SeaBright 10-Q 2007 Q3 Quarterly report

UNITED STATES SECURITIES AND
 EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2007
or
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	56-2393241
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

2101 4^th Avenue, 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.
Yes x      No o

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

      Large accelerated filer o     Accelerated filer x       Non-accelerated filer o

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

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 November 8, 2007
Common Stock, $0.01 Par Value	20,831,102

SeaBright Insurance Holdings, Inc.

Index to Form 10-Q

		Page
Part I.	Financial Information
Item 1.	Financial Statements (unaudited)	2
	Condensed Consolidated Balance Sheets as of September 30, 2007 and         December 31, 2006	2
	Condensed Consolidated Statements of Operations for the Three Months         and Nine Months Ended September 30, 2007 and 2006	3
	Condensed Consolidated Statements of Cash Flows for the Nine Months          Ended September 30, 2007 and 2006	4
	Notes to Unaudited Condensed Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	34
Item 4.	Controls and Procedures	34
Part II.	Other Information
Item 1A.	Risk Factors	35
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	35
Item 6.	Exhibits	35
Signatures		36

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

	September 30, 2007			December 31, 2006
	(Unaudited)
	(in thousands)
ASSETS
Fixed income securities available for sale, at fair value (amortized cost   $430,301 in 2007 and $399,433 in 2006)	$	429,315		$	399,119
Equity securities available for sale, at fair value (cost $8,873 in 2007 and   $802 in 2006)		9,268			813
Preferred stock available for sale, at fair value (cost $5,431)		5,358			–
Cash and cash equivalents		41,508			20,412
Accrued investment income		4,725			4,208
Premiums receivable, net of allowance		11,922			8,877
Deferred premiums		131,834			118,788
Federal income tax recoverable		954			1,263
Service income receivable		428			792
Reinsurance recoverables		12,969			13,675
Receivable under adverse development cover		2,781			2,781
Prepaid reinsurance		1,794			1,917
Property and equipment, net		2,098			1,241
Deferred income taxes, net		14,014			12,198
Deferred policy acquisition costs, net		18,059			15,433
Intangible assets, net		1,210			1,217
Goodwill		1,527			1,527
Other assets		12,022			10,014
Total assets	$	701,786		$	614,275
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Unpaid loss and loss adjustment expense	$	233,717		$	198,356
Unearned premiums		131,739			114,312
Reinsurance funds withheld and balances payable		681			309
Premiums payable		2,859			3,047
Accrued expenses and other liabilities		39,429			37,125
Surplus notes		12,000			12,000
Total liabilities		420,425			365,149
Commitments and contingencies
Stockholders’ equity:
Series A preferred stock, $0.01 par value; 750,000 shares authorized;      no shares issued and outstanding		—			—
Undesignated preferred stock, $0.01 par value; 10,000,000 shares      authorized; no shares issued and outstanding		—			—
Common stock, $0.01 par value; 75,000,000 shares authorized;      issued and outstanding – 20,823,602 shares at September 30, 2007      and 20,553,400 shares at December 31, 2006		208			205
Paid-in capital		193,134			190,593
Accumulated other comprehensive loss		(432	)		(197	)
Retained earnings		88,451			58,525
Total stockholders’ equity		281,361			249,126
Total liabilities and stockholders’ equity	$	701,786		$	614,275

See accompanying notes to unaudited condensed consolidated financial statements.

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2007			2006			2007			2006
	(in thousands, except income per share amounts)
Revenue:
Premiums earned	$	59,721		$	47,819		$	163,109		$	133,576
Claims service income		432			497			1,331			1,553
Other service income		55			31			104			78
Net investment income		5,174			3,970			14,786			10,836
Net realized loss		(25	)		(74	)		(85	)		(389	)
Other income		1,376			508			3,018			2,133
		66,733			52,751			182,263			147,787
Losses and expenses:
Loss and loss adjustment expenses		34,921			27,879			89,851			78,407
Underwriting, acquisition and insurance      expenses		15,172			10,099			42,495			29,581
Interest expense		289			285			854			813
Other expenses		2,020			1,449			5,223			3,859
		52,402			39,712			138,423			112,660
Income before taxes		14,331			13,039			43,840			35,127
Income tax expense (benefit):
Current		5,438			4,521			15,604			13,755
Deferred		(757	)		(579	)		(1,690	)		(3,076	)
		4,681			3,942			13,914			10,679
Net income	$	9,650		$	9,097		$	29,926		$	24,448
Basic earnings per share	$	0.47		$	0.45		$	1.47		$	1.23
Diluted earnings per share	$	0.46		$	0.44		$	1.43		$	1.21
Weighted average basic shares outstanding		20,350,778			20,319,525			20,336,778			19,873,930
Weighted average diluted shares outstanding		20,989,481			20,686,161			20,950,968			20,269,730

See accompanying notes to unaudited condensed consolidated financial statements.

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

	Nine Months Ended September 30,
	2007			2006
	(in thousands)
Cash flows from operating activities:
Net income	$	29,926		$	24,448
Adjustments to reconcile net income to cash provided by operating activities:
Amortization of deferred policy acquisition costs		26,564			21,079
Policy acquisition costs deferred		(29,190	)		(22,840	)
Provision for depreciation and amortization		2,058			2,087
Compensation cost on restricted stock		1,617			720
Compensation cost on stock options		530			363
Net realized loss on investments		85			389
Gain on sale of fixed assets		(1	)		—
Benefit for deferred federal income taxes		(1,690	)		(3,076	)
Changes in certain assets and liabilities:
Unpaid loss and loss adjustment expense		35,360			42,434
Unearned premiums, net of deferred premiums          and premiums receivable		1,453			(3,512	)
Reinsurance recoverables, net of reinsurance withheld		167			(206	)
Accrued investment income		(517	)		(1,018	)
Federal income tax recoverable		309			(1,052	)
Other assets and other liabilities		1,297			55
Net cash provided by operating activities		67,968			59,871
Cash flows from investing activities:
Purchases of investments		(95,333	)		(254,420	)
Sales of investments		17,758			140,438
Maturities and other		31,710			10,989
Purchases of property and equipment		(1,405	)		(585	)
Net cash used in investing activities		(47,270	)		(103,578	)
Cash flows from financing activities:
Proceeds from exercise of stock options		310			32
Deferred tax benefit from disqualifying dispositions		83			—
Grant of restricted shares of common stock		5			—
Net proceeds from follow-on public offering of common stock		—			57,562
Net cash provided by financing activities		398			57,594
Net increase in cash and cash equivalents		21,096			13,887
Cash and cash equivalents at beginning of period		20,412			12,135
Cash and cash equivalents at end of period	$	41,508		$	26,022
Supplemental disclosures:
Federal income taxes paid	$	14,850		$	14,500
Interest paid on surplus notes		852			800
Accrued expenses for purchases of investments		—			8,413

See accompanying notes to unaudited 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. (“SIH” or the Company), a Delaware corporation, was formed in June 2003. On July 14, 2003, SIH entered into a purchase agreement, effective September 30, 2003, with Kemper Employers Group, Inc. (“KEG”), Eagle Pacific Insurance Company, Inc. and Pacific Eagle Insurance Company, Inc. (referred to collectively as “Eagle”), and Lumbermens Mutual Casualty Company (“LMC”), the ultimate owner of KEG and Eagle (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.

        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. 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, permission was granted by the Illinois Department of Financial and Professional Regulation, Division of Insurance (the “Illinois Division of Insurance”) for KEIC to change its name to SeaBright Insurance Company (“SBIC”). As of September 30, 2007, SBIC is licensed to write workers’ compensation insurance in 45 states and the District of Columbia. PointSure is engaged primarily in administrative and wholesale insurance brokerage activities.

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, SBIC and PointSure (collectively, the “Company,” “we” or “us”). All significant intercompany transactions and amounts 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 and Article 10 of Regulation S-X of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). 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, 2006 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 unaudited condensed consolidated financial statements and notes should be read in conjunction with the audited financial statements and accompanying notes as of and for the year ended December 31, 2006 included in the Company’s Annual Report on Form 10-K, which was filed with the U.S. Securities and Exchange Commission (the “SEC”) on March 16, 2007.

        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 nine month periods ended September 30, 2007 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 unaudited condensed 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 unaudited condensed consolidated financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. The Company has used significant estimates in determining fair value and impairment of investment securities, unpaid loss and loss adjustment expenses, goodwill and other intangibles, earned premiums on retrospectively rated policies, earned but unbilled premiums, deferred acquisition costs, federal income taxes and certain amounts related to reinsurance.

        c. Revenue Recognition

        Premiums for primary and reinsured risks are included in revenue over the lives of the contracts in proportion to the amount of insurance protection provided (i.e., ratably over the policy periods). The portions of premiums that are applicable to the unexpired periods of the policies in-force are not included in revenue but are deferred and recorded

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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. While the typical retrospectively rated policy has five annual adjustment or measurement periods, premium adjustments continue until mutual agreement to cease future adjustments is reached with the policyholder. For the three months ended September 30, 2007 and 2006, approximately 23.2% and 29.6%, respectively, of direct premiums written related to retrospectively rated policies. For the nine months ended September 30, 2007 and 2006, approximately 19.2% and 25.7%, respectively, of direct premiums written related to retrospectively rated policies.

        The Company estimates the amount of premiums that have been earned but unbilled at the end of the period by analyzing historical earned premium adjustments made and applying an adjustment percentage against in-force earned premiums. Included in deferred premiums is an accrual for earned but unbilled premiums of $0 at September 30, 2007 and $1.5 million at December 31, 2006.

        Service income generated from various underwriting and claims service agreements with third parties is recognized as income in the period in which services are performed.

        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. Loss adjustment expenses are estimates 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. Liabilities for unpaid loss and loss adjustment expenses are not discounted to account for the time value of money.

        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 and 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 liability for unpaid loss and loss adjustment expense is reasonable. The estimates are reviewed quarterly and any necessary adjustment is included in the results of operations of the period in which the adjustment is determined.

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

        e. Reinsurance

The Company protects itself from excessive losses by reinsuring certain levels of risk in various areas of exposure with nonaffiliated reinsurers. 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 periodically using generally accepted actuarial methodologies for estimating unpaid loss and loss adjustment expense liabilities, including incurred loss and paid loss development methods. Amounts recoverable in excess of acquired reserves at September 30, 2003 are recorded gross in unpaid loss and loss adjustment expense in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations, with a corresponding amount receivable from the seller. Amounts are shown net in the unaudited condensed consolidated statements 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.

        Balances due from reinsurers on unpaid loss and loss adjustment expenses, including an estimate of such recoverables related to reserves for IBNR losses, are reported as assets and are included in reinsurance recoverables even though amounts due on unpaid loss and loss adjustment expenses are not recoverable from the reinsurer until such losses are paid. Should a reinsurer be unable or unwilling to pay such amounts to the Company when due, the Company would be liable for such obligations. The Company periodically evaluates its reinsurance recoverables, including the financial ratings of its reinsurers, and revises its estimates of such amounts as conditions and circumstances change. The Company does not believe that it is currently exposed to any material credit risk through its reinsurance agreements because most of its reinsurance is recoverable from large, well-capitalized reinsurance companies. Historically, no amounts from reinsurers have been written-off as uncollectible.

        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 are expected to be in effect when the differences are expected to reverse, net of any applicable valuation allowances. The Company evaluates the necessity of a deferred tax asset valuation allowance by determining, based on the weight of available evidence, whether it is more likely than not that some portion or all of the deferred tax asset will not be realized. When necessary, a valuation allowance is recorded to reduce the deferred tax asset to the amount that is more likely than not to be realized.

The Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109 (“FIN 48”) on January 1, 2007. At the date of adoption and as of September 30, 2007, the Company had no unrecognized tax benefits and no adjustments to liabilities or operations were required.

        The Company recognizes interest on tax related matters as interest expense and penalties as income tax expense. As of September 30, 2007, the Company had no accrued interest or penalties related to uncertain tax positions.

        The tax years 2003 through 2006 remain open to examination by the major taxing jurisdictions to which we are subject.

        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 nine month periods ended September 30, 2007 and 2006:

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
Basic weighted average shares outstanding		20,350,778		20,319,525		20,336,778		19,873,930
Weighted average shares issuable upon     exercise of outstanding stock options     and vesting of restricted stock		638,703		366,636		614,190		395,800
Diluted weighted average shares    outstanding		20,989,481		20,686,161		20,950,968		20,269,730

         h. Stock-Based Compensation

The Company accounts for awards of stock options and restricted stock according to the provisions of SFAS No. 123R, Share-Based Payment. The following table summarizes total stock-based compensation expense recognized in the unaudited condensed consolidated statements of operations for the three month and nine month periods ended September 30, 2007 and 2006:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
	(in thousands)
Stock option compensation expense   related to:
Restricted stock	$	681	$	134	$	1,616	$	362
Stock options		207		334		531		721
Total	$	888	$	468	$	2,147	$	1,083
Total related tax benefit	$	247	$	120	$	587	$	260

         i. Comprehensive Income

        The following table summarizes the Company’s comprehensive income for the three month and nine month periods ended September 30, 2007 and 2006:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2007			2006			2007			2006
	(in thousands)
Net income	$	9,650		$	9,097		$	29,926		$	24,448
Reclassification adjustment for net    realized losses recorded into income		(25	)		(74	)		(85	)		(389	)
Tax benefit related to reclassification    adjustment		9			26			30			136
Decrease (increase) in unrealized losses on    investment securities available for sale		6,117			9,135			(276	)		2,015
Tax benefit (expense) related to change in    unrealized losses		(2,142	)		(3,197	)		96			(705	)
Total comprehensive income	$	13,609		$	14,987		$	29,691		$	25,505

         j. Recently Issued Accounting Pronouncements

In September 2005, the American Institute of Certified Public Accountants (“AICPA”) released Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts (“SOP 05-1”). SOP 05-1 requires identification of transactions that result in a substantial change in an insurance contract. If it is determined that a substantial change to an insurance contract has occurred, the related unamortized deferred policy acquisition costs, unearned premiums and other related balances must be written off. SOP 05-1 is effective for fiscal years beginning after December 15, 2006. The Company adopted the provisions of SOP 05-1 as of January 1, 2007, which did not have a material effect on its consolidated financial condition or results of operations.

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109 (“FIN 48”), which provides for the recognition, measurement, presentation and disclosure of uncertain tax positions. A tax benefit from an uncertain position may be recognized

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

only if it is more likely than not that the position is sustainable based on its technical merits. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. The Company adopted the provisions of FIN 48 as of January 1, 2007, which did not have a material effect on its consolidated financial condition or results of operations.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines fair value and establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. The provisions for SFAS No. 157 are effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early adoption is permitted. The Company must adopt these new requirements no later than its first fiscal quarter of 2008. The Company expects that SFAS No. 157 will not have a material effect on its consolidated financial condition or results of operations.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115, which permits entities to choose to measure many financial instruments and certain other items at fair value in order to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently and without having to apply complex hedge accounting provisions. The provisions for SFAS No. 157 are effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early adoption is permitted. The Company must adopt these new requirements no later than its first fiscal quarter of 2008. The Company is currently evaluating the impact that adoption of SFAS No. 159 will have on its consolidated financial condition and results of operations.

        k. Reclassifications

        Certain reclassifications have been made to the prior years’ financial statements to conform to classifications used in the current year.

3.   Investments

        The consolidated cost or amortized cost, gross unrealized gains and losses, and estimated fair value of investment securities available for sale at September 30, 2007 are as follows:

	Cost or Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Fixed income securities:	(in thousands)
U.S. Treasury securities	$	9,931	$	36	$	(57	)	$	9,910
Government sponsored agency securities		38,899		122		(80	)		38,941
Corporate securities		42,669		38		(737	)		41,970
Tax-exempt municipal securities		221,895		1,268		(953	)		222,210
Mortgage pass-through securities		67,908		188		(655	)		67,440
Collateralized mortgage obligations		2,066		—		(27	)		2,039
Asset-backed securities		46,933		53		(182	)		46,805
Total fixed income securities		430,301		1,705		(2,691	)		429,315
Equity securities		8,873		399		(4	)		9,268
Preferred stock		5,431		—		(73	)		5,358
Total investment securities	$	444,605	$	2,104	$	(2,768	)	$	443,941

        Equity securities consist of investments in exchange traded funds designed to correspond to the performance of certain indexes based on domestic or international stocks. The unrealized loss on temporarily impaired investments totaled $2.8 million at September 30, 2007 for investment securities available-for-sale with a fair value of $218.1 million. Approximately $1.4 million of total unrealized losses at September 30, 2007 were from securities that had been impaired for more than one year. At September 30, 2007, no unrealized loss exceeded 20% of the related security’s book value at that date. The following table summarizes the fair value and gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss at September 30, 2007:

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

	Less Than 12 Months					12 Months or More					Total
Investment Category	Aggregate Fair Value		Aggregate Unrealized Loss			Aggregate Fair Value		Aggregate Unrealized Loss			Aggregate Fair Value		Aggregate Unrealized Loss
	(in thousands)
Fixed income securities:
U.S. Treasury securities	$	312	$	—		$	4,177	$	(57	)	$	4,489	$	(57	)
Government sponsored agency      securities		3,692		(35	)		5,572		(45	)		9,264		(80	)
Corporate securities		11,536		(246	)		22,207		(491	)		33,743		(737	)
Tax-exempt municipal securities		63,467		(719	)		31,060		(234	)		94,527		(953	)
Mortgage pass-through securities		28,701		(227	)		16,095		(428	)		44,796		(655	)
Collateralized mortgage      obligations		321		(9	)		1,718		(18	)		2,039		(27	)
Asset-backed securities		17,165		(82	)		7,023		(100	)		24,188		(182	)
Total fixed income securities		125,194		(1,318	)		87,852		(1,373	)		213,046		(2,691	)
Equity securities		641		(4	)		—		—			641		(4	)
Preferred stock		4,374		(73	)		—		—			4,374		(73	)
Total	$	130,209	$	(1,395	)	$	87,852	$	(1,373	)	$	218,061	$	(2,768	)

        The Company regularly reviews its investment 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; the Company’s 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, the Company focuses 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. The Company evaluated investment securities with September 30, 2007 fair values less than amortized cost and has determined that the decline in value is temporary and is related primarily to the change in market interest rates since purchase. Furthermore, the Company has the ability to hold the impaired investments to maturity and the intent to hold them for a period of time sufficient for recovery of their carrying amount. No other-than-temporary impairment losses were recorded in the three month or nine month periods ended September 30, 2007 and 2006.

        The amortized cost and estimated fair value of fixed income securities available for sale at September 30, 2007, 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.

	Maturity	Cost or Amortized Cost		Estimated Fair Value
		(in thousands)
Due in one year or less		$	37,901	$	37,976
Due after one year through five years			80,655		80,197
Due after five years through ten years			172,804		172,834
Due after ten years			22,035		22,024
Securities not due at a single maturity date			116,906		116,284
Total investment securities available for sale		$	430,301	$	429,315

        The amortized cost of investment securities available for sale deposited with various regulatory authorities at September 30, 2007 was $179.9 million.

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

4.   Premiums

        Direct premiums written totaled $65.6 million and $44.6 million for the three month periods ended September 30, 2007 and 2006, respectively, and $188.7 million and $144.4 million for the nine month periods then ended, respectively.

        Premiums receivable consisted of the following at September 30, 2007 and December 31, 2006:

	September 30, 2007			December 31, 2006
	(in thousands)
Premiums receivable	$	13,214		$	9,986
Allowance for doubtful accounts		(1,292	)		(1,109	)
	$	11,922		$	8,877

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. For the period from October 1, 2006 through October 1, 2007 and for the period from October 1, 2007 through October 1, 2008, the Company entered into reinsurance agreements with nonaffiliated reinsurers wherein it retains the first $1.0 million of each loss occurrence. Losses in excess of $1.0 million up to $75.0 million are reinsured as follows:

Layer	General Description
$1.0 million excess of $1.0 million each loss occurrence	Fully reinsured, subject to an aggregate annual limit of $8.0 million
$3.0 million excess of $2.0 million each loss occurrence	Fully reinsured, subject to an aggregate annual limit of $12.0 million
$5.0 million excess of $5.0 million each loss occurrence	Fully reinsured, subject to an aggregate annual limit of $15.0 million
$10.0 million excess of $10.0 million each loss occurrence	Fully reinsured, subject to a limit of $7.5 million maximum for any one life and an aggregate limit of $20.0 million.
$55.0 million excess of $20.0 million each loss occurrence	Fully reinsured in two sub-layers. The first sub-layer affords coverage of up to $30.0 million for each loss occurrence in excess of $20.0 million, subject to an aggregate annual limit of $60.0 million, and the second sub-layer affords coverage up to $25.0 million for each loss occurrence in excess of $50.0 million, subject to an annual aggregate limit of $50.0 million. Both sub-layers are subject to a limit of $5.0 million maximum for any one life.

        The above coverages are subject to various additional limitations and exclusions as more fully described in the reinsurance agreements.

        As part of the purchase of SBIC, 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 insurance liabilities at September 30, 2003. The Agreement also requires SBIC to reimburse LMC 100% of the excess of the initial insurance liabilities at September 30, 2003 over the actual loss results at December 31, 2011. The amount of adverse loss development under the Agreement recorded in the accompanying unaudited consolidated balance sheets was $2.8 million at September 30, 2007. Any increase or decrease in the amount due from LMC is included in loss and loss adjustment expenses in the unaudited consolidated statements of operations.

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

        As part of the Agreement, LMC placed into trust (the “Trust”) $1.6 million, equal to 10% of the balance sheet reserves of SBIC on the date of sale. Thereafter, the Trust shall be adjusted each quarter, if warranted, to an amount equal to the greater of (a) $1.6 million or (b) 102% of LMC’s obligations under the Agreement. The balance of the Trust, including accumulated interest, was $3.5 million at September 30, 2007 and $5.2 million at December 31, 2006. In February 2007, LMC submitted a request to withdraw approximately $1.8 million of excess funds on deposit in the trust account. After due evaluation, the Company complied with LMC’s request, resulting in a balance in the trust account of approximately $3.4 million immediately following the withdrawal.

        b. Reinsurance Assumed

        The Company involuntarily assumes residual market business either directly from various states that operate their own residual market programs or indirectly from the National Council for Compensation Insurance (the “NCCI”), which operates residual market programs on behalf of some states. The states in which we assumed residual market business at September 30, 2007 include the following: Alabama, Alaska, Arizona, Arkansas, Connecticut, Delaware, the District of Columbia, Georgia, Idaho, Illinois, Iowa, Kansas, Massachusetts, Michigan, Nevada, New Jersey, New Mexico, Oregon, South Carolina, and Virginia.

        c.  Reinsurance Recoverables and Income Statement Effects

        Balances affected by reinsurance transactions are reported gross of reinsurance in the accompanying unaudited condensed consolidated balance sheets. Reinsurance recoverables are comprised of the following amounts at September 30, 2007 and December 31, 2006:

	September 30, 2007		December 31, 2006
	(in thousands)
Reinsurance recoverables on unpaid loss and loss adjustment expenses	$	12,780	$	13,504
Reinsurance recoverables on paid losses		189		171
Total reinsurance recoverables	$	12,969	$	13,675

        The effects of reinsurance are as follows for the three month and nine month periods ended September 30, 2007 and 2006:

	Three Months Ended September 30,					Nine Months Ended September 30,
	2007		2006			2007		2006
	(in thousands)
Reinsurance assumed:
Written premiums	$	2,357	$	(1,786	)	$	6,809	$	5,460
Earned premiums		2,199		(1,127	)		6,389		4,272
Losses and loss adjustment expenses      incurred		1,462		(1,218	)		4,106		2,033
Related commissions		821		(460	)		2,360		1,498
Reinsurance ceded:
Written premiums	$	4,200	$	3,798		$	11,781	$	11,897
Earned premiums		4,286		4,126			11,754		12,088
Losses and loss adjustment expenses      incurred		530		405			391		1,238
Related commissions		313		255			878		1,165

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 nine month periods ended September 30, 2007 and 2006:

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2007			2006			2007			2006
	(in thousands)
Beginning balance:
Unpaid loss and loss adjustment expense	$	218,679		$	169,336		$	198,356		$	142,211
Reinsurance recoverables		(12,648	)		(13,620	)		(13,504	)		(13,745	)
Net		206,031			155,716			184,852			128,466
Incurred related to:
Current period		40,389			31,356			110,302			92,284
Prior periods		(5,468	)		(3,477	)		(20,451	)		(13,877	)
Total incurred		34,921			27,879			89,851			78,407
Paid related to:
Current period		(11,749	)		(7,927	)		(24,390	)		(17,168	)
Prior periods		(8,266	)		(4,630	)		(29,376	)		(18,667	)
Total paid		(20,015	)		(12,557	)		(53,766	)		(35,835	)
Unpaid loss and loss adjustment     expense, net of reinsurance recoverables		220,937			171,038			220,937			171,038
Reinsurance recoverables		12,780			13,607			12,780			13,607
Unpaid loss and loss adjustment     expense	$	233,717		$	184,645		$	233,717		$	184,645

        Loss and loss adjustment expenses are net of the release of loss reserves totaling approximately $5.5 million and $20.5 million in the three month and nine month periods ended September 30, 2007, respectively, compared to $3.5 million and $13.9 million for the same periods in 2006. The majority of these reserve releases relate to the Company’s California book of business and reflect a continuation of lower than anticipated patterns of loss payments in recent accident years as a result of reform legislation enacted there primarily in 2003 and 2004.

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 $289,000 and $854,000 for the three month and nine month periods ended September 30, 2007, respectively, and $285,000 and $813,000 for the three month and nine month periods ended September 30, 2006, respectively.

        The notes are redeemable prior to 2034 by the Company, in whole or in part, from time to time, on or after May 24, 2009 on an interest payment date or at any time prior to May 24, 2009, in whole but not in part, upon the occurrence and continuation of a tax event as defined in the agreement. The Company may not exercise its option to redeem with respect to a tax event unless it pays a premium in addition to the redemption price.

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 September 30, 2007, SBIC had a liability for guaranty fund and other assessments of $2.6 million and a guaranty fund receivable of $4.0 million. These amounts represent 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.  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 consolidated financial position or results of operations.

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

9. Share-Based Payment Arrangements

      At September 30, 2007, the Company had outstanding stock options and restricted stock granted according to the terms of two equity incentive plans. The stockholders and Board of Directors approved the 2003 Stock Option Plan (the “2003 Plan”) in September 2003, and amended and restated the 2003 Plan in February 2004, and approved the 2005 Long-Term Equity Incentive Plan (the “2005 Plan” and, together with the 2003 Plan, the “Stock Option Plans”) in December 2004. The Stock Option Plans were further amended and restated in April 2007.

      As of September 30, 2007, options to purchase 451,778 shares of common stock were outstanding under the 2003 Plan, and no additional shares were reserved for issuance under the 2003 Plan. As of September 30, 2007, 466,380 shares of restricted stock were issued under the 2005 Plan, options to purchase 558,543 shares of common stock were outstanding under the 2005 Plan and 747,877 shares were reserved for issuance under the 2005 Plan.

a. Stock Options

      The fair values of stock options granted during the three month and nine month periods ended September 30, 2007 and 2006 were determined on the dates of grant using the Black-Scholes-Merton option valuation model with the following weighted average assumptions:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2007			2006			2007			2006
Expected term (years)		6.3			6.3			6.3			6.2
Expected stock price volatility		26.0	%		26.0	%		26.2	%		26.1	%
Risk-free interest rate		4.94	%		5.02	%		4.59	%		4.75	%
Expected dividend yield		—			—			—			—
Estimated fair value per option	$	6.52		$	5.86		$	6.75		$	6.37

        The following table summarizes stock option activity for the nine months ended September 30, 2007:

	Shares Subject to Options		Weighted Average Exercise Price per Share		Weighted Average Re- maining Contractual Life (years)	Aggregate Intrinsic Value (in thousands)
Outstanding at December 31, 2006	918,154		$	9.39	7.6	$	7,916
Granted	143,700			18.29	—		—
Forfeited	(13,710	)		12.22	—		—
Exercised	(37,697	)		8.22	—		—
Cancelled	(126	)		18.40	—		—
Outstanding at September 30, 2007	1,010,321			10.66	7.2		6,478
Exercisable at September 30, 2007	614,645			8.13	6.8		5,497

        The aggregate intrinsic values in the table above are before applicable income taxes and are based on the Company’s closing stock price of $17.07 on September 30, 2007. As of September 30, 2007, total unrecognized stock-based compensation cost related to nonvested stock options was approximately $1.5 million, which is expected to be recognized over a weighted average period of approximately 32.5 months. Proceeds from the exercise of stock options totaled approximately $70,900 and $0 for the three months ended September 30, 2007 and 2006, respectively, and $310,000 and $32,400 for the nine months ended September 30, 2007 and 2006, respectively. The intrinsic value of stock options exercised during the three months ended September 30, 2007 and 2006 totaled approximately $86,000 and $0, respectively, and $373,500 and $42,300 for the nine months ended September 30, 2007 and 2006, respectively.

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

        The following table presents additional information regarding options outstanding as of September 30, 2007:

	Options Outstanding				Options Exercisable
Range of Exercise Prices	Number Outstanding	Weighted- Average Remaining Contractual Life (years)	Weighted- Average Exercise Price		Number Outstanding	Weighted- Average Exercise Price
$ 6.54	451,778	6.08	$	6.54	433,135	$	6.54
10.50-12.54	299,093	7.33		10.61	148,293		10.66
15.44-18.68	259,450	9.06		17.89	33,217		17.48
	1,010,321	7.22		10.66	614,645		8.13

b. Restricted Stock

        The following table summarizes restricted stock activity for the nine months ended September 30, 2007:

	Number of Shares		Weighted Average Grant Date Fair Value
Outstanding at December 31, 2006	233,875		$	17.39
Granted	248,255			18.17
Vested	—			—
Forfeited	(15,750	)		17.97
Outstanding at September 30, 2007	466,380			17.79

        As of September 30, 2007, there was $5.5 million of total unrecognized compensation cost related to restricted stock granted under the 2005 Plan. That cost is expected to be recognized over a weighted-average period of 25.9 months. No shares vested during the nine month periods ended September 30, 2007 and 2006.

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

Cautionary Statement  

           You should read the following discussion and analysis in conjunction with our unaudited condensed consolidated financial statements and the related notes thereto included in Item 1 of this Part I. The information contained in this quarterly report is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this quarterly report and in our other reports filed with the U.S. Securities and Exchange Commission (“SEC”), including our Annual Report on Form 10-K for the year ended December 31, 2006 filed with the SEC on March 16, 2007.

           The discussion under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2006, as updated by the discussion in Part II, Item 1A of this quarterly report, and similar discussions in our other SEC filings, describe some of the important risk factors that may affect our business, results of operations and financial condition. You should carefully consider those risks, in addition to the other information in this report and in our other filings with the SEC, before deciding to purchase, hold or sell our common stock.

        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,” “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.

- 16 -

        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 2006 Annual Report on Form 10-K.

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 45 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.

      SIH 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 the Acquisition. In the Acquisition, we acquired from LMC and certain of its affiliates the renewal rights and substantially all of the operating assets and employees of Eagle. Eagle 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 KEIC and PointSure. 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.

        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 insurance liabilities as they existed at the date of the Acquisition. Accordingly, if KEIC’s insurance liabilities increase, LMC must indemnify us in the amount of the increase. If KEIC’s insurance liabilities decrease, we must share with LMC the favorable development of those reserves. 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 approximately $3.5 million at September 30, 2007 and $5.2 million at December 31, 2006. In February 2007, LMC submitted a request to withdraw approximately $1.8 million of excess funds on deposit in the Trust. After due evaluation, the Company complied with LMC’s request, resulting in a balance in the trust account of approximately $3.4 million immediately following the withdrawal. If LMC is placed into receivership and the amount held in the collateralized reinsurance

- 17 -

trust is inadequate to satisfy the obligations of LMC to us under the adverse development cover agreement, 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 and net investment income and, to a lesser extent, from service income and net realized gains and losses from investments. We show certain non-GAAP financial measures that we believe are valuable in managing our business and evaluating our performance. These measures include gross premiums written, net premiums written, net loss ratios and net underwriting expense ratios.

Premiums Earned

      Gross premiums written is a non-GAAP financial measure representing 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 terms of 12 months. Thus, for example, for a policy that is written on July 1, 2006, one-half of the premiums would be earned in 2006 and the other half would be earned in 2007.

      Premiums earned, the most comparable GAAP measure, represents the earned portion of our net premiums written. Net premiums written, another non-GAAP financial measure, 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 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 State United States Longshore and Harbor Workers Compensation Act Assigned Risk Plan (the “Washington USL&H Assigned Risk Plan”). We immediately cede 100% of those premiums, net of our expenses, and 100% of the losses in connection with that business back to the USL&H Assigned Risk Plan. Premiums from the Washington USL&H Assigned Risk Plan are included in both direct premiums written and ceded premiums written.

      We analyze our growth and earnings potential, in part, through the non-GAAP financial measures of gross premiums written, net premiums written and in-force premiums. In-force premiums refers to our current annual gross premiums written that have active or unexpired policies, excluding premiums received from the Washington USL&H Assigned Risk Plan, and represents premiums from our total customer base. In-force premiums as of September 30, 2007 and 2006 were $258.5 million and $196.8 million, respectively. The following table provides a reconciliation of gross premiums written and net premiums written to net premiums earned:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2007			2006			2007			2006
	(in thousands)
Direct premiums written	$	65,633		$	44,612		$	188,667		$	144,428
Assumed premiums written		2,357			(1,786	)		6,809			5,460
Gross premiums written		67,990			42,826			195,476			149,888
Ceded premiums		(4,200	)		(3,798	)		(11,781	)		(11,897	)
Net premiums written		63,790			39,028			183,695			137,991
Change in unearned premiums, net of    reinsurance		(4,069	)		8,791			(20,586	)		(4,415	)
Premiums earned	$	59,721		$	47,819		$	163,109		$	133,576

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, fixed income securities and, to a lesser degree, in equity 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.

- 18 -

Claims Service Income

      We receive claims service income in return for providing claims administration services for other companies. The claims service income we receive for providing these services approximates our costs. For the nine months ended September 30, 2007 and 2006, approximately 51.9% and 65.8%, respectively, of our claims service income was generated by contracts we have with LMC to provide claims handling services for policies written by the Eagle Entities prior to the Acquisition. We expect income from these contracts to decrease substantially over the next several years as transactions related to the Eagle Entities diminish.

Other Service Income

      Following the Acquisition, we entered into servicing arrangements with LMC to provide policy administration and accounting services for 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.

      The net loss ratio, expressed as a percentage, is a key non-GAAP financial measure that we use in monitoring our profitability. The net loss ratio is calculated by dividing loss and loss adjustment expenses for the period less claims service income by premiums earned for the period.

Underwriting, Acquisition and Insurance Expenses

      In our insurance subsidiary, we refer to the expenses that we incur to underwrite risks as underwriting, acquisition and insurance expenses. Such expenses consist of commission expenses, premium taxes and fees and other underwriting expenses incurred in writing and maintaining our business. We pay commission expense in our insurance subsidiary to our brokers for the premiums that they produce for us. 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 consist of general administrative expenses such as salaries and employee benefits, rent 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.

      The net underwriting expense ratio, expressed as a percentage, is a key non-GAAP financial measure that we use in monitoring our profitability. The net underwriting expense ratio is calculated by dividing underwriting, acquisition and insurance expenses for the period less other service income by premiums earned for the period.

Interest Expense

      We incur interest expense 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 nine month periods ended September 30, 2007 and 2006

Gross Premiums Written.  Gross premiums written for the three months ended September 30, 2007 totaled $68.0 million, an increase of $25.2 million, or 58.9%, from $42.8 million in the same period of 2006. For the nine months ended September 30, 2007, gross premiums written totaled $195.5 million, an increase of $45.6 million, or 30.4%, from $149.9 million in the same period of 2006 even though we continued to experience rate reductions in California, our largest market, as well as in other states. Excluding work we perform as the servicing carrier for the Washington USL&H Assigned Risk Plan, the number of customers we serviced increased 56.4% from 573 at September 30, 2006 to 896 at September 30, 2007 and in-force payrolls, one of the factors used in determining premium charges, increased 57.6% from $3.3 billion at September 30, 2006 to $5.2 billion one year later. California

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continues to be our largest market, accounting for approximately $109.8 million (42.5%) of our in-force premiums as of September 30, 2007 compared to $112.2 million (57.0%) as of September 30, 2006, representing a decrease of $2.4 million (2.1%). The decrease in California in-force premiums resulted primarily from rate reductions brought about by reform legislation enacted several years ago.

      In December 2006, we announced the division of our Southern region into two markets, allowing us to devote greater focus and resources to further develop our key states in this region. Our Southeast region is developing business in selected states, including Florida. This region contributed approximately $3.2 million and $7.6 million to our direct premiums written in the three month and nine month periods ended September 30, 2007, respectively. The Gulf region, which is based in Houston, Texas, now focuses primarily on developing business in the states of Texas and Louisiana. This region contributed approximately $8.3 million and $26.5 million to our direct premiums written for the three month and nine month periods ended September 30, 2007, respectively. Illinois is now our second largest market and accounted for approximately $24.8 million (9.6%) of our in-force premiums as of September 30, 2007, representing an increase of $14.4 million (138.5%) from $10.4 million as of September 30, 2006. Louisiana is our third largest market, accounting for approximately $21.7 million (8.4%) of our in-force premiums as of September 30, 2007, representing an increase of $13.8 million (174.7%) from $7.9 million (4.0%) as of September 30, 2006. The remaining states in our top five markets were Alaska and Hawaii, which accounted for approximately $21.5 million (8.3%) and $13.8 million (5.3%) of our in-force premiums as of September 30, 2007, respectively, compared to $23.2 million (11.8%) and $13.8 million (7.0%), respectively, of our in-force premiums as of September 30, 2006.

        On March 30, 2007, the California Workers’ Compensation Insurance Rating Bureau (the “WCIRB”) submitted a filing with the California Insurance Commissioner recommending an 11.3% decrease in advisory pure premium rates on new and renewal policies effective on or after July 1, 2007. The filing was based on a review of loss and loss adjustment experience through December 31, 2006 and was made in response to continued reductions in California workers’ compensation claim costs. On May 29, 2007, the California Insurance Commissioner recommended a 14.2% decrease in rates effective July 1, 2007. On June 8, 2007, after completing a study of our California loss data, we filed with the California Insurance Commissioner our new rates reflecting an average reduction of 14.2% from prior rates for new and renewal workers’ compensation insurance policies written in California on or after July 1, 2007. The filing was approved on June 12, 2007. This was the eighth California rate reduction we have filed since October 1, 2003, resulting in a net cumulative reduction of our California rates of approximately 54.8%. On September 20, 2007, the WCIRB submitted a filing with the California Insurance Commissioner recommending a 4.2% increase in advisory pure premium rates on new and renewal policies effective on or after January 1, 2008. The filing was based on a review of loss and loss adjustment experience through June 30, 2007. On October 19, 2007, the WCIRB amended its filing, increasing the proposed rate increase to 5.2% based on the projected impact of Assembly Bill No. 338 (AB 338) that was signed into law on October 13, 2007. AB 338 increases the period of time, from two years to five years, from the date of injury during which disability benefits, limited to a maximum of 104 weeks, may be provided. A public hearing to consider the proposed rate increase was held on October 23, 2007. As of November 7, 2007, the California Insurance Commissioner had not announced his recommendation regarding the proposed rate increase.

        Rate reductions have also been proposed in other states in which we operate. For example, effective January 1, 2007, we adopted the following rate decreases recommended by the National Council for Compensation Insurance (the “NCCI”): 10.5% in Alaska, 12.3% in Hawaii and 2.0% in Illinois. Effective July 1, 2007, we adopted a 15.8% reduction in Louisiana, which is 2.0% more than the 13.8% rate decrease recommended by the NCCI. An NCCI-proposed rate reduction of 10.9% in Alaska, to be effective January 1, 2008, is currently pending and awaiting a decision by the Alaska Division of Insurance. On October 12, 2007, the Hawaii Insurance Commissioner approved a 19.3% rate reduction effective January 1, 2008. We have not yet decided whether to adopt all or some portion of the approved decrease.

Net Premiums Written.  Net premiums written for the three months ended September 30, 2007 totaled $63.8 million, an increase of $24.8 million, or 63.6%, from $39.0 million in the same period of 2006. For the nine months ended September 30, 2007, net premiums written totaled $183.7 million, an increase of $45.7 million, or 33.1%, from $138.0 million in the same period of 2006. The increases in net premiums written for the three month and nine month periods ended September 30, 2007 are reflective of similar increases in gross premiums written and reductions in premium rates on our ceded reinsurance contracts. Net premiums written are affected by premiums ceded under reinsurance agreements with external reinsurers. For the three months ended September 30, 2007, ceded written premiums totaled $4.2 million (6.2% of gross premiums written) compared to $3.8 million (8.9% of gross premiums written) in the same period of 2006. Ceded written premiums for the nine months ended September 30,

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2007 totaled $11.8 million (6.0% of gross premiums written) compared to $11.9 million (7.9% of gross premiums written) in the same period of 2006. The decrease in ceded premiums as a percentage of gross premiums written resulted primarily from the renewal of our excess of loss reinsurance program on October 1, 2006 at average rates that are approximately 16.8% lower than rates under the prior reinsurance program. We were able to achieve savings at the lower tiers of our program while increasing our catastrophe coverage from $50.0 million to $75.0 million.

Net Premiums Earned.  Net premiums earned for the three months ended September 30, 2007 totaled $59.7 million, an increase of $11.9 million, or 24.9%, over $47.8 million in the same period of 2006. For the nine months ended September 30, 2007, net premiums earned totaled $163.1 million, an increase of $29.5 million, or 22.1%, from $133.6 million in the same period of 2006. 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. Consequently, the amount of premiums earned in any given year depends on when during the current or prior year the underlying policies were written. Our direct premiums earned for the three months ended September 30, 2007 increased $8.7 million (16.4%) to $61.8 million from $53.1 million in 2006. Our direct premiums earned for the nine months ended September 30, 2007 increased $27.1 million (19.2%) to $168.5 million from $141.4 million for the same period in 2006. The increase in our direct premiums earned is the result of our premium growth as described above.

      Net premiums earned are also affected by premiums ceded under reinsurance agreements. Ceded premiums earned for the three month and nine month periods ended September 30, 2007 were $4.3 million and $11.8 million, respectively. This represents an increase of $0.2 million (4.9%) from $4.1 million in the three months ended September 30, 2006 and a decrease of $0.3 million (2.5%) from $12.1 million in the nine months ended September 30, 2006. A decrease in ceded premiums earned is an increase to our overall net premiums earned. Included in the net premiums earned for the three months ended September 30, 2007 is an increase of $1.1 million (95.2%) in the amount of premiums we involuntarily assume on residual market business from the NCCI, which operates residual market programs on behalf of many states. For the nine months ended September 30, 2007, assumed premiums earned increased $2.1 million (48.8%) to $6.4 million from $4.3 million in the same period of 2006.

Net Investment Income.  Net investment income for the three months ended September 30, 2007 totaled $5.2 million, an increase of $1.2 million, or 30.0%, over $4.0 million in the same period of 2006. For the nine months ended September 30, 2007, net investment income totaled $14.8 million, an increase of $4.0 million, or 37.0%, from $10.8 million in the same period of 2006. Average invested assets for the three months ended September 30 increased $89.1 million (23.5%) from $378.9 million in 2006 to $468.0 million in 2007. For the nine months ended September 30, average invested assets increased $117.1 million (34.9%) from $335.8 million in 2006 to $452.9 million in 2007. This increase in our investment portfolio is due primarily to strong cash flow from operations of $90.3 million for the year ended December 31, 2006 and $68.0 million for the nine months ended September 30, 2007 and, to a lesser degree, the $57.6 million in proceeds from the follow-on offering of our common stock in February 2006. Our yield on average invested assets for the three months ended September 30, 2007 was approximately 4.4% compared to approximately 4.2% for the same period in 2006. For the nine months ended September 30, 2007, our yield on average invested assets was 4.4% compared to approximately 4.3% for the same period in 2006.

Service Income.   Service income for the three months ended September 30, 2007 totaled $487,000, a decrease of $41,000, or 7.8%, from $528,000 in the same period of 2006. For the nine months ended September 30, 2007, service income totaled $1.4 million, a decrease of $0.2 million, or 12.5%, from $1.6 million in the same period of 2006. Our service income results primarily from service arrangements we have with LMC and other companies for claims processing, policy administration and administrative services that we perform for them. Average monthly fees from arrangements with LMC for services we provide in connection with the Eagle Entities’ insurance policies are declining as the volume of work decreases due to the run off of our predecessor’s business. Approximately 50.0% of our service income in the three-month period ended September 30, 2007 came from third party claims administration services that we provide to independent, unrelated companies and, to a lesser degree, administrative fees charged to our policyholders that have high deductible policies, compared to 46.4% in the same period of 2006. For the nine-month period ended September 30, 2007, approximately 50.1% of our service income came from such services and fees, compared to approximately 34.2% in the same period of 2006.

Other Income.   Other income for the three months ended September 30, 2007 totaled $1.4 million, an increase of $0.9 million, or 180.0%, from $0.5 million in the same period of 2006. For the nine months ended September 30, 2007, service income totaled $3.0 million, an increase of $0.9 million, or 42.9%, from $2.1 million in the same period of 2006. Other income is derived primarily from the operations of PointSure, our non-insurance subsidiary.

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PointSure represented 20 insurance companies as of September 30, 2007 and 19 companies as of September 30, 2006.

Loss and Loss Adjustment Expenses.  Loss and loss adjustment expenses for the three months ended September 30, 2007 totaled $34.9 million, an increase of $7.0 million, or 25.1%, from $27.9 million in the same period of 2006. For the nine months ended September 30, 2006, loss and loss adjustment expenses totaled $89.9 million, an increase of $11.5 million, or 14.7%, from $78.4 million in the same period of 2006. Our net loss ratio, which is calculated by dividing loss and loss adjustment expenses less claims service income by premiums earned, for the three months ended September 30, 2007 was 57.8% compared to 57.3% for the same period in 2006. Our net loss ratio for the nine months ended September 30, 2007 was 54.3% compared to 57.5% for the same period in 2006. Included in the loss ratios for the three month and nine month periods ended September 30, 2007 were reductions of approximately $5.5 million and $20.5 million, respectively, of previously recorded direct net loss reserves to reflect a continuation of lower than anticipated patterns of loss payments in recent accident years. Included in the loss ratios for the three month and nine month periods ended September 30, 2006, were reductions of approximately $3.5 million and $13.9 million, respectively. Our direct net loss reserves are net of reinsurance and exclude reserves associated with KEIC and the business we involuntarily assume from the NCCI.

      There is uncertainty about whether recent lower paid loss trends, which result primarily from California legislative reforms enacted primarily in 2003 and 2004, will be sustained, particularly in light of current efforts to change or repeal portions of the reforms. We will not know the full impact of these reforms with a high degree of confidence for several years. We have established loss reserves at September 30, 2007 that are based upon our current best estimate of loss costs, taking into consideration the recent lower paid loss claim data and incurred loss trends.

      As of September 30, 2007, we had recorded a receivable of approximately $2.8 million for adverse loss development of KEIC reserves since the date of the Acquisition. We do not expect this receivable to have any material adverse effect on our future cash flows if LMC fails to perform its obligations under the adverse development cover agreement. At September 30, 2007, we have access to approximately $3.5 million under the collateralized reinsurance trust in the event that LMC fails to satisfy its obligations under the adverse development cover agreement. The balance of the Trust, including interest, was $5.2 million at December 31, 2006. In February 2007, LMC submitted a request to withdraw approximately $1.8 million of excess funds on deposit in the trust account. After due evaluation, we complied with LMC’s request, resulting in a balance in the trust account of approximately $3.4 million immediately following the withdrawal.

Underwriting Expenses.  Underwriting expenses for the three months ended September 30, 2007 totaled $15.2 million, an increase of $5.1 million, or 50.5%, from $10.1 million in the same period of 2006. For the nine months ended September 30, 2007, underwriting expenses totaled $42.5 million, an increase of $12.9 million, or 43.6%, from $29.6 million in the same period of 2006. Our net underwriting expense ratio for the three months ended September 30, 2007, which is calculated by dividing underwriting, acquisition and insurance expenses less other service income by premiums earned, was 25.3%, compared to 21.1% for the same period in 2006. For the nine months ended September 30, 2007, our net underwriting expense ratio was 26.0%, compared to 22.1% for the same period of 2006. The increases in the net underwriting expense ratio for the three month and nine month periods ended September 30, 2007 are primarily the result of increases in the number of staff, staffing related costs and other premium production-related expenses, including commission expense, as we continue to grow our business in existing offices and in new offices recently opened in Philadelphia, Atlanta, and Phoenix. These new offices have not yet reached the premium production levels required to contribute to earnings. The total number of employees grew from 174 at September 30, 2006 to 215 at September 30, 2007, representing an increase of 23.6%. For the three month and nine month periods ended September 30, 2007, the number of employees grew 2.4% and 20.8%, respectively.

      Commission expense as a percentage of net earned premiums averaged 9.3% for the three months ended September 30, 2007 compared to 6.2% in the same period of 2006. Commission expense as a percentage of net earned premiums for the nine months ended September 30, 2007 and 2006 averaged 9.2% and 7.6%, respectively. These increases are driven primarily by the California market, as well as other markets that have experienced rate reductions, as brokers negotiate higher commission rates during a period of declining premium rates.

Interest Expense.  Interest expense related to the surplus notes issued by our insurance subsidiary in May 2004 totaled $289,000 for the three months ended September 30, 2007, compared to $285,000 for the same period in 2006, representing an increase of $4,000, or 1.4%. Interest expense for the nine months ended September 30, 2007

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totaled $854,000, compared to $813,000 for the same period in 2006, representing an increase of $41,000, or 5.0%. The surplus notes interest rate, which is calculated at the beginning of each interest payment period using the 3-month LIBOR rate plus 400 basis points, increased from 9.40% at September 30, 2006 to 9.5% at September 30, 2007.

Other Expenses.   Other expenses for the three months ended September 30, 2007 totaled $2.0 million, an increase of $0.6 million, or 42.9%, over $1.4 million in the same period of 2006. For the nine months ended September 30, 2007, other expenses totaled $5.2 million, an increase of $1.3 million, or 33.3%, from $3.9 million in the same period of 2006. Other expenses result primarily from the operations of PointSure, our non-insurance subsidiary. Other expenses for the three month and nine month periods ended September 30, 2006 included a one-time charge of $305,000 related to a legal settlement.

Federal Income Tax Expense.  The effective tax rate for the three months ended September 30, 2007 was 32.7%, compared to 30.2% for the same period in 2006. For the nine months ended September 30, 2007 our effective tax rate was 31.7% compared to 30.4% in the same period of 2006. The increases in our effective tax rate are primarily attributable to a decrease in the proportion of tax-exempt municipal securities in our portfolio and an overall increase in taxable income as a result of our continued growth. At September 30, 2007, approximately 50.0% of our investment portfolio was invested in tax-exempt municipal securities, compared to approximately 55.0% at September 30, 2006.

Net Income.   Net income was $9.7 million for the three months ended September 30, 2007, compared to $9.1 million for the same period in 2006, representing an increase of $0.6 million, or 6.6%. Net income for the nine months ended September 30, 2007 totaled $29.9 million, an increase of $5.5 million, or 22.5%, from $24.4 million in the same period of 2006. The increase in net income for the three and nine months ended September 30, 2007 resulted primarily from the factors discussed above.

Liquidity and Capital Resources

      Our principal sources of funds are underwriting operations, investment income and proceeds from sales and maturities of investments. Our primary use of funds is 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 September 30, 2007 has an effective duration of 4.89 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.

      At September 30, 2007, our portfolio was made up almost entirely of investment grade fixed income securities with fair values subject to fluctuations in interest rates. Prior to March 2005, we did not invest in common equity securities and we had no exposure to foreign currency risk. In November 2006, our investment policy was revised to allow for investment in domestic and international equities of up to 4% and 1%, respectively, of our statutory consolidated capital and surplus. 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 environment, we would expect to incur losses from such sales.

      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. For the period from October 1, 2006 through October 1, 2007 and for the period from October 1, 2007 through October 1, 2008, our reinsurance program provided us with reinsurance protection for each loss occurrence in excess of $1.0 million, up to $75.0 million, subject to retentions, annual aggregate deductibles and other limitations. Our reinsurance programs are more fully described in Note 5.a. to our unaudited condensed consolidated financial statements in Part I, Item 1 of this quarterly report and in the reinsurance agreements. Given industry and predecessor trends, we believe that we are sufficiently capitalized to retain the losses described above.

      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

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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, 2006, 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.

      SIH has minimal revenue and expenses. Currently, there are no plans to have SBIC or PointSure pay a dividend to SIH.

      Our unaudited consolidated net cash provided by operating activities for the nine months ended September 30, 2007 was $68.0 million, compared to $59.9 million for the same period in 2006. The increase resulted primarily from increases in net income, deferred federal income tax and the net of deferred and unearned premiums, offset by amounts related to unpaid loss and loss adjustment expense.

      We used net cash of $47.3 million for investing activities in the nine months ended September 30, 2007, compared to $103.6 million for the same period in 2006. In February 2006, we invested net proceeds totaling approximately $57.6 million resulting from a follow-on public offering of 3,910,000 shares of our common stock.

      For the nine months ended September 30, 2007, financing activities provided cash of $0.4 million, compared to $57.6 million in the same period in 2006. The majority of cash provided by financing activities resulted from the sale of our common stock and, to a much lesser degree, from the exercise of common stock options by our employees. On February 1, 2006, we closed a follow-on public offering of 3,910,000 shares of our common stock at a price of $15.75 per share for net proceeds of approximately $57.6 million, after deducting underwriters’ fees, commissions and offering costs totaling approximately $4.0 million.

Contractual Obligations and Commitments

      The following table identifies our contractual obligations by payment due period as of September 30, 2007:

	Payments Due by Period
	Total		Less than 1 Year		1-3 Years		4-5 Years		More than 5 Years
	(in thousands)
Long term debt obligations:
Surplus notes	$	12,000	$	—	$	—	$	—	$	12,000
Loss and loss adjustment expenses		233,717		77,127		100,732		21,502		34,356
Operating lease obligations		13,533		1,799		5,426		2,776		3,532
Total	$	259,250	$	78,926	$	106,158	$	24,278	$	49,888

      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 September 30, 2007 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.

Off-Balance Sheet Arrangements

      As of September 30, 2007, we had no off-balance sheet arrangements that had 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. Management considers 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

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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, deferred policy acquisition costs, deferred taxes, the impairment of investments, earned but unbilled premiums and retrospective premiums. The following should be read in conjunction with the notes to our financial statements.

Unpaid Loss and Loss Adjustment Expense

        Unpaid loss and loss adjustment expense represents 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 expense are amounts for case-based reserves, including estimates of future developments on those claims, and claims incurred but not yet reported to us, second injury fund expenses, and allocated and unallocated claim adjustment expenses. Due to the inherent uncertainty associated with the cost of unsettled and unreported claims, the ultimate liability may differ, perhaps materially, from the original estimate. These estimates are regularly reviewed and updated and any resulting adjustments are included in the current period’s operating results.

        Following is a summary of the gross loss and loss adjustment expense reserves by line of business as of September 30, 2007 and December 31, 2006. The workers’ compensation line of business comprises over 99% of our total loss reserves as of both dates.

	As of September 31, 2007						As of December 31, 2006
Line of Business	Case		IBNR		Total		Case		IBNR		Total
	(in thousands)
Workers’ Compensation	$	85,440	$	147,316	$	232,756	$	66,866	$	130,838	$	197,704
Ocean Marine		202		759		961		210		442		652
Total	$	85,642	$	148,075	$	233,717	$	67,076	$	131,280	$	198,356

Actuarial Loss Reserve Estimation Methods

        We use a variety of actuarial methodologies to assist us in establishing the reserve for unpaid loss and loss adjustment expense. We also make 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.

        For the current accident year, we establish the initial reserve for claims incurred-but-not-reported (“IBNR”) using an expected loss ratio (“ELR”) method. The ELR method is based on an analysis of historical loss ratios adjusted for current pricing levels, exposure growth, anticipated trends in claim frequency and severity, the impact of reform activity and any other factors that may have an impact on the loss ratio. The actual paid and incurred loss data for the accident year is reviewed each quarter and changes to the ELR may be made based on the emerging data, although changes are typically not made until the end of the accident year when the loss data can be analyzed as a complete accident year. The ELR is multiplied by the year-to-date earned premium to determine the ultimate losses for the current accident year. The actual paid and case outstanding losses are subtracted from the ultimate losses to determine the IBNR for the accident year. As the accident year matures, we incorporate a Bornhuetter-Ferguson approach, which blends the loss development and expected loss ratio methods. As each year continues to mature, this approach relies more on losses developed to date and less on the expected loss ratio. A reserve estimate implies a pattern of expected loss emergence. If this emergence does not occur as expected, it may cause us to revisit our previous assumptions. We may adjust loss development patterns, the various method weights or the expected loss ratios used in our analysis. Management employs judgment in each reserve valuation as to how to make these adjustments to reflect current information.

        For all other accident years, the estimated ultimate losses are developed using a variety of actuarial techniques as described below. In reviewing this information, we consider the following factors to be especially important at this time because they increase the variability risk factors in our loss reserve estimates:

• We wrote our first policy on October 1, 2003 and, as a result, our total reserve portfolio is relatively immature when compared to other industry data.

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• We have been growing consistently since we began operations and have entered into several new states that are not included in our predecessor’s historical data.

• At September 30, 2007, approximately $126.6 million, or 56.6%, of our direct loss reserves were related to business written in California. Over the last several years, three significant comprehensive legislative reforms were enacted in California: AB 749 was enacted in February, 2002; AB 227 and SB 228 were enacted in September, 2003; and SB 899 was enacted in April, 2004. This reform activity has resulted in uncertainty regarding the impact of the reforms on loss payments, loss development and, ultimately, loss reserves. All four bills enacted structural changes to the benefit delivery system in California, in addition to changes in the indemnity and medical benefits afforded injured workers. In response to the reform legislation and a continuing drop in the frequency of workers’ compensation claims, the pure premium rates approved by the California Insurance Commissioner effective July 1, 2007 were 65.1% lower than the pure premium rates in effect as of July 1, 2003.

Key elements of the reforms as they relate to indemnity and medical benefits were as follows:

Indemnity Benefits

AB 749 significantly increased most classes of workers’ compensation indemnity benefits over a four-year period beginning in 2003.

AB 227 and SB 228 repealed the mandatory vocational rehabilitation benefits and replaced them with a system of non-transferable education vouchers.

SB 899 required the Division of Workers’ Compensation (“DWC”) Administrative Director to adopt, on or before January 1, 2005, a new permanent disability rating schedule (“PDRS”) based in part on American Medical Association guidelines. Also, temporary disability was limited to a duration of two years.

SB 899 provided that, effective April 19, 2004, apportionment of disability for purposes of permanent disability determination must be based on causation.

Medical Benefits

AB 749 repealed the presumption given to the primary treating physician (except when the worker has pre-designated a personal physician), effective for injuries occurring on or after January 1, 2003. (SB 228 and SB 899 later extended this to all future medical treatment on earlier injuries.)

SB 228 required the DWC Administrative Director to establish, by December 1, 2004, an Official Medical Treatment Utilization Schedule meeting specific criteria. SB 228 also provided that beginning three months after the publication date of the updated American College of Occupational and Environmental Medical (“ACOEM”) Practice Guidelines and continuing until such time as the DWC Administrative Director establishes an Official Medical Treatment Utilization Schedule, the ACOEM standards will be presumed to be correct regarding the extent and scope of all medical treatment. The DWC Administrative Director has subsequently adopted the ACOEM Guidelines as the Official Medical Treatment Utilization Schedule.

SB 228 limited the number of chiropractic visits and the number of physical therapy visits to 24 each per claim.

SB 228 established a prescription medication fee schedule set at 100% of Medi-Cal Schedule amounts.

SB 228 provided that the maximum facility fee for services performed in an ambulatory surgical center may not exceed 120% of the Medicare fees for the same service performed in a hospital outpatient facility.

SB 899 provided that after January 1, 2005, an employer or insurer may establish medical provider networks meeting certain conditions and, with limited exceptions, medical treatment can be provided within those networks.

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        These reforms are a source of variability in the reserve estimates as legislative changes affecting benefit levels not only impact the cost of benefits but also the rate at which accident year benefits or losses develop over time. In addition, several of the reforms face ongoing challenges, as noted below:

– The PDRS was revised effective January 1, 2005. The revised schedule has resulted in significantly reduced permanent disability awards. Proposed legislation to revise the PDRS was recently vetoed by the Governor. It is possible, however, that the PDRS will be modified by the California Division of Workers’ Compensation through the regulatory process. A change to the PDRS could result in increased claim costs.

– Legislation was recently passed that extends the period in which injured workers are eligible for wage replacement benefits. This legislation applies to injuries occurring on or after January 1, 2008. The change could result in increased temporary disability claim costs.

– Legislation enacted in 2004 placed a cap of 24 visits on certain categories of physical medicine, including physical therapy and chiropractic care. Legislation was recently passed that eliminates the cap for post surgical care. The legislation may increase claim costs for claims involving post surgical physical medicine.

        Workers’ compensation is considered a long-tail line of business, as it takes a relatively long period of time to finalize claims from a given accident year. Management believes that it generally takes workers’ compensation losses approximately 48 to 60 months after the start of an accident year until the data is viewed as fully credible for paid and incurred reserve evaluation methods. As indicated above, we wrote our first policy on October 1, 2003 so our first complete accident year is 2004. As of September 30, 2007, accident year 2004 is 45 months developed, accident year 2005 is 33 months developed and accident year 2006 is 21 months developed. Our loss reserve estimates are subject to considerable variation due to the relative immaturity of the accident years from a development standpoint.

        We review the following significant components of loss reserves on a quarterly basis:

• IBNR reserves for losses – This includes amounts for the medical and indemnity components of the workers’ compensation claim payments, net of subrogation recoveries and deductibles;

• IBNR reserves for defense and cost containment expenses (“DCC”, also referred to as allocated loss adjustment expenses (“ALAE”)), net of subrogation recoveries and deductibles;

• reserve for adjusting and other expenses, also known as unallocated loss adjustment expenses (“ULAE”); and

• reserve for loss based assessments, also referred to as the “8F reserve” in reference to Section 8, Compensation for Disability, subsection (f), Injury increasing disability, of the United States Longshore and Harbor Workers’ Compensation Act (“USL&H”) Act.

        The reserves for losses and DCC are also reviewed gross and net of reinsurance (referred to as “net”). For gross losses, the claims for the Washington USL&H Plan, the KEIC claims assumed in the Acquisition and claims assumed from the NCCI residual market pools are excluded from this discussion.

        IBNR reserves include a provision for future development on known claims, a reopened claims reserve, a provision for claims incurred but not reported and a provision for claims in transit (incurred and reported but not recorded).

        Our analysis is done separately for the indemnity, medical and DCC components of the total loss reserves within each accident year. In addition, the analysis is completed separately for the following three categories: State Act California; State Act excluding California; and USL&H. The business is divided into these three categories for the determination of ultimate losses due to differences in the laws that cover each of these categories.

        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. Because the benefits are established by state statute there can be significant variation in these benefits by state. We refer to this coverage as State Act.

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        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. We refer to the business covered under the USL&H Act and the Jones Act as USL&H.

        Because there are different laws and benefit levels that affect the State Act versus USL&H business, there is a strong likelihood that these categories will exhibit different loss development characteristics which will influence the ultimate loss calculations. Separating the data into the State Act and USL&H categories allows us to use actuarial methods that contemplate these differences.

        The State Act category is further split into California and non-California groupings. This is due to the extensive reform activity that has taken place in California as discussed above. Since the California data is subject to additional variation due to the reform activity, separating the data in this fashion allows us to review the non-California State Act data with no impact from the California reform activity.

        Development factors, expected loss rates and expected loss ratios are derived from the combined experience of us and our predecessor

        Gross ultimate loss (indemnity, medical and ALAE separately) for each category is estimated using the following actuarial methods:

• paid loss (or ALAE) development;

• incurred loss (or ALAE) development;

• Bornhuetter-Ferguson using ultimate premiums and paid loss (or ALAE); and

• Bornhuetter-Ferguson using ultimate premiums and incurred loss (or ALAE).

        A gross ultimate value is selected by reviewing the various ultimate estimates and applying actuarial judgment to achieve a reasonable point estimate of the ultimate liability. The gross IBNR reserve equals the selected gross ultimate loss minus the gross paid losses and gross case reserves as of the valuation date. The selected gross ultimate loss and ALAE are reviewed and updated on a quarterly basis.

Variation in Ultimate Loss Estimates

        In light of our short operating history and uncertainties concerning the effects of recent legislative reforms, specifically as they relate to our California workers’ compensation experience, the actuarial techniques discussed above use the historical experience of our predecessor as well as industry information in the analysis of loss reserves. We are able to effectively draw on the historical experience of our predecessor because most of the current members of our management and adjusting staff also served as the management and adjusting staff of our predecessor.

        These techniques recognize, among other factors:

• our claims experience and that of our predecessor;

• the industry’s claim experience;

• historical trends in reserving patterns and loss payments;

• the impact of claim inflation and/or deflation;

• the pending level of unpaid claims;

• the cost of claim settlements;

• legislative reforms affecting workers’ compensation;

• the overall environment in which insurance companies operate; and

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• trends in claim frequency and severity.

        In addition, there are loss and loss adjustment expense risk factors that affect workers’ compensation claims that can change over time and also cause our loss reserves to fluctuate. Some examples of these risk factors include, but are not limited to, the following:

• recovery time from the injury;

• degree of patient responsiveness to treatment;

• use of pharmaceutical drugs;

• type and effectiveness of medical treatments;

• frequency of visits to healthcare providers;

• changes in costs of medical treatments;

• availability of new medical treatments and equipment;

• types of healthcare providers used;

• availability of light duty for early return to work;

• attorney involvement;

• wage inflation in states that index benefits; and

• changes in administrative policies of second injury funds.

        Variation can also occur in the loss reserves due to factors that affect our book of business in general. Some examples of these risk factors include, but are not limited to, the following:

• injury type mix;

• change in mix of business by state;

• change in mix of business by employer type;

• small volume of internal data; and

• significant exposure growth over recent data periods.

Impact of Changes in Key Assumptions on Reserve Volatility  

        The most significant factor currently impacting our loss reserve estimates is the reliance on historical reserving patterns and loss payments from our predecessor and the industry, also referred to as loss development. This is due to our limited operating history as discussed above. The actuarial methods that we use depend at varying levels on loss development patterns based on past information. Development is defined as the difference, on successive valuation dates, between observed values of certain fundamental quantities that may be used in the loss reserve estimation process. For example, the data may be paid losses, case incurred losses and the change in case reserves or claim counts, including reported claims, closed claims or reopened claims. Development can be expected, meaning it is consistent with prior results; favorable (better than expected); or unfavorable (worse than expected). In all cases, we are comparing the actual development of the data in the current valuation with what was expected based on the historical patterns in the underlying data. Favorable development indicates a basis for reducing the estimated ultimate loss amounts while unfavorable development indicates a basis for increasing the estimated ultimate loss amounts. We reflect the favorable or unfavorable development in loss reserves in the results of operations in the period in which the ultimate loss estimates are changed.

        Due to the relative immaturity of our book of business, the challenge has been to give the right weight in the ultimate loss estimation process to the new data as it becomes available. As discussed above, management believes

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that it generally takes workers’ compensation losses approximately 48 to 60 months after the start of an accident year until the data is viewed as fully credible for paid and incurred reserve evaluation methods. Due to our limited operating history, our oldest complete accident year was 45 months old as of September 30, 2007. Due to the favorable development exhibited by the data for accident years 2004 and 2005 at 17 to 18 months of development, management began to place more weight on the results of the Bornhuetter-Ferguson method in its ultimate loss estimates for accident year 2005. As new data emerges and continues to demonstrate favorable development, this adds credibility to the existing data which enables management to reflect it more fully in its estimation process. For all accident years, we have not completely relied on the most recent data points in our loss development selections. Because of recent favorable development trends, we believe this has the effect of increasing our estimated reserves as compared to reserves calculated with complete reliance on these data points. Estimating loss reserves is an uncertain and complex process which involves actuarial techniques and management judgment. Actuarial analysis generally assumes that past patterns demonstrated in the data will repeat themselves and that the data provides a basis for estimating future loss reserves. However, since conditions and trends that have affected losses in the past may not occur in the future in the same manner, if at all, future results may not be reliably predicted by the prior data. We believe that our loss development factor selections are appropriate given the relative immaturity of our data. Over time, as the data for these accident years mature and uncertainty surrounding the ultimate outcome of the claim costs diminishes, the full impact of the actual loss development will be factored into our assumptions and selections.

        In the third quarter of 2007 we experienced development in all three categories. For State Act California there was favorable development for accident years 2005 and 2006 that resulted in a reduction of our gross ultimate loss estimates of $1.9 million and $2.3 million, respectively. For accident year 2004 there was unfavorable development for ALAE which resulted in an increase in our gross ultimate ALAE estimate of $150,000. For non-California State Act there was favorable development for accident year 2006 that resulted in a reduction to our gross ultimate loss estimate of $1.5 million. For USL&H there was favorable development for accident year 2006 that resulted in a reduction of our gross ultimate loss estimates by $603,000. For accident years 2003 and 2004 there was unfavorable development which resulted in an increase in our gross ultimate loss estimates of $50,000 and $400,000, respectively. For all other accident years the development was at expected levels which did not warrant a change to our gross ultimate loss estimates.

Reserve Sensitivities

        Although many factors influence the actual cost of claims and the corresponding unpaid loss and loss adjustment expense estimates, we do not measure and estimate values for all of these variables individually. This is due to the fact that many of the factors that are known to impact the cost of claims cannot be measured directly. This is the case for the impact of economic inflation on claim costs, coverage interpretations and jury determinations. In most instances, we rely on historical experience or industry information to estimate values for the variables that are explicitly used in the unpaid loss and loss adjustment expense analysis. We assume that the historical effect of these unmeasured factors, which is embedded in our experience or industry experience, is representative of future effects of these factors. It is important to note that actual claims costs will vary from our estimate of ultimate claim costs, perhaps by substantial amounts, due to the inherent variability of the business written, the potentially significant claim settlement lags and the fact that not all events affecting future claim costs can be estimated.

        As discussed in the previous section, there are a number of variables that can impact, individually or in combination, the adequacy of our loss and loss adjustment expense liabilities. While the actuarial methods employed factor in amounts for these circumstances, they may prove to be inadequate. For example, there may be a number of claims where the unpaid loss and loss adjustment expense associated with future medical treatment proves to be inadequate because the injured workers do not respond to medical treatment as expected by the claims examiner. If we assume this affects 10% of the open claims and, on average, the unpaid loss and loss adjustment expenses on these claims are 20% inadequate, this would result in our unpaid loss and loss adjustment expense liability being inadequate by approximately $4.7 million, or 2%, as of September 30, 2007. Another example is claim inflation. Claim inflation can result from medical cost inflation or wage inflation. As discussed above, the actuarial methods employed include an amount for claim inflation based on historical experience. We assume that the historical effect of this factor, which is embedded in our experience and industry experience, is representative of future effects for claim inflation. To the extent that the historical factors, and the actuarial methods utilized, are inadequate to recognize future inflationary trends, our unpaid loss and loss adjustment expense liabilities may be inadequate. If our estimate of future medical trend is two percentage points inadequate (e.g., if we estimate a 9% annual trend and the actual trend is 11%), our unpaid loss and loss adjustment expense liability could be inadequate. The amount of the inadequacy would depend on the mix of medical and indemnity payments and the length of time until the claims

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are paid. For example, if we assume that 50% of the unpaid loss and loss adjustment expense is associated with medical payments and an average payout period of 5 years, our unpaid loss and loss adjustment expense liabilities would be inadequate by approximately $11.7 million on a pre-tax basis, or 5%, as of September 30, 2007. Under these assumptions, the inadequacy of approximately $11.7 million represents approximately 4.2% of total stockholders’ equity at September 30, 2007. The impact of any reserve deficiencies, or redundancies, on our reported results and future earnings is discussed below.

      In the event that our estimates of ultimate unpaid loss and loss adjustment expense liabilities prove to be greater or less than the ultimate liability, our future earnings and financial position could be positively or negatively impacted. Future earnings would be reduced by the amount of any deficiencies in the year(s) in which the claims are paid or the unpaid loss and loss adjustment expense liabilities are increased. For example, if we determined our unpaid loss and loss adjustment expense liability of $233.7 million as of September 30, 2007 to be 5% inadequate, we would experience a reduction in future earnings up to approximately $11.7 million, depending on a number of other factors including federal income taxes. This reduction could be realized in one year or multiple years, depending on when the deficiency is identified. The deficiency would also impact our financial position because our surplus would be reduced by an amount equivalent to the reduction in net income. Any deficiency is typically recognized in the unpaid loss and loss adjustment expense liability and, accordingly, it typically does not have a material effect on our liquidity because the claims have not been paid. Since the claims will typically be paid out over a multi-year period, we have generally been able to adjust our investments to match the anticipated future claim payments. Conversely, if our estimates of ultimate unpaid loss and loss adjustment expense liabilities prove to be redundant, our future earnings and financial position would be improved.

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. We calculate amounts recoverable from reinsurers based on our estimates of the underlying loss and loss adjustment expenses, which themselves are subject to significant judgments and uncertainties described above under the heading “Unpaid Loss and Loss Adjustment Expenses.” Changes in the estimates and assumptions underlying the calculation of our loss reserves may have an impact on the balance of our reinsurance recoverables. In general, one would expect an increase in our underlying loss reserves on claims subject to reinsurance to have an upward impact on our reinsurance recoverables. The amount of the impact on reinsurance recoverables would depend on a number of considerations including, but not limited to, the terms and attachment points of our reinsurance contracts and the incurred amount on various claims subject to reinsurance. We also bear credit risk with respect to our reinsurers, which can be significant considering that some claims may remain open for an extended period of time.

      We periodically evaluate our reinsurance recoverables, including the financial ratings of our reinsurers, and revise our estimates of such amounts as conditions and circumstances change. Changes in reinsurance recoverables are recorded in the period in which the estimate is revised. As of September 30, 2007 and December 31, 2006, we had no reserve for uncollectible reinsurance recoverables. We assessed the collectibility of our period-end receivables and believe that all amounts are collectible based on currently available information.

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 charged 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 estimated investment income, anticipated losses and settlement expenses and certain other costs we expect to incur as the premium is earned. Judgments regarding the ultimate recoverability of these deferred costs are highly dependent upon the estimated future costs associated with our unearned premiums. If our expected claims and expenses, after considering investment income, exceed our unearned premiums, we would be required to write-off a portion of deferred policy acquisition costs. To date, we have not needed to write-off any portion of our deferred acquisition costs. We will continue to monitor the balance of deferred acquisition costs for recoverability.

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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 income statement 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. This analysis requires management to make various estimates and assumptions, including the scheduled reversal of deferred tax liabilities, projected future taxable income and the effect of tax planning strategies. If actual results differ from management’s estimates and assumptions, we may be required to establish a valuation allowance to reduce the deferred tax assets to the amounts more likely than not to be realized. The establishment of a valuation allowance could have a significant impact on our financial position and results of operations in the period in which it is deemed necessary. To date, we have not needed to record a valuation allowance against our deferred tax assets. We anticipate that our deferred tax assets will increase as our business continues to grow. We will continue to monitor the balance of our deferred tax assets for realizability.

Impairment of Investment Securities

      Impairment of investment securities results in a charge to operations when the fair value of a security declines below our cost and is deemed to be other-than-temporary. We regularly review our investment 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, including interest rates.

      In general, we focus on those securities whose fair value was less than 80% of their amortized cost or cost, as appropriate, for six or more consecutive months. We also analyze the entire portfolio for other factors that might indicate a risk of impairment. Other-than-temporary impairment losses result in a permanent reduction of the carrying value of the underlying investment. To date, we have not needed to record any other-than-temporary impairments of our investment securities. Please refer to the tables in Note 3 of the unaudited condensed consolidated financial statements in Part I, Item 1 of this quarterly report for additional information on unrealized losses on our investment securities. Please refer to Part I, Item 3 of this quarterly report for tables showing the sensitivity of the fair value of our fixed-income investments to selected hypothetical changes in interest rates.

Earned But Unbilled Premiums

      Shortly following the expiration of an insurance policy, we perform a final payroll audit of our insureds to determine the final premium to be billed and earned. These final audits generally result in an audit adjustment, either increasing or decreasing the estimated premium earned and billed to date. We estimate the amount of premiums that have been earned but are unbilled at the end of a reporting period by analyzing historical earned premium adjustments made at final audit for the preceding 12 months and applying the average adjustment percentage against our in-force earned premium for the period. These estimates are subject to changes in policyholders’ payrolls due to growth, economic conditions, seasonality and other factors and to fluctuations in our in-force premium. For example, the amount of our accrual for premiums earned but unbilled fluctuated between $0 and $1.2 million in 2007 and between $1.2 million and $1.8 million in 2006. The balance of our accrual for premiums earned but unbilled totaled $0 and $1.5 million at September 30, 2007 and December 31, 2006, respectively. Although considerable variability is inherent in such estimates, management believes that the accrual for earned but unbilled premiums is reasonable. The estimates are reviewed quarterly and adjusted as necessary as experience develops or new information becomes known. Any such adjustments are included in current operations.

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Retrospective Premiums

      The premiums for our retrospectively rated loss sensitive plans are reflective of the customer’s loss experience because, beginning six months after the expiration of the relevant insurance policy, and annually thereafter, we recalculate the premium payable during the policy term based on the current value of the known losses that occurred during the policy term. While the typical retrospectively rated policy has around five annual adjustment or measurement periods, premium adjustments continue until mutual agreement to cease future adjustments is reached with the policyholder. 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 our 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.

      We bear credit risk with respect to retrospectively rated policies. Because of the long duration of our loss sensitive plans, there is a risk that the customer will fail to pay the additional premium. Accordingly, we obtain collateral in the form of letters of credit or deposits to mitigate credit risk associated with our loss sensitive plans. If we are unable to collect future retrospective premium adjustments from an insured, we would be required to write-off the related amounts, which could impact our financial position and results of operations. To date, there have been no such write-offs. Retrospectively rated policies accounted for approximately 19.2% of direct premiums written in the nine months ended September 30, 2007 and approximately 25.8% of direct premiums written in the year ended December 31, 2006.

Recent Accounting Pronouncements

In September 2005, the American Institute of Certified Public Accountants (“AICPA”) released Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts (“SOP 05-1”). SOP 05-1 requires identification of transactions that result in a substantial change in an insurance contract. If it is determined that a substantial change to an insurance contract has occurred, the related unamortized deferred policy acquisition costs, unearned premiums and other related balances must be written off. SOP 05-1 is effective for fiscal years beginning after December 15, 2006. We adopted the provisions of SOP 05-1 as of January 1, 2007, which did not have a material effect on our consolidated financial condition or results of operations.

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109 (“FIN 48”), which provides for the recognition, measurement, presentation and disclosure of uncertain tax positions. A tax benefit from an uncertain position may be recognized only if it is more likely than not that the position is sustainable based on its technical merits. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. We adopted the provisions of FIN 48 as of January 1, 2007, which did not have a material effect on our consolidated financial condition or results of operations.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines fair value and establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. The provisions for SFAS No. 157 are effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early adoption is permitted. We must adopt these new requirements no later than our first fiscal quarter of 2008. We expect that SFAS No. 157 will not have a material effect on our consolidated financial condition or result of operations.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115, which permits entities to choose to measure many financial instruments and certain other items at fair value in order to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently and without having to apply complex hedge accounting provisions. The provisions for SFAS No. 157 are effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early adoption is permitted. We must adopt these new requirements no later than our first fiscal quarter of 2008. We are currently evaluating the impact that the adoption of SFAS No. 159 will have on our consolidated financial condition and results of operations.

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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.

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 manager, 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 $429.3 million at September 30, 2007 that are subject to interest rate risk, compared with $372.3 million at September 30, 2006. 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 as of September 30, 2007 and 2006. It illustrates the sensitivity of the fair value of fixed-income investments to selected hypothetical changes in interest rates as of September 30, 2007 and 2006. 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.

Interest Rate Risk as of September 30, 2007

Hypothetical Change in Interest Rates	Estimated Change in Fair Value			Fair Value		Hypothetical Percentage Increase (Decrease) in Portfolio Value
	($ in thousands)
200 basis point increase	$	(36,689	)	$	392,626		(8.5	)%
100 basis point increase		(18,147	)		411,168		(4.2	)%
No change		—			429,315		—
100 basis point decrease		17,752			447,067		4.1	%
200 basis point decrease		35,110			464,425		8.2	%

Interest Rate Risk as of December 31, 2006

Hypothetical Change in Interest Rates	Estimated Change in Fair Value			Fair Value		Hypothetical Percentage Increase (Decrease) in Portfolio Value
	($ in thousands)
200 basis point increase	$	(33,246	)	$	365,873		(8.3	)%
100 basis point increase		(16,349	)		382,770		(4.1	)%
No change		—			399,119		—
100 basis point decrease		15,802			414,921		4.0	%
200 basis point decrease		31,056			430,175		7.8	%

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 Rule 13a-15(e) under 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 SEC and is accumulated and communicated to our management, including our

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Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

        There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our third fiscal quarter of 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II -- OTHER INFORMATION

Item 1A. Risk Factors

You should carefully consider the risks described below and in our Annual Report on Form 10-K filed with the SEC on March 16, 2007, together with all of the other information included in this quarterly report. Such risks and uncertainties are not the only ones facing us. If any such risks actually occur, our business, financial condition or operating results could be harmed. Any such risks 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. Such risks 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 “Cautionary Statement” in Part I, Item 2.

        Under the heading “Item 1A. Risk Factors—Risk Related to Our Business—Intense competition could adversely affect our ability to sell policies at rates we deem adequate” in our Annual Report on Form 10-K filed with the SEC on March 16, 2007, we include a discussion about a series of recent filings from the WCIRB to the California Insurance Commissioner recommending decreases in advisory pure premium rates on new and renewal policies and subsequent rate reductions. We hereby update such discussion by adding that, on September 20, 2007, the WCIRB submitted an additional filing with the California Insurance Commissioner recommending a 4.2% increase in advisory pure premium rates on new and renewal policies effective on or after January 1, 2008. The filing was based on a review of loss and loss adjustment experience through June 30, 2007. On October 19, 2007, the WCIRB amended its filing, increasing the proposed rate increase to 5.2% based on the projected impact of Assembly Bill No. 338 (AB 338) that was signed into law on October 13, 2007. AB 338 increases the period of time from the date of injury, from two years to five years, during which disability benefits, limited to a maximum of 104 weeks, may be provided. A public hearing to consider the proposed rate increase was held on October 23, 2007. As of November 7, 2007, the California Insurance Commissioner had not announced his recommendation regarding the proposed rate increase.

        As previously noted, we are unable to predict the impact that proposed rate reductions in other states or the proposed rate increase in California, if approved and adopted by us, might have on our future financial position and results of operations. If any of our competitors adopt premium rate reductions that are greater than ours, we may be unable to compete effectively and our business, financial condition and results of operations could be materially adversely affected.

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. Our use of the proceeds from the offering does not represent a change in the use of proceeds described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006 filed with the SEC on March 16, 2007.

        We did not purchase any of our equity securities during the three months ended September 30, 2007.

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: November 9, 2007
	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