SeaBright 10Q 2005 Q2 Quarterly report

UNITED STATES SECURITIES AND
EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


þ		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2005


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 000-51124

SeaBright Insurance Holdings, Inc.

(Exact name of registrant as specified in its charter)


Delaware (State or other jurisdiction of incorporation or organization)		56-2393241 (IRS Employer Identification No.)

2101 4^thAvenue, Suite 1600
Seattle, Washington 98121
(Address of principal executive offices, including zip code)

(206) 269-8500
(Registrant’s telephone number, including area code)

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 past 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. Yesþ Noo

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yeso Noþ

Indicate the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date:


Class		Shares outstanding as of August 10, 2005
Common Stock, $0.01 Par Value		16,402,808

SeaBright Insurance Holdings, Inc.

Index to Form 10-Q


	Page
Part I. Financial Information

Item 1. Financial Statements		2

Condensed Consolidated Balance Sheets as of June 30, 2005 and December 31, 2004		2

Condensed Consolidated Statements of Operations for the Three Months and Six Months Ended June 30, 2005 and 2004		3

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2005 and 2004		4

Notes to Unaudited Condensed Consolidated Financial Statements		5

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		12

Factors That May Affect Our Business, Future Operating Results and Financial Condition		20

Item 3. Quantitative and Qualitative Disclosures About Market Risk		32

Item 4. Controls and Procedures		33

Part II. Other Information

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		33

Item 6. Exhibits		34

Signatures		35
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS


	June 30,		December 31,
	2005		2004
	(Unaudited)
	(in thousands)
ASSETS
Investment securities available for sale, at fair value	$	210,751	$	105,661
Cash and cash equivalents		28,158		8,279
Accrued investment income		2,256		1,096
Premiums receivable, net of allowance		9,752		7,397
Deferred premiums		78,534		59,243
Retrospective premiums accrued		4,146		1,086
Federal income tax recoverable		—		397
Service income receivable		333		304
Reinsurance recoverables		16,435		13,484
Receivable under adverse development cover		2,853		2,853
Prepaid reinsurance		5,554		5,254
Property and equipment, net		728		493
Deferred federal income taxes, net		6,445		3,604
Deferred policy acquisition costs, net		9,184		7,588
Intangible assets, net		1,727		2,093
Goodwill		1,527		1,821
Other assets		7,257		5,459

Total assets	$	385,640	$	226,112


LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Unpaid loss and loss adjustment expense	$	103,896	$	68,228
Unearned premiums		86,424		67,626
Reinsurance funds withheld and balances payable		3,009		1,553
Premiums payable		3,423		3,128
Accrued expenses and other liabilities		29,423		15,207
Federal income tax payable		610		—
Surplus notes		12,000		12,000

Total liabilities		238,785		167,742


Commitments and contingencies

Stockholders’ equity:
Series A preferred stock, $0.01 par value; 750,000 shares authorized; issued and outstanding – no shares at June 30, 2005 and 508,265.25 shares at December 31, 2004		—		5
Undesignated preferred stock, $0.01 par value; 10,000,000 shares authorized; no shares issued and outstanding		—		—
Common stock, $0.01 par value; authorized – 75,000,000 shares at June 30, 2005 and 10,000,000 shares at December 31, 2004; issued and outstanding – 16,402,808 shares at June 30, 2005 and no shares at December 31, 2004		164		—
Paid-in capital		131,453		50,831
Accumulated other comprehensive income		1,310		530
Retained earnings		13,928		7,004

Total stockholders’ equity		146,855		58,370

Total liabilities and stockholders’ equity	$	385,640	$	226,112

See accompanying notes to condensed consolidated financial statements.

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
	(dollars in thousands, except income per share amounts)
Revenue:
Premiums earned	$	39,645		$	15,650		$	68,804		$	24,163
Net investment income		1,796			497			3,095			945
Net realized gain (loss)		118			(10	)		62			17
Claims service income		694			785			1,276			1,570
Other service income		50			208			100			595
Other income		812			755			1,986			1,308

		43,115			17,885			75,323			28,598

Losses and expenses:
Loss and loss adjustment expenses		26,988			11,370			47,255			17,969
Underwriting, acquisition and insurance expenses		8,637			3,669			15,016			6,216
Other expenses		1,510			1,335			3,231			2,350

		37,135			16,374			65,502			26,535

Income before federal income taxes		5,980			1,511			9,821			2,063


Federal income tax expense (benefit):
Current		3,439			1,086			6,159			1,798
Deferred		(1,675	)		(542	)		(3,262	)		(1,056	)

		1,764			544			2,897			742

Net income	$	4,216		$	967		$	6,924		$	1,321


Basic earnings per share	$	0.26		$	—		$	0.47		$	—
Diluted earnings per share	$	0.25		$	0.14		$	0.44		$	0.19

Weighted average basic shares outstanding		16,402,808			—			14,590,343			—
Weighted average diluted shares outstanding		16,613,182			6,996,792			15,653,942			6,992,453

See accompanying notes to condensed consolidated financial statements.

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)


	Six Months Ended June 30,
	2005			2004
	(in thousands)
Cash flows from operating activities:
Net income	$	6,924		$	1,321
Adjustments to reconcile net income to cash provided by operating activities:
Amortization of deferred policy acquisition costs		8,956			2,556
Policy acquisition costs deferred		(10,552	)		(7,382	)
Provision for depreciation and amortization		1,209			733
Net realized gain on investments		(62	)		(12	)
Gain on sale of fixed assets		—			(5	)
Benefit for deferred federal income taxes		(3,262	)		(1,055	)
Amortization of compensation expense		6			—
Changes in certain assets and liabilities:
Federal income tax recoverable and payable		1,007			213
Unpaid loss and loss adjustment expense		35,668			10,042
Reinsurance recoverables, net of reinsurance withheld		(4,193	)		(2,668	)
Unearned premiums, net of deferred premiums and premiums receivable		(5,908	)		7,416
Accrued investment income		(1,160	)		(237	)
Other assets and other liabilities		4,133			4,314

Net cash provided by operating activities		32,766			15,236


Cash flows from investing activities:
Purchases of investments		(233,053	)		(22,560	)
Sales of investments		126,425			8,258
Maturities and other		13,327			1,542
Purchases of property and equipment		(361	)		(173	)

Net cash used in investing activities		(93,662	)		(12,933	)


Cash flows from financing activities:
Issuance of common stock		80,775			—
Issuance of surplus notes		—			12,000
Issuance of preferred stock		—			5,161

Net cash provided by financing activities		80,775			17,161


Net increase in cash and cash equivalents		19,879			19,464
Cash and cash equivalents at beginning of period		8,279			5,008

Cash and cash equivalents at end of period	$	28,158		$	24,472


Supplemental disclosures:
Accrued expenses for purchases of investments	$	11,184		$	8,986
Federal income taxes paid		5,216			1,585
Interest paid on surplus notes		399			—

See accompanying notes to condensed consolidated financial statements.

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Organization

SeaBright Insurance Holdings, Inc., a Delaware corporation (“SIH”), was formed in June 2003. On July 14, 2003, SIH entered into a purchase agreement with Kemper Employers Group, Inc. (“KEG”), Eagle Pacific Insurance Company, Inc. and Pacific Eagle Insurance Company, Inc. (collectively “Eagle” or the “Eagle Entities”), and Lumbermens Mutual Casualty Company (“LMC”) (the “Acquisition”). Under this agreement, SIH acquired Kemper Employers Insurance Company (“KEIC”), PointSure Insurance Services, Inc. (“PointSure”), and certain assets of Eagle, primarily renewal rights.

SeaBright Insurance Company (“SBIC”), formerly KEIC, is licensed to write workers’ compensation insurance in 43 states and the District of Columbia. Domiciled in the State of Illinois and commercially domiciled in the State of California, SBIC focuses on employers with complex workers’ compensation exposures and provides coverage under multiple state and federal acts, applicable common law or negotiated agreements. Prior to the Acquisition, beginning in 2000, KEIC wrote business only in California. In May 2002, KEIC ceased writing business and by December 31, 2003, all premiums related to business prior to the Acquisition were 100% earned.

PointSure is engaged primarily in administrative and brokerage activities. The Eagle Entities, from whom we purchased certain assets, were both writers of state act workers’ compensation insurance and United States Longshore and Harbor Workers’ Compensation Act (“USL&H”) insurance, whose policies are in run-off as of June 30, 2005.

Under new ownership, KEIC resumed writing business effective October 1, 2003, primarily targeting policy renewals for former Eagle business in the states of California, Hawaii and Alaska. In November 2003, the Illinois Department of Financial and Professional Regulation, Division of Insurance (the “Illinois Division of Insurance”) granted permission for KEIC to change its name to SeaBright Insurance Company.

2. Summary of Significant Accounting Policies

a. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of SIH and its wholly owned subsidiaries, PointSure and SBIC (collectively, the “Company”). All significant intercompany transactions among these affiliated entities have been eliminated in consolidation.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the instructions to Form 10-Q. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. The condensed consolidated balance sheet at December 31, 2004 has been derived from the audited financial statements at that date but does not include all of the information and notes required by GAAP for complete financial statements. These financial statements and notes should be read in conjunction with the audited financial statements and notes for the year ended December 31, 2004 included in the Company’s Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 28, 2005.

In the opinion of management, the unaudited condensed consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, necessary to state fairly the financial information set forth therein. Results of operations for the three month and six month periods ended June 30, 2005 are not necessarily indicative of the results expected for the full fiscal year or for any future period.

b. Use of Estimates

The preparation of the consolidated financial statements in conformity with GAAP requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. For example, the Company used significant estimates in determining the unpaid loss and loss adjustment expenses, goodwill and other intangibles, earned premiums on retrospectively rated policies, earned but unbilled premiums, federal income taxes and amounts related to reinsurance. Actual results could differ from those estimates. Such estimates and judgments could change in the future as more information becomes known, which could impact the amounts reported and disclosed herein.

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

c. Revenue Recognition

Premiums for primary and reinsured risks are included in revenue over the life of the contract in proportion to the amount of insurance protection provided (i.e., ratably over the policy period). The portion of the premium that is applicable to the unexpired period of the policies in-force is not included in revenue but is deferred and recorded as unearned premium in the liability section of the balance sheet. Deferred premiums represent the unbilled portion of annual premiums.

Earned premiums on retrospectively rated policies are based on the Company’s estimate of loss experience as of the measurement date. Loss experience includes known losses specifically identifiable to a retrospective policy as well as provisions for future development on known losses and for losses incurred but not yet reported, which are developed using actuarial loss development factors that are consistent with how the Company projects losses in general. For retrospectively rated policies, the governing contractual minimum and maximum rates are established at policy inception and are made a part of the insurance contract. Premiums from retrospectively rated policies totaled 41.8% and 47.8% of total premiums written for the three month periods ended June 30, 2005 and 2004, respectively, and 34.6% and 39.8% of total premiums written for the six month periods then ended, respectively.

d. Unpaid Loss and Loss Adjustment Expense

Unpaid loss and loss adjustment expense represents an estimate of the ultimate net cost of all unpaid losses incurred through the specified period. The loss adjustment expense component is an estimate of unpaid expenses to be incurred in settlement of the claims included in the liability for unpaid losses. These liabilities, which anticipate salvage and subrogation recoveries and are presented gross of amounts recoverable from reinsurers, include estimates of future trends in claim severity and frequency and other factors that could vary as the losses are ultimately settled.

The Company uses independent actuaries to assist in the evaluation of the adequacy of its reserve for unpaid loss and loss adjustment expense. In light of the Company’s short operating history and uncertainties concerning the effects of legislative reform specifically as it relates to the Company’s California workers compensation class of business, actuarial techniques are applied that use the historical experience of the Company’s predecessor as well as industry information in the analysis of unpaid loss and loss adjustment expense. These techniques recognize, among other factors:

	•		the Company’s claims experience and that of its predecessor;

	•		the industry’s claims experience;

	•		historical trends in reserving patterns and loss payments;

	•		the impact of claim inflation;

	•		the pending level of unpaid claims;

	•		the cost of claim settlements;

	•		legislative reforms affecting workers’ compensation; and

	•		the environment in which insurance companies operate.

Although it is not possible to measure the degree of variability inherent in such estimates, management believes that the reserve for unpaid loss and loss adjustment expense is adequate. Estimates are reviewed periodically and any necessary adjustment is included in the results of operations of the period in which the adjustment is determined.

e. Reinsurance

The Company protects itself from excessive losses by reinsuring with nonaffiliated reinsurers certain levels of risk in various areas of exposure. Reinsurance premiums, commissions, expense reimbursements and reserves related to ceded business are accounted for on a basis consistent with that used in accounting for original policies issued and the terms of the reinsurance contracts. The unpaid loss and loss adjustment expense subject to the adverse development cover with LMC is calculated on a quarterly basis using generally accepted actuarial methodology.

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amounts recoverable in excess of acquired reserves at September 30, 2003 are recorded gross in unpaid loss and loss adjustment expense in accordance with SFAS No. 141, “Business Combinations,” with a corresponding amount receivable from the seller. Amounts are shown net in the statement of operations. Premiums ceded to other companies are reported as a reduction of premiums written and earned. Reinsurance recoverables are determined based on the terms and conditions of the reinsurance contracts.

f. Income Taxes

The asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse, net of any applicable valuation allowances.

g. Earnings Per Share

The following table provides the reconciliation of basic and diluted weighted average shares outstanding used in calculating earnings per share for the three month and six month periods ended June 30, 2005 and 2004:


	Three Months Ended June 30,				Six Months Ended June 30,
	2005		2004		2005		2004
Basic weighted average shares outstanding		16,402,808		—		14,590,343		—
Weighted average shares issuable upon:
Conversion of preferred stock outstanding prior to initial public offering		—		6,996,792		859,426		6,992,453
Exercise of stock options and vesting of restricted stock		210,374		—		204,173		—

Diluted weighted average shares outstanding		16,613,182		6,996,792		15,653,942		6,992,453

h. Stock Based Compensation

The Company measures its employee stock-based compensation arrangements using the provisions outlined in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” which is an intrinsic value-based method of recognizing compensation costs. The Company has adopted the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-based Compensation.” None of the Company’s stock options had an intrinsic value at grant date and, accordingly, no compensation cost has been recognized for its stock option plan activity.

The following table illustrates the effect on net income for the three month and six month periods ended June 30, 2005 and 2004 as if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock based compensation:


	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
	(in thousands, except income per share data)
Net income:
As reported	$	4,216		$	967		$	6,924		$	1,321
Less SFAS No. 123 compensation costs, net of taxes		(60	)		(18	)		(120	)		(35	)

Pro forma net income	$	4,156		$	949		$	6,804		$	1,286


Net income per common share:
Basic — as reported	$	0.26		$	—		$	0.47		$	—

Basic — pro-forma	$	0.25		$	—		$	0.47		$	—
							��

Diluted — as reported	$	0.25		$	0.14		$	0.44		$	0.19

Diluted — pro-forma	$	0.25		$	0.14		$	0.43		$	0.18

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The compensation expense included in pro forma net income is not likely to be representative of the effect on reported net income for future years because options vest over several years and additional awards may be made each year.

i. Recent Accounting Statements

SFAS No. 123 (revised 2004), “Share-based Payment,” was issued in December 2004. SFAS No. 123(R) is a revision of SFAS No. 123. SFAS No. 123(R) supersedes APB Opinion No. 25 and amends SFAS No. 95, “Statement of Cash Flows.” Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations based on their fair values. Pro forma disclosure is no longer an alternative.

SFAS No. 123(R) must be adopted no later than January 1, 2006, and the Company expects to adopt the Statement on or before that date. As permitted by SFAS No. 123, the Company currently accounts for share-based payments to employees using the intrinsic value method as detailed in Opinion No. 25 and, as such, generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of SFAS No. 123(R)’s fair value method will have an impact on the Company’s results of operations, although it will have no impact on the Company’s overall financial position. The impact of adoption of SFAS No. 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had the Company adopted SFAS No. 123(R) in prior periods, the impact of the standard would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net income and earnings per share discussed above.

j. Comprehensive Income

The following table summarizes the Company’s comprehensive income (loss) for the three month and six month periods ended June 30, 2005 and 2004:


	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
	(in thousands)
Net income	$	4,216		$	967		$	6,924		$	1,321
Reclassification adjustment for net realized gains (losses) recorded into income		118			(15	)		62			12
Tax (expense) benefit related to reclassification adjustment		(41	)		5			(22	)		(4	)
Increase (decrease) in unrealized gain on investment securities available for sale		3,857			(1,814	)		1,138			(1,148	)
Tax (expense) benefit related to unrealized gains (losses)		(1,350	)		617			(398	)		391

Total comprehensive income (loss)	$	6,800		$	(240	)	$	7,704		$	572

3. Investments

The consolidated cost or amortized cost, gross unrealized gains and losses, and estimated fair value of investment securities available for sale at June 30, 2005 are as follows:


	June 30, 2005
	Cost or		Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost		Gains		Losses			Fair Value
	(In thousands)
U.S. Treasury securities	$	19,182	$	258	$	(26	)	$	19,414
Government sponsored agency securities		9,600		53		(19	)		9,634
Corporate securities		23,325		166		(130	)		23,361
Tax-exempt municipal securities		115,711		1,625		(38	)		117,298
Mortgage pass-through securities		32,115		136		(34	)		32,217
Collateralized mortgage obligations		1,972		6		(11	)		1,967
Asset-backed securities		6,830		32		(2	)		6,860

Total investment securities available for sale	$	208,735	$	2,276	$	(260	)	$	210,751

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The unrealized loss on temporarily impaired investments totaled $260,000 at June 30, 2005 for investment securities available for sale with a fair value of $36.6 million. All were impaired for less than one year. The Company evaluated investment securities with June 30, 2005 fair values less than amortized cost and has determined that the decline in value is temporary and is related to the change in market interest rates since purchase.

The amortized cost and estimated fair value of investment securities available for sale at June 30, 2005, by contractual maturity, are set forth below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.


	Cost or
	Amortized		Estimated
Maturity	Cost		Fair Value
	(In thousands)
Due in one year or less	$	4,943	$	4,920
Due after one year through five years		40,975		40,984
Due after five years through ten years		98,131		99,561
Due after ten years		23,769		24,242
Securities not due at a single maturity date		40,917		41,044

Total investment securities available for sale	$	208,735	$	210,751

The amortized cost of investment securities available for sale deposited with various regulatory authorities was $51.0 million at June 30, 2005.

4. Premiums

Direct premiums written totaled $52.8 million and $39.9 million for the three month periods ended June 30, 2005 and 2004, respectively, and $96.9 million and $63.6 million for the six month periods then ended, respectively.

Premiums receivable consisted of the following at June 30, 2005 and December 31, 2004:


	June 30,			December 31,
	2005			2004
	(In thousands)
Premiums receivable	$	10,598		$	8,068
Allowance for doubtful accounts		(846	)		(671	)

	$	9,752		$	7,397

5. Reinsurance

a. Reinsurance Ceded

Under reinsurance agreements, the Company cedes various amounts of risk to nonaffiliated insurance companies for the purpose of limiting the maximum potential loss arising from the underlying insurance risks. Effective October 1, 2004, the Company entered into reinsurance agreements wherein it retains the first $500,000 of each loss occurrence. Losses in excess of $500,000 up to $100.0 million are 100% reinsured with nonaffiliated reinsurers.

As part of the Acquisition, SIH and LMC entered into an adverse development excess of loss reinsurance agreement (the “Agreement”). The Agreement, after taking into account any recoveries from third party reinsurers, requires LMC to reimburse SBIC 100% of the excess of the actual loss at December 31, 2011 over the initial loss reserves at September 30, 2003. The Agreement also requires SBIC to reimburse LMC 100% of the excess of the initial loss reserves at September 30, 2003 over the actual loss results at December 31, 2011. The amount of adverse loss development under the Agreement was $2.9 million at June 30, 2005. The increase in the amount due from LMC is netted against loss and loss adjustment expense in the accompanying unaudited condensed consolidated statements of operations.

As part of the Agreement, LMC placed into trust (the “Trust”) an amount equal to 10% of the balance sheet reserves of SBIC on the date of the Acquisition. Thereafter, the Trust shall be adjusted each quarter, if warranted, to an amount equal to 102% of LMC’s obligations under the Agreement. Initial loss reserves were $16.0 million. The balance of the Trust was $4.9 million at June 30, 2005 and $4.8 million at December 31, 2004.

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

b. Reinsurance Assumed

The Company assumes business from the National Council for Compensation Insurance in the states of Alabama, Alaska, Arizona, Illinois, Nevada, New Jersey, Oregon and South Carolina as part of the Residual Market Pool program.

c. Reinsurance Recoverables and Income Statement Effects

Balances affected by reinsurance transactions are reported gross of reinsurance in the accompanying condensed consolidated balance sheets. Reinsurance recoverables are comprised of the following amounts at June 30, 2005 and December 31, 2004:


	June 30,		December 31,
	2005		2004
	(In thousands)
Reinsurance recoverables on unpaid loss and loss adjustment expenses	$	15,343	$	12,582
Reinsurance recoverables on paid losses		1,092		902

Total reinsurance recoverables	$	16,435	$	13,484

The effects of reinsurance on statement of operations amounts are as follows for the three month and six month periods ended June 30, 2005 and 2004:


	Three Months Ended June 30,				Six Months Ended June 30,
	2005		2004		2005		2004
			(in thousands)
Reinsurance assumed:
Written premiums	$	3,910	$	—	$	4,129	$	—
Earned premiums		3,175		—		3,400		—
Losses and loss adjustment expenses incurred		2,282		—		2,410		—

Reinsurance ceded:
Written premiums	$	6,556	$	4,089	$	11,818	$	6,978
Earned premiums		6,069		2,475		11,519		3,806
Losses and loss adjustment expenses incurred		1,963		105		4,140		96

6. Unpaid Loss and Loss Adjustment Expenses

The following table summarizes the activity in unpaid loss and loss adjustment expense for the three month and six month periods ended June 30, 2005 and 2004:


	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
				(in thousands)
Beginning balance	$	69,183		$	22,000		$	55,646		$	18,495
Incurred related to:
Current period		26,988			11,370			47,255			17,969
Prior periods		—			—			—			—

Total incurred		26,988			11,370			47,255			17,969

Paid related to:
Current period		(4,354	)		(2,251	)		(6,863	)		(3,678	)
Prior periods		(3,264	)		(1,507	)		(7,485	)		(3,174	)

Total paid		(7,618	)		(3,758	)		(14,348	)		(6,852	)

Unpaid loss and loss adjustment expense, net of reinsurance recoverables		88,553			29,612			88,553			29,612
Reinsurance recoverables		15,343			10,164			15,343			10,164

Unpaid loss and loss adjustment expense	$	103,896		$	39,776		$	103,896		$	39,776

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

7. Surplus Notes

In a private placement on May 26, 2004, SBIC issued $12.0 million in subordinated floating rate surplus notes due in 2034. Interest, paid quarterly in arrears, is calculated at the beginning of the interest payment period using the 3-month LIBOR rate plus 400 basis points, subject to certain limitations. Interest expense totaled $211,000 and $408,000 for the three month and six month periods ended June 30, 2005, respectively, and $63,000 for the three month and six month periods ended June 30, 2004.

8. Contingencies

a. SBIC is subject to guaranty fund and other assessments by the states in which it writes business. Guaranty fund assessments are accrued at the time premiums are written. Other assessments are accrued either at the time of assessment or in the case of premium-based assessments, at the time the premiums are written, or in the case of loss-based assessments, at the time the losses are incurred. As of June 30, 2005, SBIC has recorded a liability for guaranty fund and other assessments of $3.8 million and a guaranty fund receivable of $1.6 million. This amount represents management’s best estimate based on information received from the states in which it writes business and may change due to many factors, including the Company’s share of the ultimate cost of current and future insolvencies. The majority of assessments are paid out in the year following the year in which the premium is written or the losses are paid. Guaranty fund receivables and other surcharge items are generally realized by a charge to new and renewing policyholders in the year following the year in which the related assessments were paid.

b. In June 2004, the Company was notified of a claim for damages brought by an individual against PointSure. In April 2005, a complaint against PointSure in connection with this matter was filed in the Superior Court of Washington for King County. The complaint alleges breach and unjust enrichment related to the termination of an alleged contract between PointSure and the plaintiff and seeks a judgment awarding damages to the plaintiff in an amount to be proven at trial, plus attorneys’ fees and costs. The Company disputes the allegations in the complaint and is defending this case vigorously. Management believes the outcome of this matter will not have a material adverse effect on the Company’s financial position.

c. The Company is involved in various claims and lawsuits arising in the ordinary course of business. Management believes the outcome of these matters will not have a material adverse effect on the Company’s financial position.

9. Initial Public Offering

On January 26, 2005, the Company closed its initial public offering of 8,625,000 shares of common stock, including the underwriters’ over-allotment option to purchase 1,125,000 shares of common stock, at a price of $10.50 per share for net proceeds of approximately $80.8 million, after deducting underwriters’ fees, commissions and offering costs totaling approximately $9.8 million. As part of the initial public offering, all 508,365.25 outstanding shares of the Company’s Series A convertible preferred stock were converted into 7,777,808 shares of the Company’s common stock. Included in other assets at December 31, 2004 was approximately $1.3 million of offering costs associated with the initial public offering. These costs were deducted from the gross proceeds of the offering at closing.

On January 26, 2005, the Company contributed approximately $74.8 million of the net proceeds to SBIC. The Company intends to use the remaining net proceeds for general corporate purposes, including supporting the growth of PointSure. The use of proceeds from the offering does not represent a material change from the use of proceeds described in the prospectus that was included in the related Registration Statement on Form S-1. Except for the contribution of proceeds to SBIC, no proceeds or expenses were paid to the Company’s directors, officers, ten percent shareholders or affiliates.

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

10. Common Stock Options and Restricted Stock Awards

The following table summarizes stock option activity since December 31, 2004:


	Number of
	Options
Stock options outstanding at December 31, 2004		491,508
Options granted		310,351
Options forfeited		—

Stock options outstanding at June 30, 2005		801,859

In March 2005, the Compensation Committee of the Board of Directors granted 2,000 shares of restricted common stock to each of three non-employee directors. The restricted shares automatically vest on the third anniversary of the date of grant. In the six month period ended June 30, 2005, the Company recorded compensation expense totaling $6,200 in connection with these shares.

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

The following discussion of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and accompanying notes to those statements included in this quarterly report and with our 2004 audited financial statements and notes thereto included in our Annual Report onForm 10-K, which was filed with the Securities and Exchange Commission on March 28, 2005.

Overview

We are a specialty provider of multi-jurisdictional workers’ compensation insurance. We are domiciled in Illinois, commercially domiciled in California and headquartered in Seattle, Washington. We are licensed in 43 states and the District of Columbia to write workers’ compensation insurance. Traditional providers of workers’ compensation insurance provide coverage to employers under one or more state workers’ compensation laws, which prescribe benefits that employers are obligated to provide to their employees who are injured arising out of or in the course of employment. We focus on employers with complex workers’ compensation exposures and provide coverage under multiple state and federal acts, applicable common law or negotiated agreements. We also provide traditional state act coverage in markets we believe are underserved. Our workers’ compensation policies are issued to employers who also pay the premiums. The policies provide payments to covered, injured employees of the policyholder for, among other things, temporary or permanent disability benefits, death benefits and medical and hospital expenses. The benefits payable and the duration of such benefits are set by statute and vary by jurisdiction and with the nature and severity of the injury or disease and the wages, occupation and age of the employee.

SeaBright Insurance Holdings, Inc. (“SeaBright” or the “Company”) was formed in 2003 by members of our current management and entities affiliated with Summit Partners, a leading private equity and venture capital firm, for the purpose of completing a management-led buyout that closed on September 30, 2003, which we refer to as the Acquisition. In the Acquisition, we acquired from Lumbermens Mutual Casualty Company (“LMC”) and certain of its affiliates the renewal rights and substantially all of the operating assets and employees of Eagle Pacific Insurance Company and Pacific Eagle Insurance Company, which we collectively refer to as Eagle or the Eagle Entities. Eagle Pacific began writing specialty workers’ compensation insurance policies in the mid-1980’s. The Acquisition gave us renewal rights to an existing portfolio of business, representing a valuable asset given the renewal nature of our business, and a fully operational infrastructure that would have taken many years to develop. These renewal rights gave us access to Eagle’s customer lists and the right to seek to renew Eagle’s continuing in-force insurance contracts.

In the Acquisition, we also acquired 100% of the issued and outstanding capital stock of Kemper Employers Insurance Company (“KEIC”) and PointSure Insurance Services, Inc. (“PointSure”), a wholesale insurance broker and third party claims administrator. We acquired KEIC, a shell company with no in-force policies or employees, solely for the purpose of acquiring its workers’ compensation licenses in 43 states and the District of Columbia and for its certification with the United States Department of Labor. Subsequent to the Acquisition, KEIC was renamed “SeaBright Insurance Company.” SeaBright Insurance Company received an “A–” (Excellent) rating from A.M. Best following the completion of the Acquisition.

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At closing of the Acquisition, $4.0 million of the purchase price was placed into escrow for a period of two years. These funds are available to us as security for various obligations of LMC pursuant to various agreements entered into in connection with the Acquisition. The escrow agent will release the funds remaining in the escrow account to Kemper Employers Group, Inc. on October 2, 2005. To minimize our exposure to any past business underwritten by KEIC, we entered into an adverse development cover agreement in connection with the Acquisition. Under the terms of this agreement, we and LMC are required to indemnify each other with respect to developments in KEIC’s loss reserves as they existed at the date of the Acquisition. Accordingly, if KEIC’s loss reserves increase, LMC must indemnify us in the amount of the increase. To support LMC’s obligations under the adverse development cover, LMC funded a trust account at the time of the Acquisition in the amount of $1.6 million as collateral for LMC’s potential future obligations to us under the adverse development cover. The minimum amount that must be maintained in the trust account is equal to the greater of (a) $1.6 million or (b) 102% of the then existing quarterly estimate of LMC’s total obligations under the adverse development cover. The amount on deposit in the trust account was increased to $4.8 million on December 23, 2004 and totaled approximately $4.9 million at June 30, 2005. If LMC is placed into receivership and the amount held in the collateralized reinsurance trust is inadequate to satisfy the obligations of LMC to us under the adverse development cover, it is unlikely that we would recover any future amounts owing by LMC to us.

Principal Revenue and Expense Items

We derive our revenue primarily from premiums earned, net investment income and realized gains and losses on investments, and service fee income.

Premiums Earned

Gross premiums written include all premiums billed and unbilled by an insurance company during a specified policy period. Premiums are earned over the terms of the related policies. At the end of each accounting period, the portions of premiums that are not yet earned are included in unearned premiums and are realized as revenue in subsequent periods over the remaining terms of the policies. Our policies typically have a term of 12 months. Thus, for example, for a policy that is written on July 1, 2004, one-half of the premiums would be earned in 2004 and the other half would be earned in 2005.

Premiums earned are the earned portion of our net premiums written. Net premiums written is the difference between gross premiums written and premiums ceded or paid to reinsurers (ceded premiums written). Our gross premiums written is the sum of both direct premiums and assumed premiums before the effect of ceded reinsurance. Assumed premiums are premiums that we have received from another company under a reinsurance agreement or from an authorized state-mandated pool.

We earn our direct premiums written from our maritime, alternative dispute resolution (“ADR”) and state act customers. We also earn a small portion of our direct premiums written from employers who participate in the Washington Maritime Assigned Risk Plan. We immediately cede 100% of those premiums, net of our expenses, and 100% of the losses in connection with that business to the plan. Premiums from the Washington Maritime Assigned Risk Plan are included in both direct premiums written and ceded premiums written.

Net Investment Income and Realized Gains and Losses on Investments

We invest our statutory surplus and the funds supporting our insurance liabilities (including unearned premiums and unpaid loss and loss adjustment expense) in cash, cash equivalents and fixed income securities. Our investment income includes interest earned on our invested assets. Realized gains and losses on invested assets are reported separately from net investment income. We earn realized gains when invested assets are sold for an amount greater than their amortized cost in the case of fixed maturity securities and recognize realized losses when investment securities are written down as a result of an other-than-temporary impairment or sold for an amount less than their carrying cost.

Claims Service Income

Substantially all of our claims service income is from contracts we have with LMC to provide claims handling services for the policies written by the Eagle Entities prior to the Acquisition. The claims service income we receive for providing these services approximates our costs and will substantially decrease over the next several years as transactions related to the Eagle Entities diminish.

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Other Service Income

Following the Acquisition, we entered into servicing arrangements with LMC to provide policy administration and accounting services for the policies written by the Eagle Entities prior to the Acquisition. The fee income we receive for providing these services approximates our costs and will substantially decrease over the next several years as transactions related to the Eagle Entities diminish.

Our expenses consist primarily of:

Loss and Loss Adjustment Expenses

Loss and loss adjustment expenses represent our largest expense item and include (1) claim payments made, (2) estimates for future claim payments and changes in those estimates for current and prior periods and (3) costs associated with investigating, defending and adjusting claims.

Underwriting, Acquisition and Insurance Expenses

We refer to the expenses that we incur to underwrite risks as underwriting, acquisition and insurance expenses. Underwriting expenses consist of commission expenses, premium taxes and fees and other underwriting expenses incurred in writing and maintaining our business.

Commission Expenses.We pay commission expense to our brokers for the premiums that they produce for us.

Premium Taxes and Fees.We pay state and local taxes based on premiums, as well as licenses, fees, assessments and contributions to workers’ compensation security funds.

Other Underwriting Expenses.Other underwriting expenses consist of general administrative expenses such as salaries, rent, office supplies, depreciation and all other operating expenses not otherwise classified separately, and boards, bureaus and assessments of statistical agencies for policy service and administration items such as rating manuals, rating plans and experience data.

Interest Expense

Included in other expense is interest expense we incur on $12.0 million in surplus notes that our insurance subsidiary issued in May 2004. The interest expense is paid quarterly in arrears. The interest expense for each interest payment period is based on the three-month LIBOR rate two London banking days prior to the interest payment period plus 400 basis points.

Results of Operations

Three Month and Six Month Periods Ended June 30, 2005 and 2004

Gross Premiums Written.Gross premiums written for the three months ended June 30, 2005 totaled $56.7 million, an increase of $16.8 million, or 42.1%, from $39.9 million in the same period of 2004. For the six months ended June 30, 2005, gross premiums written totaled $101.0 million, an increase of $37.4 million, or 58.8%, from $63.6 million in the same period in 2004. We began writing new insurance contracts on October 1, 2003 and began renewing some of the existing contracts of our predecessor expiring after that date. The three months ended June 30, 2004 was only our third quarter of operations as SeaBright Insurance Company. A significant portion of the 2005 increase in gross premiums written is attributable to our expansion in California state act contractor business, which accounted for approximately 53.1% and 59.6% of premiums written in the three month and six month periods ended June 30, 2005, respectively, compared to approximately 40.7% and 35.9% in the three month and six month periods ended June 30, 2004, respectively.

On May 31, 2005, the California Insurance Commissioner issued a decision adopting an advisory pure premium rate reduction of 18% for California workers’ compensation policies incepting on or after July 1, 2005. The decision was issued in response to reductions in 2004 workers’ compensation claim costs in California, as well as anticipated future claim cost reductions, as a result of reform legislation enacted primarily in 2003 and 2004. The California Insurance Commissioner’s decision is advisory only and insurance companies may choose whether or not to adopt the new rates. On June 6, 2005, after completing a study of our California loss data, we filed with the California Department of Insurance our rates for new and renewal workers’ compensation insurance policies written in California on or after July 1, 2005. The filing was approved on June 28, 2005. The new rates reflect an average

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reduction of 14.2% from prior rates and are in response to emerging favorable trends in loss costs resulting from reform legislation. We expect this reduction in premium revenue to be offset by a reduction in claim costs. Therefore, we do not expect this rate reduction to have a significant negative impact on our financial position or results of operations. If the anticipated claim cost reductions are not realized, we may file new rates to increase our pure premium rates accordingly.

Net Premiums Written.Net premiums written totaled $50.2 million for the three months ended June 30, 2005 compared to $35.8 million in the same period in 2004, representing an increase of $14.4 million, or 40.2%. For the six months ended June 30, 2005, net premiums written totaled $89.2 million, an increase of $32.6 million, or 57.6% from $56.6 million in the same period in 2004. Net premiums written are affected by premiums ceded under reinsurance agreements with external reinsurers. Ceded written premiums for the six months ended June 30, 2005 totaled $11.8 million (11.7% of gross premiums written) compared to $7.0 million (11.0% of gross premiums written) in the same period of 2004. Certain of our reinsurance contracts provide for the ceding of premiums on a direct premiums written basis, while others provide for the ceding on a direct premiums earned basis.

Net Premiums Earned.Net premiums earned were $39.6 million for the three months ended June 30, 2005 compared to $15.7 million for the same period in 2004, representing an increase of $23.9 million, or 152.2%. For the six months ended June 30, 2005, net premiums earned totaled $68.8 million, an increase of $44.6 million, or 184.3%, from $24.2 million in the same period of 2004. As previously discussed, this increase is due to the increase in net premiums written and to the fact that we had been in business for only nine months at June 30, 2004. We record the entire annual policy premium as unearned premium when written and earn the premium over the life of the policy, which is generally twelve months. Because we acquired renewal rights and not policies in the Acquisition, our actual results for the three month and six month periods ended June 30, 2004 do not reflect premiums earned on any policies written prior to September 30, 2003, the date of the Acquisition.

Net Investment Income.Net investment income was $1.8 million for the three months ended June 30, 2005 compared to $497,000 for the same period in 2004, representing an increase of $1.3 million, or 261.6%. For the six months ended June 30, 2005, net investment income totaled $3.1 million, an increase of $2.2 million, or 232.8%, from $945,000 in the same period of 2004. These increases are due primarily to an increase of approximately $99.6 million, or 129.7%, in average invested funds for the six months ended June 30, 2005 over the same period in 2004. In May 2004, SeaBright Insurance Company issued, in a private placement, $12.0 million in subordinated floating rate surplus notes due in 2034. In June 2004, we sold 51,615.25 shares of Series A convertible preferred stock to our then-existing preferred stockholders and certain members of management for total gross proceeds of $5.2 million. In January 2005, we completed the initial public offering of our common stock, resulting in net proceeds of approximately $80.8 million. Our yield on average invested assets for the six months ended June 30, 2005 was approximately 3.5% compared to approximately 2.5% for the same period in 2004.

Service Income.Service income totaled $744,000 for the three months ended June 30, 2005 compared to $993,000 for the same period in 2004, representing a decrease of $249,000, or 25.1%. For the six months ended June 30, 2005, service income totaled $1.4 million, a decrease of $0.8 million, or 36.4%, from $2.2 million in the same period of 2004. Our service income results from service arrangements we have with LMC for claims processing services, policy administration and administrative services that we perform in connection with the Eagle Entities’ insurance policies. Average monthly service income is declining as the volume of work decreases as a result of the run off of our predecessor’s business.

Other Income.Other income totaled $812,000 for the three months ended June 30, 2005 compared to $755,000 for the same period in 2004, representing an increase of $57,000, or 7.5%. For the six months ended June 30, 2005, other income totaled $2.0 million, an increase of $0.7 million, or 53.8%, from $1.3 million in the same period of 2004. Other income results primarily from the operations of PointSure, our non-insurance subsidiary. The increases in other income for the three month and six month periods ended June 30, 2005 resulted primarily from an increase in PointSure’s agency and direct billed commission income, which totaled $1.9 million for the six months ended June 30, 2005 compared to $0.8 million in the same period of 2004, representing an increase of $1.1 million, or 133.1%. Most of this income is passed through as commission expense to brokers and producers.

Loss and Loss Adjustment Expenses.Loss and loss adjustment expenses totaled $27.0 million for the three months ended June 30, 2005 compared to $11.4 million for the same period in 2004, representing an increase of $15.6 million, or 136.8%. For the six months ended June 30, 2005, loss and loss adjustment expenses totaled $47.3 million, an increase of $29.3 million, or 162.8%, from $18.0 million in the same period of 2004. The higher loss and loss adjustment expenses for the quarter and six months ended June 30, 2005 are attributable to the increase in

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premiums earned for the period. Our net loss ratio for the three month and six month periods ended June 30, 2005 was 66.3% and 66.8%, respectively, compared to 67.6% and 67.9%, respectively, for the same periods in 2004. As a result of the impact of regulatory reforms enacted in California primarily in 2003 and 2004, we are using a selected current accident year loss ratio, inclusive of the effects of the 14.2% reduction in our California rates for policies incepting on or after July 1, 2005, of 68% compared to a current accident year loss ratio of 70% used in 2004.

At June 30, 2005, we had recorded a receivable from LMC, and an associated reduction in loss and loss adjustment expenses, of approximately $2.9 million for adverse loss development since the date of the Acquisition, according to the terms of the adverse development cover. If LMC fails to pay its obligation under the adverse development cover, we do not expect such failure to have a material adverse impact on our financial position or results of operations since this amount is fully collateralized by the collateralized reinsurance trust, the balance of which was approximately $4.9 million at June 30, 2005.

Underwriting Expenses.Underwriting expenses totaled $8.6 million for the three months ended June 30, 2005 compared to $3.7 million for the same period in 2004, representing an increase of $4.9 million, or 132.4%. For the six months ended June 30, 2005, underwriting expenses totaled $15.0 million, an increase of $8.8 million, or 141.9%, from $6.2 million in the same period of 2004. Our net underwriting expense ratio for the three month and six month periods ended June 30, 2005 was 21.7%, compared to 22.1% and 23.3% for the same periods in 2004. The decreases in the net underwriting expense ratio resulted primarily from the fact that our premiums earned grew at a faster rate than our underwriting expenses, which allowed us to absorb more of our fixed costs. We have increased our staffing levels and related expenses in preparation for anticipated growth of our business.

Other Expenses.Other expenses totaled $1.5 million for the three months ended June 30, 2005 compared to $1.3 million for the same period in 2004, representing an increase of $0.2 million, or 15.4%. For the six months ended June 30, 2005, other expenses totaled $3.2 million, an increase of $0.8 million, or 33.3%, from $2.4 million in the same period of 2004. These increases resulted primarily from an increase in PointSure’s operating expenses and interest expense related to $12.0 million in surplus notes issued by our insurance subsidiary in May 2004. As explained above under “Other Income,” the majority of the increase is due to an increase in PointSure’s commission expense, which totaled $1.7 million for the six months ended June 30, 2005 compared to $0.7 million in the same period of 2004, representing an increase of $1.0 million, or 142.9%. Most of this expense is a pass-through of agency and direct billed commission income received from insurance companies.

Federal Income Tax Expense.The effective tax rate for the three month and six month periods ended June 30, 2005 was 29.5%, compared to 36.0% for the same periods in 2004. The decreases in our effective tax rate in 2005 resulted primarily from an increase in the percentage of our portfolio invested in tax-exempt securities. At June 30, 2005, approximately 55.4% of our portfolio was invested in tax-exempt securities, compared to approximately 26.8% at June 30, 2004.

Net Income.Net income was $4.2 million for the three months ended June 30, 2005, compared to $967,000 for the same period in 2004, representing an increase of $3.2 million. Net income for the six months ended June 30, 2005 totaled $6.9 million, an increase of $5.6 million from $1.3 million in the same period of 2004. The increase in net income resulted primarily from increases in premiums earned and investment income for the period, offset by decreases in service income and increases in loss and loss adjustment expenses, underwriting acquisition and insurance expenses, and other expenses, including interest expense related to the surplus notes.

Liquidity and Capital Resources

Our principal ongoing sources of funds are underwriting operations, investment income and proceeds from sales and maturities of investments. Our primary uses of funds are to pay claims and operating expenses and to purchase investments.

Our investment portfolio is structured so that investments mature periodically over time in reasonable relation to current expectations of future claim payments. Since we have a limited claims history, we have derived our expected future claim payments from industry and predecessor trends and included a provision for uncertainties. Our investment portfolio as of June 30, 2005 has an effective duration of 5.3 years with individual maturities extending out to 30 years. Currently, we make claim payments from positive cash flow from operations and invest excess cash in securities with appropriate maturity dates to balance against anticipated future claim payments. As these securities mature, we intend to invest any excess funds in investments with appropriate durations to match against expected future claim payments.

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Our ability to adequately provide funds to pay claims comes from our disciplined underwriting and pricing standards and the purchase of reinsurance to protect us against severe claims and catastrophic events. Effective October 1, 2004, our reinsurance program provides us with 100% reinsurance protection for each loss occurrence in excess of $500,000, up to $100.0 million. The agreements for the current reinsurance program expire on October 1, 2005, at which time we expect to renew the program. Given industry and predecessor trends, we believe we are sufficiently capitalized to retain the first $500,000 of each loss occurrence.

At June 30, 2005, our portfolio is made up almost entirely of investment grade fixed income securities with market values subject to fluctuations in interest rates. Prior to 2005, we did not invest in common equity securities and we had no exposure to foreign currency risk. In February 2005, our investment policy was revised to allow for the investment of up to 2% of our investment portfolio in foreign fixed income securities. While we have structured our investment portfolio to provide an appropriate matching of maturities with anticipated claim payments, if we decide or are required in the future to sell securities in a rising interest rate environment, we would expect to incur losses from such sales.

Our insurance subsidiary is required by law to maintain a certain minimum level of surplus on a statutory basis. Surplus is calculated by subtracting total liabilities from total admitted assets. The National Association of Insurance Commissioners has a risk-based capital standard designed to identify property and casualty insurers that may be inadequately capitalized based on inherent risks of each insurer’s assets and liabilities and its mix of net premiums written. Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action. As of December 31, 2004, the last date that we were required to update the annual risk-based capital calculation, the statutory surplus of our insurance subsidiary was in excess of the prescribed risk-based capital requirements that correspond to any level of regulatory action.

SeaBright operates as a holding company and has minimal revenue and expenses. Currently, there are no plans to have our insurance subsidiary or PointSure pay a dividend to SeaBright.

Our consolidated net cash provided by operating activities for the six month period ended June 30, 2005 was $32.8 million, compared to our cash flow from operations of $15.2 million for the same period in 2004. The increase is primarily attributable to increases in unpaid loss and loss adjustment expense, federal income taxes payable, and amortization of deferred policy acquisition costs, offset by increases in policy acquisition costs deferred, accrued investment income, deferred federal income tax benefit, unearned premiums and balances related to reinsurance recoverables, all as a result of the growth of our business.

We used net cash of $93.7 million for investing activities for the six month period ended June 30, 2005, compared to $12.9 million for the same period in 2004. The difference between periods is primarily attributable to the fact that we invested net proceeds totaling approximately $80.8 million resulting from the sale of 8,625,000 shares of common stock in our initial public offering described below.

For the six months ended June 30, 2005, financing activities provided cash of $80.8 million, primarily from the sale of 8,625,000 shares of common stock in our initial public offering described below. For the six months ended June 30, 2004, $12.0 million of cash was provided from the issuance of surplus notes and $5.2 million was provided from the issuance of shares of preferred stock.

On January 26, 2005, we closed the initial public offering of 8,625,000 shares of our common stock, including the underwriters’ over-allotment option to purchase 1,125,000 shares of our common stock, at a price of $10.50 per share for net proceeds of approximately $80.8 million, after deducting underwriters’ fees, commissions and offering costs totaling approximately $9.8 million. On January 26, 2005, we contributed approximately $74.8 million of the net proceeds to SeaBright Insurance Company. We intend to use the remaining net proceeds for general corporate purposes, including supporting the growth of PointSure. In connection with the initial public offering, all 508,365.25 outstanding shares of our Series A convertible preferred stock were converted into 7,777,808 shares of common stock.

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Contractual Obligations and Commitments

The following table identifies our contractual obligations due by period as of June 30, 2005:


	Payments Due by Period
			Less than						More than
	Total		1 Year		1-3 Years		4-5 Years		5 Years
	(in thousands)
Long term debt obligations:
Surplus notes	$	12,000	$	—	$	—	$	—	$	12,000
Loss and loss adjustment expenses		103,896		14,857		50,078		14,961		24,000
Operating and lease obligations.		3,210		809		2,164		237		—

Total	$	119,106	$	15,666	$	52,242	$	15,198	$	36,000

The loss and loss adjustment expense payments due by period in the table above are based upon the loss and loss adjustment expense estimates as of June 30, 2005 and actuarial estimates of expected payout patterns and are not contractual liabilities as to time certain. Our contractual liability is to provide benefits under the policies. As a result, our calculation of loss and loss adjustment expense payments due by period is subject to the same uncertainties associated with determining the level of unpaid loss and loss adjustment expenses generally and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. Actual payments of loss and loss adjustment expenses by period will vary, perhaps materially, from the above table to the extent that current estimates of loss and loss adjustment expenses vary from actual ultimate claims amounts and as a result of variations between expected and actual payout patterns. See the discussion under the heading “Factors That May Affect Our Business, Future Operating Results and Financial Condition – Our loss reserves are based on estimates and may be inadequate to cover our actual losses” in this Item 2 for a discussion of the uncertainties associated with estimating unpaid loss and loss adjustment expenses.

Off-Balance Sheet Arrangements

As of June 30, 2005, we had no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Critical Accounting Policies, Estimates and Judgments

It is important to understand our accounting policies in order to understand our financial statements. We consider some of these policies to be critical to the presentation of our financial results, since they require management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the financial reporting date and throughout the period being reported upon. Some of the estimates result from judgments that can be subjective and complex, and consequently, actual results reflected in future periods might differ from these estimates.

The most critical accounting policies involve the reporting of unpaid loss and loss adjustment expenses, including losses that have occurred but were not reported to us by the financial reporting date; the amount and recoverability of reinsurance recoverable balances; accounting for our adverse development cover; deferred policy acquisition costs; deferred taxes; goodwill and other intangible assets; retrospective premiums; earned but unbilled premiums; and the impairment of investment securities. The following should be read in conjunction with the notes to our financial statements.

Unpaid Loss and Loss Adjustment Expenses

Unpaid loss and loss adjustment expenses represent our estimate of the expected cost of the ultimate settlement and administration of losses, based on known facts and circumstances. Included in unpaid loss and loss adjustment expenses are amounts for case-based reserves, including estimates of future developments on these claims; claims incurred but not yet reported to us; second injury fund assessments; allocated claim adjustment expenses; and unallocated claim adjustment expenses. We use actuarial methodologies to assist us in establishing these estimates, including judgments relative to estimates of future claims severity and frequency, length of time to achieve ultimate resolution, judicial theories of liability and other third-party factors that are often beyond our control. Due to the inherent uncertainty associated with the cost of unsettled and unreported claims, the ultimate liability may differ materially from the original estimates. These estimates are regularly reviewed and updated and any resulting adjustments are included in the current period’s operating results. Because of the relative immaturity of our unpaid

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loss and loss adjustment expense data, actuarial techniques are applied that use the historical experience of our predecessor as well as industry information in the analysis of our unpaid loss and loss adjustment expenses.

Reinsurance Recoverables

Reinsurance recoverables on paid and unpaid losses represent the portion of the loss and loss adjustment expenses that is assumed by reinsurers. These recoverables are reported on our balance sheet separately as assets, as reinsurance does not relieve us of our legal liability to policyholders and ceding companies. We are required to pay losses even if a reinsurer fails to meet its obligations under the applicable reinsurance agreement. Reinsurance recoverables are determined based in part on the terms and conditions of reinsurance contracts, which could be subject to interpretations that differ from ours based on judicial theories of liability. In addition, we bear credit risk with respect to the reinsurers, which can be significant considering that some of the unpaid loss and loss adjustment expenses remain outstanding for an extended period of time.

Adverse Development Cover

The unpaid loss and loss adjustment expense subject to the adverse development cover with LMC is calculated on a quarterly basis using generally accepted actuarial methodologies. Amounts recoverable in excess of acquired reserves at September 30, 2003 are recorded gross in unpaid loss and loss adjustment expense in accordance with SFAS No. 141, “Business Combinations,” with a corresponding amount receivable from the seller. Amounts are shown net in the statement of operations.

Deferred Policy Acquisition Costs

We defer commissions, premium taxes and certain other costs that vary with and are primarily related to the acquisition of insurance contracts. These costs are capitalized and amortized to expense in proportion to the recognition of premiums earned. The method followed in computing deferred policy acquisition costs limits the amount of these deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, anticipated losses and settlement expenses and certain other costs that we expect to incur as the premium is earned. Judgments as to ultimate recoverability of these deferred costs are highly dependent upon estimated future loss costs associated with the premiums written.

Deferred Taxes

We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statement of operations in the period that includes the enactment date.

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. If necessary, we would establish a valuation allowance to reduce the deferred tax assets to the amounts more likely than not to be realized.

Goodwill and Other Intangible Assets

Goodwill represents the excess of costs over fair value of assets of businesses acquired. Goodwill and other intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but are instead tested for impairment at least annually. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets.”

Retrospective Premiums

Retrospective premiums for primary and reinsured risks are included in income as earned on a pro rata basis over the effective period of the respective policies. Earned premiums on retrospectively rated policies are based on

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the Company’s estimate of loss experience as of the measurement date. Unearned premiums are deferred and include that portion of premiums written that is applicable to the unexpired period of the policies in force and estimated adjustments of premiums on policies that have retrospective rating endorsements.

Earned But Unbilled Premiums

We estimate the amount of premiums that have been earned but are unbilled at the end of the period by analyzing historical earned premium adjustments made and applying an adjustment percentage against premiums earned for the period.

Impairment of Investment Securities

Impairment of investment securities results in a charge to operations when the market value of a security declines to below our cost and is deemed to be other-than-temporary. We regularly review our fixed maturity portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of investments. A number of criteria are considered during this process, including, but not limited to, the following: the current fair value as compared to amortized cost or cost, as appropriate, of the security; the length of time the security’s fair value has been below amortized cost; our intent and ability to retain the investment for a period of time sufficient to allow for an anticipated recovery in value; specific credit issues related to the issuer; and current economic conditions. In general, we focus on those securities whose fair values were less than 80% of their amortized cost or cost, as appropriate, for six or more consecutive months. Other-than-temporary impairment losses result in a permanent reduction of the carrying amount of the underlying investment. Significant changes in the factors considered when evaluating investments for impairment losses could result in a significant change in impairment losses reported in the financial statements.

Recent Accounting Pronouncements

SFAS No. 123 (revised 2004), “Share-based Payment,” was issued in December 2004. Statement No. 123(R) is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” Statement No. 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and amends SFAS No. 95, “Statement of Cash Flows.” Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations based on their fair values. Pro forma disclosure is no longer an alternative.

SFAS No. 123(R) must be adopted no later than January 1, 2006, and we expect to adopt the Statement on or prior to that date. As permitted by SFAS No. 123, we currently account for share-based payments to employees using the intrinsic value method as detailed in Opinion No. 25 and, as such, generally recognize no compensation cost for employee stock options. Accordingly, the adoption of SFAS No. 123(R)’s fair value method will have an impact on our results of operations, although it will have no impact on our overall financial position. The impact of adoption of SFAS No. 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had we adopted SFAS No. 123(R) in prior periods, the impact of the standard would have approximated the impact of SFAS No. 123 as described in Note 2.h. of the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this quarterly report.

Factors That May Affect Our Business, Future Operating Results and Financial Condition

You should carefully consider the risks described below, together with all of the other information included in this quarterly report. The risks and uncertainties described below are not the only ones facing our company. If any of the following risks actually occurs, our business, financial condition or operating results could be harmed. Any of the risks described below could result in a significant or material adverse effect on our financial condition or results of operations, and a corresponding decline in the market price of our common stock. You could lose all or part of your investment. The risks discussed below also include forward-looking statements and our actual results may differ substantially from those discussed in those forward-looking statements. Please refer to the discussion under the heading “Note on Forward-Looking Statements” in this Item 2.

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Risks Related to Our Business

Our loss reserves are based on estimates and may be inadequate to cover our actual losses.

If we fail to accurately assess the risks associated with the businesses that we insure, our loss reserves may be inadequate to cover our actual losses and we may fail to establish appropriate premium rates. We establish loss reserves in our financial statements that represent an estimate of amounts needed to pay and administer claims with respect to insured events that have occurred, including events that have not yet been reported to us. Loss reserves are estimates and are inherently uncertain; they do not and cannot represent an exact measure of liability. Accordingly, our loss reserves may prove to be inadequate to cover our actual losses. Any changes in these estimates are reflected in our results of operations during the period in which the changes are made, with increases in our loss reserves resulting in a charge to our earnings.

Our loss reserve estimates are based on estimates of the ultimate cost of individual claims and on actuarial estimation techniques. Several factors contribute to the uncertainty in establishing these estimates. Judgment is required in actuarial estimation to ascertain the relevance of historical payment and claim settlement patterns under current facts and circumstances. Key assumptions in the estimation process are the average cost of claims over time, which we refer to as severity trends, including the increasing level of medical, legal and rehabilitation costs, and costs associated with fraud or other abuses of the medical claim process. If there are unfavorable changes in severity trends, we may need to increase our loss reserves, as described above.

Our geographic concentration ties our performance to the business, economic and regulatory conditions in California, Hawaii and Alaska. Any single catastrophe or other condition affecting losses in these states could adversely affect our results of operations.

Our business is concentrated in California (62.0% of direct premiums written for the six months ended June 30, 2005), Alaska (10.4% of direct premiums written for the same period) and Hawaii (8.1% of direct premiums written for the same period). Accordingly, unfavorable business, economic or regulatory conditions in those states could negatively impact our business. For example, California, Hawaii and Alaska are states that are susceptible to severe natural perils, such as tsunamis, earthquakes and hurricanes, along with the possibility of terrorist acts. Accordingly, we could suffer losses as a result of catastrophic events in those states. Although geographic concentration has not adversely affected our business in the past, we may in the future be exposed to economic and regulatory risks or risks from natural perils that are greater than the risks faced by insurance companies that conduct business over a greater geographic area. This concentration of our business could have a material adverse effect on our financial condition or results of operations.

If we are unable to obtain or collect on our reinsurance protection, our business, financial condition and results of operations could be materially adversely affected.

We buy reinsurance coverage to protect us from the impact of large losses. Reinsurance is an arrangement in which an insurance company, called the ceding company, transfers insurance risk by sharing premiums with another insurance company, called the reinsurer. Conversely, the reinsurer receives or assumes reinsurance from the ceding company. We currently participate in a workers’ compensation and employers’ liability excess of loss reinsurance treaty program covering all of the business that we write pursuant to which our reinsurers are liable for 100% of the ultimate net losses in excess of $500,000 for the business we write, up to a $100.0 million limit. The treaty program provides coverage in several layers. The availability, amount and cost of reinsurance depend on market conditions and may vary significantly. As a result of catastrophic events, such as the events of September 11, 2001, we may incur significantly higher reinsurance costs, more restrictive terms and conditions, and decreased availability. For example, the second layer of our current excess of loss reinsurance treaty program provides for a sub-limit on our reinsurers’ maximum liability in the amount of $8.0 million for losses caused by acts determined by the U.S. Office of Homeland Security to be terrorist acts, and the third and fourth layers of our reinsurance program expressly do not cover losses caused by any act of terrorism, as defined in the Terrorism Risk Insurance Act of 2002 (the “Terrorism Risk Act”). Because of these sub-limits and exclusions, which are common in the wake of the events of September 11, 2001, we have significantly greater exposure to losses resulting from acts of terrorism. The incurrence of higher reinsurance costs and more restrictive terms could materially adversely affect our business, financial condition and results of operations.

The agreements for our current workers’ compensation excess of loss reinsurance treaty program expire on October 1, 2005. Although we currently expect to renew the program upon its expiration, any decrease in the amount of our reinsurance at the time of renewal, whether caused by the existence of more restrictive terms and

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conditions or decreased availability, will also increase our risk of loss and, as a result, could materially adversely affect our business, financial condition and results of operations. We have not experienced difficulty in qualifying for or obtaining sufficient reinsurance to appropriately cover our risks in the past. We currently have 10 reinsurers participating in our excess of loss reinsurance treaty program, and believe that this is a sufficient number of reinsurers to provide us with reinsurance in the volume that we require. However, it is possible that one or more of our current reinsurers could cancel participation, or we could find it necessary to cancel the participation of one of our reinsurers, in our excess of loss reinsurance treaty program. In either of those events, if our reinsurance broker is unable to spread the cancelled or terminated reinsurance among the remaining reinsurers in the program, we estimate that it could take approximately one to three weeks to identify and negotiate appropriate documentation with a replacement reinsurer. During this time, we would be exposed to an increased risk of loss, the extent of which would depend on the volume of cancelled reinsurance.

In addition, we are subject to credit risk with respect to our reinsurers. Reinsurance protection that we receive does not discharge our direct obligations under the policies we write. We remain liable to our policyholders, even if we are unable to make recoveries to which we believe we are entitled under our reinsurance contracts. Losses may not be recovered from our reinsurers until claims are paid, and, in the case of long-term workers’ compensation cases, the creditworthiness of our reinsurers may change before we can recover amounts to which we are entitled. Although we have not experienced problems in the past resulting from the failure of a reinsurer to pay our claims in a timely manner, if we experience these problems in the future, our costs would increase and our revenues would decline. As of June 30, 2005, we had $21.4 million of net amounts recoverable from our reinsurers that we would be obligated to pay if our reinsurers failed to pay us.

The insurance business is subject to extensive regulation and legislative changes, which impact the manner in which we operate our business.

Our insurance business is subject to extensive regulation by the applicable state agencies in the jurisdictions in which we operate, perhaps most significantly by the Illinois Department of Financial and Professional Regulation, Division of Insurance (the “Illinois Division of Insurance”) and the California Department of Insurance. These state agencies have broad regulatory powers designed to protect policyholders, not stockholders or other investors. These powers include, among other things, the ability to:

	•		place limitations on our ability to transact business with our affiliates;

	•		regulate mergers, acquisitions and divestitures involving our insurance company subsidiary;

	•		require SeaBright Insurance Company and PointSure to comply with various licensing requirements and approvals that affect our ability to do business;

	•		approve or reject our policy coverage and endorsements;

	•		place limitations on our investments and dividends;

	•		set standards of solvency to be met and maintained;

	•		regulate rates pertaining to our business;

	•		require assessments for the provision of funds necessary for the settlement of covered claims under certain policies provided by impaired, insolvent or failed insurance companies;

	•		require us to comply with medical privacy laws; and

	•		prescribe the form and content of, and examine, our statutory financial statements.

For example, our ability to transact business with our affiliates and to enter into mergers, acquisitions and divestitures involving our insurance company subsidiary is limited by the requirements of the insurance holding company laws of Illinois and California. To comply with these laws, we are required to file notices with the Illinois Division of Insurance and the California Department of Insurance to seek their respective approvals at least 30 days before engaging in any intercompany transactions, such as sales, purchases, exchanges of assets, loans, extensions of credit, cost sharing arrangements and extraordinary dividends or other distributions to shareholders. Under these holding company laws, any change of control transaction also requires prior notification and approval. Because

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these governmental agencies may not take action or give approval within the 30 day period, these notification and approval requirements may subject us to business delays and additional business expense. If we fail to give these notifications, we may be subject to significant fines and penalties and damaged working relations with these governmental agencies.

In addition, workers’ compensation insurance is statutorily provided for in all of the states in which we do business. State laws and regulations provide for the form and content of policy coverage and the rights and benefits that are available to injured workers, their representatives and medical providers. For example, in California, on January 1, 2003, workers’ compensation legislation became effective that provides for increases in the benefits payable to injured workers. Also, in California, workers’ compensation legislation intended to reduce certain costs was enacted in September 2003 and April 2004. Among other things, this legislation established an independent medical review process for resolving medical disputes, tightened standards for determining impairment ratings by applying specific medical treatment guidelines, capped temporary total disability payments to 104 weeks from first payment and enables injured workers to access immediate medical care up to $10,000 but requires them to get medical care through a network of doctors chosen by the employer. The implementation of these reforms affects the manner in which we coordinate medical care costs with employers and the manner in which we oversee treatment plans.

Our business is also affected by federal laws, including the USL&H Act, which is administered by the Department of Labor, and the Merchant Marine Act of 1920, or Jones Act. The USL&H Act contains various provisions affecting our business, including the nature of the liability of employers of longshoremen, the rate of compensation to an injured longshoreman, the selection of physicians, compensation for disability and death and the filing of claims. Currently, builders of recreational boats over 65 feet in length are subject to the USL&H Act. A proposed amendment to the USL&H Act would eliminate builders of recreational boats from the reach of the USL&H Act. If this proposed amendment is adopted, we expect that we would lose a total of approximately $3.0 million in annual direct written premium from policies currently providing USL&H Act coverage. The proposed amendment would not have a material impact on our policies providing coverage under the Jones Act, which gives certain employees at sea the right to sue their employers if such employees are injured.

In addition, we are impacted by the Terrorism Risk Act, as discussed earlier, and by the Gramm Leach Bliley Act of 2002 related to disclosure of personal information. Moreover, changes in federal tax laws could also impact our business.

This extensive regulation of our business may affect the cost or demand for our products and may limit our ability to obtain rate increases or to take other actions that we might desire to increase our profitability. In addition, we may be unable to maintain all required approvals or comply fully with the wide variety of applicable laws and regulations, which are continually undergoing revision, or the relevant authority’s interpretation of such laws and regulations.

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

Rating agencies rate insurance companies based on each company’s ability to pay claims. Our insurance company subsidiary currently has a rating of “A–” (Excellent) from A.M. Best, which is the rating agency that we believe has the most influence on our business. The ratings of A.M. Best are subject to periodic review using, among other things, proprietary capital adequacy models, and are subject to revision or withdrawal at any time. Insurance ratings are directed toward the concerns of policyholders and insurance agents and are not intended for the protection of investors or as a recommendation to buy, hold or sell any of our securities. Our competitive position relative to other companies is determined in part by our A.M. Best rating. We believe that our business is particularly sensitive to our A.M. Best rating because we focus on larger customers which tend to give substantial weight to the A.M. Best rating of their insurers. We expect that any reduction in our A.M. Best rating below “A–” would cause a reduction in the number of policies we write and could have a material adverse effect on our results of operations and our financial position.

The effects of emerging claim and coverage issues on our business are uncertain.

As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect our business by either extending coverage beyond our underwriting intent or by increasing the number or size of claims. In some instances, these changes may not become apparent until some time after we have issued insurance contracts that are

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affected by the changes. As a result, the full extent of liability under our insurance contracts may not be known for many years after a contract is issued. For example, the number or nature of existing occupational diseases may expand beyond our expectation. In addition, medical costs associated with permanent and partial disabilities may inflate more rapidly or higher than we currently expect. Expansions of this nature may expose us to more claims than we anticipated when we wrote the underlying policy.

Intense competition could adversely affect our ability to sell policies at rates we deem adequate.

In most of the states in which we operate, we face significant competition which, at times, is intense. If we are unable to compete effectively, our business and financial condition could be materially adversely affected. Competition in our businesses is based on many factors, including premiums charged, services provided, financial strength ratings assigned by independent rating agencies, speed of claims payments, reputation, perceived financial strength and general experience. We compete with regional and national insurance companies and state-sponsored insurance funds, as well as potential insureds that have decided to self-insure. Many of our competitors have substantially greater financial and marketing resources than we do, and some of our competitors benefit financially by not being subject to federal income tax. Intense competitive pressure on prices can result from the actions of even a single large competitor.

In addition, our competitive advantage may be limited due to the small number of insurance products that we offer. Some of our competitors have additional competitive leverage because of the wide array of insurance products that they offer. For example, it may be more convenient for a potential customer to purchase numerous different types of insurance products from one insurance carrier. We do not offer a wide array of insurance products due to our targeted market niches, and we may lose potential customers to our larger, more diverse competitors as a result.

If we are unable to realize our investment objectives, our financial condition may be adversely affected.

Investment income is an important component of our revenues and net income. The ability to achieve our investment objectives is affected by factors that are beyond our control. For example, United States participation in hostilities with other countries and large-scale acts of terrorism may adversely affect the economy generally, and our investment income could decrease. Interest rates are highly sensitive to many factors, including governmental monetary policies and domestic and international economic and political conditions. These and other factors also affect the capital markets, and, consequently, the value of the securities we own. The outlook for our investment income is dependent on the future direction of interest rates and the amount of cash flows from operations that are available for investment. The fair values of fixed maturity investments that are “available for sale” fluctuate with changes in interest rates and cause fluctuations in our stockholders’ equity. Any significant decline in our investment income as a result of rising interest rates or general market conditions would have an adverse effect on our net income and, as a result, on our stockholders’ equity and our policyholders’ surplus.

We could be adversely affected by the loss of one or more principal employees or by an inability to attract and retain staff.

Our success will depend in substantial part upon our ability to attract and retain qualified executive officers, experienced underwriting talent and other skilled employees who are knowledgeable about our business. We rely substantially upon the services of our senior management team and key employees, consisting of John G. Pasqualetto, Chairman, President and Chief Executive Officer; Richard J. Gergasko, Executive Vice President; Joseph S. De Vita, Senior Vice President, Chief Financial Officer and Assistant Secretary; Richard W. Seelinger, Senior Vice President – Claims; Marc B. Miller, M.D., Senior Vice President and Chief Medical Officer; Jeffrey C. Wanamaker, Vice President – Underwriting; D. Drue Wax, Senior Vice President, General Counsel and Secretary;

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James L. Borland, III, Vice President and Chief Information Officer; M. Philip Romney, Vice President – Finance, Principal Accounting Officer and Assistant Secretary; and Chris A. Engstrom, President – PointSure. Although we are not aware of any planned departures or retirements, if we were to lose the services of members of our management team, our business could be adversely affected. Many of our principal employees possess skills and extensive experience relating to our market niches. Were we to lose any of these employees, it may be challenging for us to attract a replacement employee with comparable skills and experience in our market niches. We have employment agreements with some of our executive officers. We do not currently maintain key man life insurance policies with respect to any member of our senior management team or other employees.

We may require additional capital in the future, which may not be available or only available on unfavorable terms.

Our future capital requirements depend on many factors, including our ability to write new business successfully and to establish premium rates and loss reserves at levels sufficient to cover losses. To the extent that our current capital is insufficient to support future operating requirements and/or cover claim losses, we may need to raise additional funds through financings or curtail our growth. We believe that the net proceeds from the initial public offering of our common stock, completed in January 2005, will satisfy our capital requirements for the foreseeable future. However, because the timing and amount of our future needs for capital will depend on our growth and profitability, we cannot provide any assurance in that regard. If we had to raise additional capital, equity or debt financing may not be available at all or may be available only on terms that are not favorable to us. In the case of equity financings, dilution to our stockholders could result, and in any case such securities may have rights, preferences and privileges that are senior to those applicable to our existing shareholders. If we cannot obtain adequate capital on favorable terms or at all, we may be unable to support future growth or operating requirements and, accordingly, our business, financial condition or results of operations could be materially adversely affected.

Our status as an insurance holding company with no direct operations could adversely affect our ability to pay dividends in the future.

SeaBright is a holding company that transacts its business through its operating subsidiaries, SeaBright Insurance Company and PointSure. Our primary assets are the stock of these operating subsidiaries. Our ability to pay expenses and dividends depends, in the long run, upon the surplus and earnings of our subsidiaries and the ability of our subsidiaries to pay dividends to us. Payment of dividends by SeaBright Insurance Company is restricted by state insurance laws, including laws establishing minimum solvency and liquidity thresholds, and could be subject to contractual restrictions in the future, including those imposed by indebtedness we may incur in the future. SeaBright Insurance Company is required to report any ordinary dividends to the Illinois Division of Insurance and the California Department of Insurance prior to the payment of the dividend. In addition, SeaBright Insurance Company is not authorized to pay any extraordinary dividends to SeaBright under Illinois or California insurance laws without prior regulatory approval from the Illinois Division of Insurance or the California Department of Insurance. As a result, at times, we may not be able to receive dividends from SeaBright Insurance Company and we may not receive dividends in amounts necessary to pay dividends on our capital stock. In addition, the payment of dividends by us is within the discretion of our board of directors and will depend on numerous factors, including our financial condition, our capital requirements and other factors that our board of directors considers relevant. Currently, we do not intend to pay dividends on our capital stock.

We rely on independent insurance brokers to distribute our products.

Our business depends in part on the efforts of independent insurance brokers to market our insurance programs successfully and produce business for us and on our ability to offer insurance programs and services that meet the requirements of the clients and customers of these brokers. The majority of the business in our workers’ compensation operations is produced by a group of approximately 93 licensed insurance brokers. Brokers are not obligated to promote our insurance programs and may sell competitors’ insurance programs. Several of our competitors offer a broader array of insurance programs than we do. Accordingly, our brokers may find it easier to promote the broader range of programs of our competitors than to promote our niche selection of insurance products. If our brokers fail or choose not to market our insurance programs successfully or to produce business for us, our growth may be limited and our financial condition and results of operations may be negatively affected.

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We have a limited operating history as a stand-alone entity and may experience difficulty in transitioning to an independent public company.

We commenced operations in October 2003 after acquiring KEIC, the renewal rights from, and substantially all of the operating assets, systems and employees of, the Eagle Entities and PointSure, a wholesale insurance broker and third party claims administrator affiliated with the Eagle Entities. Although our management team is the same management team that operated the Eagle Entities and PointSure for approximately five years prior to the Acquisition, we have a limited operating history as a stand-alone entity and do not have the same resources available to us that the Eagle Entities and PointSure had prior to the Acquisition. Accordingly, our future results of operations or financial condition as a stand-alone entity may vary from the results realized by the Eagle Entities and PointSure prior to the Acquisition. An investor in our common stock should consider that our history as a stand-alone entity is relatively short and that there is a limited basis for evaluating our performance.

In addition, upon completion of our initial public offering in January 2005, we became a publicly traded company and are now responsible for complying with the various federal and legal regulatory requirements applicable to public companies. We will incur increased costs as a result of being a public company, particularly in light of recently enacted and proposed changes in laws, regulations and listing requirements, including those related to the Sarbanes-Oxley Act of 2002. Our business and financial condition may be adversely affected if we are unable to effectively manage these increased costs.

Assessments and other surcharges for guaranty funds and second injury funds and other mandatory pooling arrangements may reduce our profitability.

Virtually all states require insurers licensed to do business in their state to bear a portion of the unfunded obligations of impaired or insolvent insurance companies. These obligations are funded by assessments that are expected to continue in the future as a result of insolvencies. Assessments are levied by guaranty associations within the state, up to prescribed limits, on all member insurers in the state on the basis of the proportionate share of the premium written by member insurers in the lines of business in which the impaired, insolvent or failed insurer is engaged. Accordingly, the assessments levied on us may increase as we increase our premiums written. Many states also have laws that established second injury funds to provide compensation to injured employees for aggravation of a prior condition or injury, which are funded by either assessments based on paid losses or premium surcharge mechanisms. For example, Alaska requires insurers to contribute to its second injury fund annually an amount equal to the compensation the injured employee is owed multiplied by a contribution rate based on the fund’s reserve rate. In addition, as a condition of the ability to conduct business in some states, including California, insurance companies are required to participate in mandatory workers’ compensation shared market mechanisms or pooling arrangements, which provide workers’ compensation insurance coverage from private insurers. Although we price our products to account for the obligations that we may have under these pooling arrangements, we may not be successful in estimating our liability for these obligations. Accordingly, our prices may not fully account for our liabilities under pooling arrangements, which may cause a decrease in our profits. As we write policies in new states that have pooling arrangements, we will be required to participate in additional pooling arrangements. Further, the insolvency of other insurers in these pooling arrangements would likely increase the liability for other members remaining in the pool. The effect of these assessments and mandatory shared market mechanisms or changes in them could reduce our profitability in any given period or limit our ability to grow our business.

In the event LMC is placed into receivership, we could lose our rights to fee income and protective arrangements that were established in connection with the Acquisition, our reputation and credibility could be adversely affected and we could be subject to claims under applicable voidable preference and fraudulent transfer laws.

The assets that SeaBright acquired in the Acquisition were acquired from LMC and certain of its affiliates. LMC and its insurance company affiliates are currently operating under a three-year “run off” plan approved by the Illinois Division of Insurance. “Run off” is the professional management of an insurance company’s discontinued, distressed or non-renewed lines of insurance and associated liabilities outside of a judicial proceeding. Under the run off plan, LMC will attempt to buy back some of its commercial line policies and institute aggressive expense control measures in order to reduce its future loss exposure and allow it to meet its obligations to current policyholders. According to LMC’s statutory financial statements as of and for the year ended December 31, 2004, LMC had a statutory surplus of $171.4 million, a decrease of approximately $31.0 million from its surplus of $202.4 million as of December 31, 2003. On an operating basis, LMC lost approximately $66.0 million in the year ended December 31, 2004. In connection with the Acquisition, we established various arrangements with LMC and certain of its affiliates, including (1) servicing arrangements entitling us to fee income for providing claims administration

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services for Eagle and (2) other protective arrangements designed to minimize our exposure to any past business underwritten by KEIC, the shell entity that we acquired from LMC for its insurance licenses, and any adverse developments in KEIC’s loss reserves as they existed at the date of the Acquisition. In the event LMC is placed into receivership, our business could be adversely affected in the following ways.

	•		A receiver could seek to reject or terminate one or more of the services agreements that were established in connection with the Acquisition between us and LMC or its affiliates, including Eagle. In that event, we could lose the revenue we currently receive under these services agreements. Our projected revenue under these agreements is approximately $1.5 million in 2005 and $0.9 million in 2006.

	•		To minimize our exposure to any past business underwritten by KEIC, we entered into an arrangement with LMC at the time of the Acquisition requiring LMC to indemnify us in the event of adverse development of the loss reserves in KEIC’s balance sheet as they existed on the date of closing of the Acquisition. We refer to this arrangement as the adverse development cover. To support LMC’s obligations under the adverse development cover, LMC funded a trust account at the time of the Acquisition. The minimum amount that must be maintained in the trust account is equal to the greater of (a) $1.6 million or (b) 102% of the then-existing quarterly estimate of LMC’s total obligations under the adverse development cover. We refer to this trust account as the collateralized reinsurance trust because the funds on deposit in the trust account serve as collateral for LMC’s potential future obligations to us under the adverse development cover. LMC initially funded the trust account with $1.6 million to support its obligations under the adverse development cover. In September 2004, we and LMC retained an independent actuary to determine the appropriate amount of loss reserves that are subject to the adverse development cover as of September 30, 2004. In accordance with the terms of the protective arrangements that we have established with LMC, on December 23, 2004, LMC deposited into the collateralized reinsurance trust an additional approximately $3.2 million, resulting in a total balance in the trust account, including interest earnings, of approximately $4.9 million at June 30, 2005. If LMC is placed into receivership and the amount held in the collateralized reinsurance trust is inadequate to satisfy the obligations of LMC to us under the adverse development cover, it is unlikely that we would recover any future amounts owed by LMC to us under the adverse development cover in excess of the amounts currently held in trust because the director of the Illinois Division of Insurance would have control of the assets of LMC.

	•		Some of our customers are insured under Eagle insurance policies that we service pursuant to the claims administration servicing agreement described above. Although SeaBright is a separate legal entity from LMC and its affiliates, including Eagle, Eagle’s policyholders may not readily distinguish SeaBright from Eagle and LMC if those policies are not honored in the event LMC is found to be insolvent and placed into court-ordered liquidation. If that were to occur, our market reputation, credibility and ability to renew the underlying policies could be adversely affected.

	•		In connection with the Acquisition, LMC and its affiliates made various transfers and payments to SeaBright, including approximately $13.0 million under the commutation agreement and approximately $4.9 million to fund the collateralized reinsurance trust. In the event that LMC is placed into receivership, it is possible that a receiver or creditor could assert a claim seeking to unwind or recover these payments under applicable voidable preference and fraudulent transfer laws.

Risks Related to Our Industry

Recent investigations into insurance brokerage practices could cause volatility in our stock and adversely affect our business.

On October 14, 2004, the Attorney General of the State of New York filed a well-publicized civil complaint against a large insurance broker concerning, among other things, allegations that so-called contingent commissions conflicted with the broker’s duties to customers, that the broker steered unsuspecting commercial clients to insurers with which the broker had lucrative contingent commission arrangements, and that the broker and several insurers for whom it produced business engaged in bid-rigging in connection with insurance premium quotes for commercial property and casualty insurance. This investigation of the insurance industry has expanded to involve additional companies and practices, including tying practices in connection with the purchase of reinsurance through brokers as well as brokerage commissions paid in connection with producing group life and health insurance business. As a result of the attendant publicity and because other states’ attorneys general and insurance regulators have also initiated their own investigations of industry practices relating to broker compensation, stock prices of companies in

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the insurance industry have experienced substantial volatility and may experience continued volatility for the foreseeable future.

The Illinois Division of Insurance is among the regulators investigating insurance industry practices in the wake of the New York Attorney General’s investigation. Our insurance company subsidiary, which is incorporated in Illinois, received and, in November of 2004, responded to a subpoena from the Illinois Division of Insurance requesting answers to interrogatories and production of certain documents relating to the Department’s investigation of producer compensation arrangements. We understand that these inquiries were made to all domestic Illinois insurers and major brokerages who transact business in Illinois. On May 26, 2005, the Division of Insurance reported to the Illinois House Insurance Committee that its investigation continues. We anticipate that officials from other jurisdictions in which we do business may also initiate investigations into similar matters and, accordingly, we could receive additional subpoenas and requests for information with respect to these matters. The volatility caused by the many developments relating to broker compensation may affect the price of our stock regardless of our practices in dealing with brokers.

Additionally, proposed legislation or new regulatory requirements are expected to be imposed on the insurance industry and will impact our business and the manner in which we compensate our brokers. On December 29, 2004, the National Association of Insurance Commissioners (the “NAIC”) approved model producer compensation amendments to the Producer Licensing Model Act. The brokerage provision is based on a producer: (1) receiving compensation from the customer or (2) representing the customer in the placement of the business. The producer is required to obtain the customer’s consent in order to receive compensation from the insurer and to disclose the amount of that compensation or, if that is not known, the method by which compensation will be determined with a reasonable estimate of the amount, where possible. In the agent provision, which also may apply to some brokerage situations, the producer must disclose to the customer that the producer will be receiving compensation from the insurer, or that the producer represents the insurer and may provide services to the customer for the insurer.

The California Department of Insurance has also proposed new regulations concerning brokers. On May 9, 2005, it held a workshop on its revised regulatory proposal and, among other activities, agreed to exclude wholesale brokers from the proposed disclosure obligations and offered to create an industry/California Department of Insurance task force to work on the draft regulations. The Oregon Department of Consumer and Business Services, Insurance Division on May 25, 2005 adopted new regulations effective August 15, 2005 which address broker disclosure of compensation. The regulations exempt intermediary producers, such as wholesale brokers, from the new requirements.

Although PointSure, our in-house wholesale broker, currently provides disclosure to its customers regarding any contingent compensation arrangements it may receive, PointSure may become subject to additional disclosure requirements under various proposed regulations, and it is unclear how these regulations, which primarily target retail brokers, will be applied to wholesale brokers. The New York Attorney General’s investigation and all developing regulatory responses related to the investigation represent an evolving area of law, and we cannot, at this point, predict its consequences for the industry or for us.

We may face substantial exposure to losses from terrorism for which we are required by law to provide coverage.

Under our workers’ compensation policies, we are required to provide workers’ compensation benefits for losses arising from acts of terrorism. The impact of any terrorist act is unpredictable, and the ultimate impact on us would depend upon the nature, extent, location and timing of such an act. Notwithstanding the protection provided by the reinsurance we have purchased and any protection provided by the Terrorism Risk Act, the risk of severe losses to us from acts of terrorism has not been eliminated because, as discussed above, our excess of loss reinsurance treaty program contains various sub-limits and exclusions limiting our reinsurers’ obligation to cover losses caused by acts of terrorism. Furthermore, the Terrorism Risk Act is scheduled to expire on December 31, 2005 and may not be renewed, or if it is renewed, it may provide different and possibly reduced protection against the financial impacts of acts of terrorism. Accordingly, events may not be covered by, or may exceed the capacity of, our reinsurance protection and any protection offered by the Terrorism Risk Act or any successor legislation. Thus, any acts of terrorism could materially adversely affect our business and financial condition.

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The threat of terrorism and military and other actions may result in decreases in our net income, revenue and assets under management and may adversely affect our investment portfolio.

The threat of terrorism, both within the United States and abroad, and military and other actions and heightened security measures in response to these types of threats, may cause significant volatility and declines in the equity markets in the United States and abroad, as well as loss of life, property damage, additional disruptions to commerce and reduced economic activity. Actual terrorist attacks could cause a decrease in our stockholders’ equity, net income and/or revenue. The effects of these changes may result in a decrease in our stock price. In addition, some of the assets in our investment portfolio may be adversely affected by declines in the bond markets and declines in economic activity caused by the continued threat of terrorism, ongoing military and other actions and heightened security measures.

We cannot predict at this time whether and the extent to which industry sectors in which we maintain investments may suffer losses as a result of potential decreased commercial and economic activity, or how any such decrease might impact the ability of companies within the affected industry sectors to pay interest or principal on their securities, or how the value of any underlying collateral might be affected.

We can offer no assurances that terrorist attacks or the threat of future terrorist events in the United States and abroad or military actions by the United States will not have a material adverse effect on our business, financial condition or results of operations.

Our results of operations and revenues may fluctuate as a result of many factors, including cyclical changes in the insurance industry, which may cause the price of our common stock to be volatile.

The results of operations of companies in the insurance industry historically have been subject to significant fluctuations and uncertainties. Our profitability can be affected significantly by:

	•		competition;

	•		rising levels of loss costs that we cannot anticipate at the time we price our products;

	•		volatile and unpredictable developments, including man-made, weather-related and other natural catastrophes or terrorist attacks;

	•		changes in the level of reinsurance capacity and capital capacity;

	•		changes in the amount of loss reserves resulting from new types of claims and new or changing judicial interpretations relating to the scope of insurers’ liabilities; and

	•		fluctuations in interest rates, inflationary pressures and other changes in the investment environment, which affect returns on invested assets and may impact the ultimate payout of losses.

The supply of insurance is related to prevailing prices, the level of insured losses and the level of industry surplus which, in turn, may fluctuate in response to changes in rates of return on investments being earned in the insurance industry. As a result, the insurance business historically has been a cyclical industry characterized by periods of intense price competition due to excessive underwriting capacity as well as periods when shortages of capacity permitted favorable premium levels. During 1998, 1999 and 2000, the workers’ compensation insurance industry experienced substantial pricing competition, and this pricing competition greatly affected the ability of our predecessor to increase premiums. Beginning in 2001, we witnessed a decrease in pricing competition in the industry, which enabled us to raise our rates. Although rates for many products have increased in recent years, the supply of insurance may increase, either by capital provided by new entrants or by the commitment of additional capital by existing insurers, which may cause prices to decrease. Any of these factors could lead to a significant reduction in premium rates, less favorable policy terms and fewer submissions for our underwriting services. In addition to these considerations, changes in the frequency and severity of losses suffered by insureds and insurers may affect the cycles of the insurance business significantly, and we expect to experience the effects of such cyclicality. This cyclicality may cause the price of our securities to be volatile.

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Risks Related to Our Common Stock

The price of our common stock may decrease.

The trading price of shares of our common stock may decline for many reasons, some of which are beyond our control, including, among others:

	•		quarterly variations in our results of operations;

	•		changes in expectations as to our future results of operations, including financial estimates by securities analysts and investors;

	•		announcements of claims against us by third parties;

	•		changes in law and regulation;

	•		results of operations that vary from those expected by securities analysts and investors; and

	•		future sales of shares of our common stock.

In addition, the stock market in recent years has experienced substantial price and volume fluctuations that sometimes have been unrelated or disproportionate to the operating performance of companies whose shares are traded. As a result, the trading price of shares of our common stock may decrease and you may not be able to sell your shares at or above the price you pay to purchase them.

Future sales of shares of our common stock may affect their market price and the future exercise of options may depress our stock price and will result in immediate and substantial dilution.

We cannot predict what effect, if any, future sales of shares of our common stock, or the availability of shares for future sale, will have on the market price of our common stock. Sales of substantial amounts of our common stock in the public market, or the perception that such sales could occur, could adversely affect the market price of our common stock and may make it more difficult for you to sell your shares at a time and price which you deem appropriate.

As of June 30, 2005, there were 16,402,808 shares of our common stock outstanding. Moreover, 807,859 additional shares of our common stock will be issuable upon the full exercise or conversion of options and shares of restricted stock outstanding at June 30, 2005. In the event that any outstanding options are exercised, you will suffer dilution of your investment.

Applicable insurance laws may make it difficult to effect a change of control of our company.

Our insurance company subsidiary is domiciled in the state of Illinois and commercially domiciled in the state of California. The insurance holding company laws of Illinois and California require advance approval by the Illinois Division of Insurance and the California Department of Insurance of any change in control of SeaBright Insurance Company. “Control” is generally presumed to exist through the direct or indirect ownership of 10% or more of the voting securities of a domestic insurance company or of any entity that controls a domestic insurance company. In addition, insurance laws in many states contain provisions that require prenotification to the insurance commissioners of a change in control of a non-domestic insurance company licensed in those states. Any future transactions that would constitute a change in control of SeaBright Insurance Company, including a change of control of SeaBright, would generally require the party acquiring control to obtain the prior approval of the Illinois Division of Insurance and the California Department of Insurance and may require pre-acquisition notification in applicable states that have adopted pre-acquisition notification provisions. Obtaining these approvals may result in a material delay of, or deter, any such transaction.

These laws may discourage potential acquisition proposals and may delay, deter or prevent a change of control of SeaBright, including through transactions, and in particular unsolicited transactions, that some or all of the stockholders of SeaBright might consider to be desirable.

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Entities affiliated with Summit Partners have the ability to significantly influence our business, which may be disadvantageous to other stockholders and adversely affect the trading price of our common stock.

Following the completion of the initial public offering of our common stock in January 2005, entities affiliated with Summit Partners, collectively, beneficially own approximately 46.6% of our outstanding common stock. As a result, these stockholders, acting together, will have the ability to exert substantial influence over all matters requiring approval by our stockholders, including the election and removal of directors and any proposed merger, consolidation or sale of all or substantially all of our assets and other corporate transactions. In addition, these stockholders may have interests that are different from ours. Under our amended and restated certificate of incorporation, none of the Summit entities or any director, officer, stockholder, member, manager or employee of the Summit entities has any duty to refrain from engaging directly or indirectly in the same or similar business activities or lines of business that we do. In the event that any Summit entity acquires knowledge of a potential transaction or matter which may be a corporate opportunity for itself and us, the Summit entity will not have any duty to communicate or offer such opportunity to us and will not be liable to us or our stockholders for breach of any fiduciary duty relating to such corporate opportunity. Our officers, directors and principal stockholders could delay or prevent an acquisition or merger even if the transaction would benefit other stockholders. Moreover, this concentration of stock ownership may make it difficult for stockholders to replace management. In addition, this significant concentration of stock ownership may adversely affect the trading price of our common stock because investors often perceive disadvantages in owning stock in companies with significant or controlling stockholders. This concentration could be disadvantageous to other stockholders with interests different from those of our officers, directors and principal stockholders and the trading price of shares of our common stock could be adversely affected.

Anti-takeover provisions in our amended and restated certificate of incorporation and by-laws and under the laws of the State of Delaware could impede an attempt to replace or remove our directors or otherwise effect a change of control of our company, which could diminish the value of our common stock.

Our amended and restated certificate of incorporation and by-laws contain provisions that may make it more difficult for stockholders to replace directors even if the stockholders consider it beneficial to do so. In addition, these provisions could delay or prevent a change of control that a stockholder might consider favorable. For example, these provisions may prevent a stockholder from receiving the benefit from any premium over the market price of our common stock offered by a bidder in a potential takeover. Even in the absence of an attempt to effect a change in management or a takeover attempt, these provisions may adversely affect the prevailing market price of our common stock if they are viewed as discouraging takeover attempts in the future. In addition, Section 203 of the Delaware General Corporation Law may limit the ability of an “interested stockholder” to engage in business combinations with us. An interested stockholder is defined to include persons owning 15% or more of any class of our outstanding voting stock.

Our amended and restated certificate of incorporation and by-laws contain the following provisions that could have an anti-takeover effect:

	•		stockholders have limited ability to call stockholder meetings and to bring business before a meeting of stockholders;

	•		stockholders may not act by written consent; and

	•		our board of directors may authorize the issuance of preferred stock with such rights, powers and privileges as the board deems appropriate.

These provisions may make it difficult for stockholders to replace management and could have the effect of discouraging a future takeover attempt which is not approved by our board of directors but which individual stockholders might consider favorable.

Note on Forward-Looking Statements

Some of the statements in this Item 2 and elsewhere in this quarterly report may include forward-looking statements that reflect our current views with respect to future events and financial performance. These statements include forward-looking statements both with respect to us specifically and the insurance sector in general. Statements that include the words “expect,” “intend,” “plan,” “believe,” “project,” “estimate,” “may,” “should,”

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“anticipate,” “will” and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the federal securities laws or otherwise.

All forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in these statements. We believe that these factors include but are not limited to the following:

	•		ineffectiveness or obsolescence of our business strategy due to changes in current or future market conditions;

	•		increased competition on the basis of pricing, capacity, coverage terms or other factors;

	•		greater frequency or severity of claims and loss activity, including as a result of natural or man-made catastrophic events, than our underwriting, reserving or investment practices anticipate based on historical experience or industry data;

	•		the effects of acts of terrorism or war;

	•		developments in financial and capital markets that adversely affect the performance of our investments;

	•		changes in regulations or laws applicable to us, our subsidiaries, brokers or customers;

	•		our dependency on a concentrated geographic market;

	•		changes in the availability, cost or quality of reinsurance and failure of our reinsurers to pay claims timely or at all;

	•		decreased demand for our insurance products;

	•		loss of the services of any of our executive officers or other key personnel;

	•		the effects of mergers, acquisitions and divestitures that we may undertake;

	•		changes in rating agency policies or practices;

	•		changes in legal theories of liability under our insurance policies;

	•		changes in accounting policies or practices; and

	•		changes in general economic conditions, including inflation and other factors.

The foregoing factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this quarterly report. We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.

If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary materially from what we project. Any forward-looking statements you read in this quarterly report reflect our views as of the date of this quarterly report with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. Before making an investment decision, you should carefully consider all of the factors identified in this quarterly report that could cause actual results to differ.

Additional information concerning these and other factors is contained in our SEC filings, including, but not limited to, our 2004 Annual Report on Form 10-K.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market risk is the potential economic loss principally arising from adverse changes in the fair value of financial instruments. The major components of market risk affecting us are credit risk and interest rate risk.

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Credit Risk

Credit Risk is the potential economic loss principally arising from adverse changes in the financial condition of a specific debt issuer. We address this risk by investing primarily in fixed-income securities which are rated “A” or higher by Standard & Poor’s. We also independently, and through our outside investment managers, monitor the financial condition of all of the issuers of fixed-income securities in the portfolio. To limit our exposure to risk, we employ stringent diversification rules that limit the credit exposure to any single issuer or business sector.

Interest Rate Risk

We had fixed-income investments with a fair value of $210.8 million at June 30, 2005 that are subject to interest rate risk. We manage the exposure to interest rate risk through a disciplined asset/liability matching and capital management process. In the management of this risk, the characteristics of duration, credit and variability of cash flows are critical elements. These risks are assessed regularly and balanced within the context of the liability and capital position.

The table below summarizes our interest rate risk. It illustrates the sensitivity of the fair value of fixed-income investments to selected hypothetical changes in interest rates as of June 30, 2005. The selected scenarios are not predictions of future events, but rather illustrate the effect that such events may have on the fair value of our fixed-income portfolio and shareholders’ equity.


						Hypothetical
						Percentage
						Increase
	Estimated					(Decrease) in
	Change in					Shareholders’
Hypothetical Change in Interest Rates	Fair Value			Fair Value		Equity
	($ in thousands)
200 basis point increase	$	(23,544	)	$	187,207		(11.2	)%
100 basis point increase		(11,680	)		199,071		(5.5	)%
No change		—			210,751		—
100 basis point decrease		11,680			222,431		5.5	%
200 basis point decrease		23,544			234,295		11.2	%

Item 4. Controls and Procedures

Under the supervision and with the participation of management, including our Chief Executive Officer and our Chief Financial Officer, we have carried out an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information we are required to disclose in reports that are filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms specified by the Securities and Exchange Commission. There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the period covered in this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

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

On January 19, 2005, the SEC declared effective our Registration Statement on Form S-1, as amended (Registration No. 333-119111), as filed with the SEC in connection with the initial public offering of 8,625,000 shares of our common stock. Proceeds to SeaBright, after accounting for approximately $6.3 million in underwriting discounts and commissions and approximately $3.5 million in other expenses of the offering, were approximately $80.8 million. The offering closed on January 26, 2005.

On January 26, 2005, we contributed approximately $74.8 million of the net proceeds to SeaBright Insurance Company. We intend to use the remaining net proceeds for general corporate purposes, including supporting the growth of PointSure. Except for the capital contribution to SeaBright Insurance Company, as of June 30, 2005, we had not used any of the remaining net proceeds from the offering. Our use of the proceeds from the offering does not

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represent a material change in the use of proceeds described in the prospectus included as part of the Registration Statement.

We did not purchase any of our equity securities during the six months ended June 30, 2005.

Item 6. Exhibits

The list of exhibits in the Exhibit Index to this quarterly report 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.


	SEABRIGHT INSURANCE HOLDINGS, INC.

Date: August 12, 2005

	By:	/s/ Joseph S. De Vita

		Joseph S. De Vita
		Senior Vice President, Chief Financial Officer and
		Assistant Secretary (Principal Financial Officer)

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EXHIBIT INDEX

The list of exhibits in the Exhibit Index to this quarterly report on Form 10-Q is incorporated herein by reference. Exhibits 31.1 and 31.2 are being filed as part of this quarterly report on Form 10-Q. Exhibits 32.1 and 32.2 are being furnished with this quarterly report on Form 10-Q.


Exhibit
Number		Description
31.1		Rule 13a-14(a) Certification (Chief Executive Officer)

31.2		Rule 13a-14(a) Certification (Chief Financial Officer)

32.1		Section 1350 Certification (Chief Executive Officer)

32.2		Section 1350 Certification (Chief Financial Officer)

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. freshman Avg

SeaBright Inactive 10-Q2005 Q2 Quarterly report

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