 2007

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EXHIBIT INDEX

Exhibit No.			Exhibit Description
	10	.49	Amendment No. 2, dated October 25, 2007 to American Physicians Capital, Inc. Stock Compensation Plan.
	10	.50	Form of Amendment No. 1 to Form of Executive Employment Agreement dated February 23, 2005, by and between American Physicians Assurance Corporation and each of R. Kevin Clinton, Frank H. Freund and Annette E. Flood.
	10	.51	Amendment No. 1, dated October 25, 2007, to the Incentive Compensation Plan as of March 2007.
	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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