SeaBright 10-Q Quarterly report

UNITED STATES SECURITIES AND
EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

     (Mark One)

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

For the quarterly period ended September 30, 2006

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

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

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

          Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo

          Indicate by check mark whether the registrant is 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 filero  Accelerated filero  Non-accelerated filerþ

          Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Act): Yeso Noþ

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

Class	Shares outstanding as of November 10, 2006
Common Stock, $0.01 Par Value	20,549,400

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, 2006 and December 31, 2005		2
Condensed Consolidated Statements of Operations for the Three Months and Nine Months Ended September 30, 2006 and 2005		3
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2006 and 2005		4
Notes to Unaudited Condensed Consolidated Financial Statements		5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		17
Item 3. Quantitative and Qualitative Disclosures About Market Risk		26
Item 4. Controls and Procedures		27
Part II. Other Information
Item 1A. Risk Factors		27
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		30
Item 6. Exhibits		30
Signatures		31
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

- 1 -

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

	September 30, 2006			December 31, 2005
	(Unaudited)
	(in thousands)
ASSETS
Investment securities available for sale, at fair value (amortized cost $372,633 in 2006     and $260,015 in 2005)	$	372,310		$	258,049
Equity securities available for sale, at fair value (amortized cost $3,037     in 2005)		–			3,054
Cash and cash equivalents		26,022			12,135
Accrued investment income		4,077			3,059
Premiums receivable, net of allowance		10,494			9,863
Deferred premiums		93,751			88,982
Federal income tax recoverable		1,114			62
Service income receivable		582			472
Reinsurance recoverables		14,019			14,375
Receivable under adverse development cover agreement		3,352			3,352
Prepaid reinsurance		1,828			2,019
Property and equipment, net		1,088			870
Deferred federal income taxes, net		11,830			9,323
Deferred policy acquisition costs, net		12,060			10,299
Intangible assets, net		1,220			1,464
Goodwill		1,527			1,527
Other assets		8,630			8,370
Total assets	$	563,904		$	427,275
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Unpaid loss and loss adjustment expense	$	184,645		$	142,211
Unearned premiums		88,751			86,863
Reinsurance funds withheld and balances payable		240			333
Premiums payable		2,078			3,101
Accrued expenses and other liabilities		36,330			27,089
Surplus notes		12,000			12,000
Total liabilities		324,044			271,597
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 - 20,549,400 shares at September 30, 2006
and 16,411,143 shares at December 31, 2005		205			164
Paid-in capital		190,121			131,485
Accumulated other comprehensive loss		(210	)		(1,267	)
Retained earnings		49,744			25,296
Total stockholders’ equity		239,860			155,678
Total liabilities and stockholders’ equity	$	563,904		$	427,275

See accompanying notes to unaudited condensed consolidated financial statements.

- 2 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2006			2005			2006			2005
	(in thousands, except income per share amounts)
Revenue:
Premiums earned	$	47,819		$	40,719		$	133,576		$	109,523
Net investment income		3,970			2,132			10,836			5,227
Net realized gain (loss)		(74	)		(14	)		(389	)		48
Claims service income		497			523			1,553			1,799
Other service income		31			41			78			141
Other income		508			874			2,133			2,860
		52,751			44,275			147,787			119,598
Losses and expenses:
Loss and loss adjustment expenses		27,829			27,095			78,291			74,350
Underwriting, acquisition and insurance
expenses		9,704			8,058			28,666			23,074
Other expenses		2,179			1,411			5,703			4,642
		39,712			36,564			112,660			102,066
Income before federal income taxes		13,039			7,711			35,127			17,532
Federal income tax expense (benefit):
Current		4,521			3,049			13,755			9,208
Deferred		(579	)		(405	)		(3,076	)		(3,667	)
		3,942			2,644			10,679			5,541
Net income	$	9,097		$	5,067		$	24,448		$	11,991
Basic earnings per share	$	0.45		$	0.31		$	1.23		$	0.79
Diluted earnings per share	$	0.44		$	0.30		$	1.21		$	0.75
Weighted average basic shares outstanding		20,319,525			16,403,929			19,873,930			15,201,515
Weighted average diluted shares outstanding		20,686,161			16,703,313			20,269,730			16,007,576

See accompanying notes to unaudited condensed consolidated financial statements.

- 3 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

	Nine Months Ended September 30,
	2006			2005
	(in thousands)
Cash flows from operating activities:
Net income	$	24,448		$	11,991
Adjustments to reconcile net income to cash provided by operating activities:
Amortization of deferred policy acquisition costs		21,079			14,156
Policy acquisition costs deferred		(22,840	)		(15,438	)
Provision for depreciation and amortization		2,087			1,981
Net realized (gain) loss on investments		389			(48	)
Benefit for deferred federal income taxes		(3,076	)		(3,667	)
Stock based compensation		1,083			12
Changes in certain assets and liabilities:
Federal income tax recoverable		(1,052	)		(354	)
Unpaid loss and loss adjustment expense		42,434			52,899
Reinsurance recoverables, net of reinsurance withheld		(206	)		(1,128	)
Unearned premiums, net of deferred premiums
and premiums receivable		(3,512	)		(5,591	)
Accrued investment income		(1,018	)		(1,544	)
Other assets and other liabilities		55			4,283
Net cash provided by operating activities		59,871			57,552
Cash flows from investing activities:
Purchases of investments		(254,420	)		(309,425	)
Sales of investments		140,438			163,052
Maturities and other		10,989			16,340
Purchases of property and equipment		(585	)		(596	)
Net cash used in investing activities		(103,578	)		(130,629	)
Cash flows from financing activities:
Issuance of common stock		57,562			80,775
Exercise of stock options		32			15
Net cash provided by financing activities		57,594			80,790
Net increase in cash and cash equivalents		13,887			7,713
Cash and cash equivalents at beginning of period		12,135			8,279
Cash and cash equivalents at end of period	$	26,022		$	15,992
Supplemental disclosures:
Federal income taxes paid	$	14,500		$	9,625
Accrued expenses for purchases of investments		8,413			3,843
Interest paid on surplus notes		800			622

See accompanying notes to unaudited condensed consolidated financial statements.

- 4 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.  Organization

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

        SeaBright Insurance Company (“SBIC”), formerly KEIC, is licensed to write workers’ compensation insurance in 44 states and the District of Columbia. Domiciled in the State of Illinois and commercially domiciled in the State of California, SBIC focuses on employers with complex workers’ compensation exposures and provides coverage under multiple state and federal acts, applicable common law or negotiated agreements. Prior to the Acquisition, beginning in 2000, KEIC wrote business only in California. In May 2002, KEIC ceased writing business and by December 31, 2003, all premiums related to business prior to the Acquisition were 100% earned.

        PointSure is engaged primarily in administrative and wholesale insurance brokerage activities. The Eagle Entities, from whom the Company purchased certain assets, wrote state act workers’ compensation insurance and United States Longshore and Harbor Workers’ Compensation Act (“USL&H”) insurance, before their policies went into run-off on September 30, 2003.

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

2. Summary of Significant Accounting Policies

      a. Basis of Presentation

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

        The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of 1934, as amended. 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, 2005 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, 2005 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 29, 2006.

        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, 2006 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. For example, the Company used significant estimates in determining amounts related to unpaid loss and loss adjustment expense, goodwill and other intangibles, earned premiums on retrospectively rated policies, earned but

- 5 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

unbilled premiums, federal income taxes, reinsurance, stock-based compensation arrangements and other-than-temporary impairment of investment securities. Actual results could differ from those estimates. Such estimates and judgments could change in the future as more information becomes known, which could impact the amounts reported and disclosed herein.

      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 as unearned premium in the liability section of the balance sheet. Deferred premiums represent the unbilled portion of annual premiums.

        Earned premiums on retrospectively rated policies are based on the Company’s estimate of loss experience as of the measurement date. Loss experience includes known losses specifically identifiable to a retrospective policy as well as provisions for future development on known losses and for losses incurred but not yet reported, which are developed using actuarial loss development factors that are consistent with how the Company projects losses in general. For retrospectively rated policies, the governing contractual minimum and maximum rates are established at policy inception and are made a part of the insurance contract. Premiums from retrospectively rated policies totaled 29.6% and 21.2% of total premiums written for the three month periods ended September 30, 2006 and 2005, respectively, and 25.7% and 30.8% of total premiums written for the nine month periods then ended, respectively.

      d. Unpaid Loss and Loss Adjustment Expense

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

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

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

• the industry’s claims experience;

• historical trends in reserving patterns and loss payments;

• the impact of claim inflation;

• the pending level of unpaid claims;

• the cost of claim settlements;

• legislative reforms affecting workers’ compensation; and

• the environment in which insurance companies operate.

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

- 6 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

      e. Reinsurance

        The Company attempts to protect itself from excessive losses by reinsuring with nonaffiliated reinsurers certain levels of risk in various areas of exposure. Reinsurance premiums, commissions, expense reimbursements and liabilities 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 agreement with LMC is estimated on a quarterly basis using generally accepted actuarial methodology. Amounts estimated to be recoverable in excess of acquired insurance liabilities 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 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.

      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.

      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, 2006 and 2005:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2006		2005		2006		2005
Basic weighted average shares outstanding		20,319,525		16,403,929		19,873,930		15,201,515
Weighted average shares issuable upon:
Conversion of preferred stock       outstanding prior to initial public       offering		–		–		–		569,803
Exercise of stock options and vesting of       restricted stock		366,636		299,384		395,800		236,258
Diluted weighted average shares outstanding		20,686,161		16,703,313		20,269,730		16,007,576

      h. Stock-Based Compensation

        The Company adopted SFAS No. 123R,Share-Based Payment, on January 1, 2006, using the modified-prospective transition method. Prior to adoption, the Company measured its employee stock-based compensation arrangements using the provisions outlined in Accounting Principles Board (“APB”) Opinion No. 25,Accounting for Stock Issued to Employees, which is an intrinsic value-based method of recognizing compensation costs, and adopted the disclosure-only provisions of SFAS No. 123,Accounting for Stock-based Compensation. None of the Company’s stock options granted prior to adoption had an intrinsic value at grant date and, accordingly, no compensation cost was recognized for its stock option plan activity prior to adoption.

        Under the modified-prospective transition method, stock-based compensation cost is recognized in the unaudited condensed consolidated financial statements for granted, modified, or settled share-based payments. Compensation cost recognized includes the estimated cost for stock options granted on or after January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R, and the estimated expense for the portion of awards granted prior to January 1, 2006 vesting in the current period, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123. Results for prior periods have not been restated, as provided for under the modified-prospective method.

- 7 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

        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, 2006 is shown in the following table. No compensation cost was capitalized during the three month or nine month periods ended September 30, 2006.

	Three Months Ended September 30, 2006		Nine Months Ended September 30, 2006
	(in thousands)
Stock based compensation expense related to:
Stock options	$	134	$	362
Nonvested stock		334		721
Total	$	468	$	1,083
Total related tax benefit	$	120	$	260

        The following table shows the effect on net income and earnings per share for the three month and nine month periods ended September 30, 2005 as if compensation cost had been recognized based upon the estimated fair value on the grant date of stock options in accordance with SFAS No. 123, as amended by SFAS No. 148,Accounting for Stock-Based Compensation – Transition and Disclosure, and as if such cost had been determined in accordance with SFAS No. 123R:

	Three Months Ended September 30, 2005			Nine Months Ended September 30, 2005
	(in thousands, except income per share amounts)
Information as previously reported:
Net income	$	5,067		$	11,991
Less SFAS No. 123 compensation costs, net of taxes		(61	)		(181	)
Pro forma net income	$	5,006		$	11,810
Net income per common share:
Basic – as reported	$	0.31		$	0.79
Basic – pro forma	$	0.31		$	0.78
Diluted – as reported	$	0.30		$	0.75
Diluted – pro forma	$	0.30		$	0.74
Information calculated as if the fair value method had been applied to all awards:
Net income	$	5,067		$	11,991
Less SFAS No. 123 compensation costs, net of taxes		(86	)		(255	)
Pro forma net income	$	4,981		$	11,736
Net income per common share:
Basic – as reported	$	0.31		$	0.79
Basic – pro forma	$	0.30		$	0.77
Diluted – as reported	$	0.30		$	0.75
Diluted – pro forma	$	0.30		$	0.73

        Disclosures for the three month and nine month periods ended September 30, 2006 are not presented because the amounts are recognized in the unaudited condensed consolidated financial statements. The compensation cost included in the pro forma net income is not likely to be representative of the effect on reported net income for future years because options vest over several years and additional awards may be made each year.

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

      i. Comprehensive Income

        The following table summarizes the Company’s comprehensive income for the three month and nine month periods ended September 30, 2006 and 2005:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2006			2005			2006			2005
	(in thousands)
Net income	$	9,097		$	5,067		$	24,448		$	11,991
Reclassification adjustment for net    realized gains (losses) recorded into    income		(74	)		(14	)		(389	)		48
Tax (expense) benefit related to    reclassification adjustment		26			5			136			(17	)
Increase (decrease) in unrealized gain on    investment securities available for sale		9,135			(3,497	)		2,015			(2,359	)
Tax (expense) benefit related to unrealized    gains (losses)		(3,197	)		1,224			(705	)		826
Total comprehensive income	$	14,987		$	2,785		$	25,505		$	10,489

      j. Recently Issued Accounting Pronouncements

        In July 2006, the Financial Accounting Standards Board (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. The Company expects that FIN 48 will 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. The Company expects that SFAS No. 157 will not have a material effect on its consolidated financial condition or result of operations.

        In September 2006, the SEC issued Staff Accounting Bulletin No. 108,Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). SAB 108 provides interpretive guidance on how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in the current year financial statements. SAB 108 requires registrants to quantify misstatements using both an income statement (“rollover”) and balance sheet (“iron curtain”) approach and evaluate whether either approach results in a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. If prior year errors that had been previously considered immaterial now are considered material based on either approach, no restatement is required so long as management properly applied its previous approach and all relevant facts and circumstances were considered. If prior years are not restated, the cumulative effect adjustment is recorded in opening accumulated earnings as of the beginning of the fiscal year of adoption. SAB 108 is effective for fiscal years ending on or after November 15, 2006, with earlier adoption encouraged. The Company expects that SAB 108 will not have a material effect on its consolidated financial condition or results of operations.

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, 2006 are as follows:

- 9 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

	Cost or Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
	(in thousands)
U.S. Treasury securities	$	19,250	$	49	$	(2,745	)	$	19,025
Government sponsored agency securities		21,518		8		(2,293	)		21,297
Corporate securities		30,558		2		(7,100	)		29,850
Tax-exempt municipal securities		203,438		1,676		(541	)		204,573
Mortgage pass-through securities		76,790		306		(530	)		76,566
Collateralized mortgage obligations		2,859		2		(33	)		2,828
Asset-backed securities		18,220		60		(1,097	)		18,171
Total investment securities available for sale	$	372,633	$	2,103	$	(2,426	)	$	372,310

        The unrealized loss on temporarily impaired investments totaled $2.4 million at September 30, 2006 for investment securities available for sale with a fair value of $176.5 million. Approximately $2.0 million of total unrealized losses were from securities that had been impaired for more than one year. At September 30, 2006, no unrealized loss exceeded 20% of the related security’s book value at that date. The following table presents information about fixed maturity securities with unrealized losses at September 30, 2006:

Fixed maturity securities with unrealized losses at September 30, 2006	Aggregate Fair Value		Aggregate Unrealized Loss			Fair Value as % of Cost Basis
	(in thousands)
Greater than or equal to $50,000 and for:
Less than one year (1 issue)	$	1,560	$	(87	)		94.7	%
One year or longer (2 issues)		6,282		(184	)		97.2	%
Less than $50,000 and for:
Less than one year (78 issues)		60,926		(375	)		99.4	%
One year or longer (149 issues)		107,704		(1,780	)		98.4	%
Total	$	176,472	$	(2,426	)		98.6	%

        The Company regularly reviews its fixed maturity portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of investments. A number of criteria are considered during this process, including, but not limited to, the following: the current fair value as compared to amortized cost or cost, as appropriate, of the security; the length of time the security’s fair value has been below amortized cost; 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, 2006 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. Therefore, no other-than-temporary impairment losses were recorded in the nine months ended September 30, 2006 and 2005.

        The amortized cost and estimated fair value of fixed income securities available for sale at September 30, 2006, 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.

- 10 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Maturity	Cost or Amortized Cost		Estimated Fair Value
	(in thousands)
Due in one year or less	$	11,652	$	11,612
Due after one year through five years		72,268		71,476
Due after five years through ten years		156,837		157,289
Due after ten years		34,007		34,368
Securities not due at a single maturity date		97,869		97,565
Total investment securities available for sale	$	372,633	$	372,310

        The amortized cost of investment securities available for sale deposited with various regulatory authorities was $118.4 million at September 30, 2006.

4. Premiums

        Direct premiums written totaled $44.6 million and $37.5 million for the three month periods ended September 30, 2006 and 2005, respectively, and $144.4 million and $134.4 million for the nine month periods then ended, respectively.

        Premiums receivable consisted of the following at September 30, 2006 and December 31, 2005:

	September 30, 2006			December 31, 2005
	(in thousands)
Premiums receivable	$	11,391		$	10,750
Allowance for doubtful accounts		(897	)		(887	)
	$	10,494		$	9,863

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, 2005 through October 1, 2006, the Company entered into reinsurance agreements with nonaffiliated reinsurers wherein it retains the first $500,000 of each loss occurrence. Losses in excess of $500,000 up to $50.0 million are reinsured as follows:

Layer	General Description
$500,000 excess of $500,000 each loss occurrence	Reinsured 50%, subject to an annual aggregate deductible of $1.5 million and an aggregate limit of $10.0 million.
$4.0 million excess of $1.0 million each loss occurrence	Fully reinsured, subject to an annual aggregate deductible of $2.0 million and an aggregate limit of $16.0 million.
$5.0 million excess of $5.0 million each loss occurrence	Fully reinsured, subject to an annual aggregate limit of $15.0 million.
$40.0 million excess of $10.0 million each loss occurrence	Fully reinsured in two sub-layers. The first sub-layer affords coverage of up to $10.0 million for each loss occurrence in excess of $10.0 million, subject to a limit of $7.5 million maximum any one loss and an aggregate limit of $20.0 million. The second sub-layer affords coverage up to $30.0 million for each loss occurrence in excess of $20.0 million, subject to a limit of $5.0 million maximum any one loss and an aggregate limit of $60.0 million.

- 11 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

        On October 1, 2006, the Company entered into new reinsurance agreements with nonaffiliated reinsurers wherein it retains the first $1.0 million of each loss occurrence. The new reinsurance program, which is effective through October 1, 2007, provides coverage up to $75.0 million per loss occurrence 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.
$65.0 million excess of $10.0 million each los occurrence	Fully reinsured in three sub-layers. The first sub-layer affords coverage of up to $10.0 million for each loss excess of $10.0 million, subject to a limit of $7.5 million maximum any one loss and an aggregate limit of $20.0 million. The second sub-layer affords coverage 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 third sub-layer affords coverage up to $25.0 million for each loss occurrence in excess of $50.0 million. The second and third sub-layers are subject to a limit of $5.0 million maximum any one loss.

        The above coverage is subject to various limitations and exclusions as more fully described in the reinsurance agreements.

        As part of the Acquisition, SIH and LMC entered into an adverse development excess of loss reinsurance agreement (the “Agreement”). The Agreement, after taking into account any recoveries from third party reinsurers, requires LMC to reimburse SBIC 100% of the excess of the actual loss at December 31, 2011 over the initial 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 was $3.4 million at September 30, 2006. Any increase or decrease in the amount due from LMC is included in loss and loss adjustment expenses in the consolidated statements of operations.

        As part of the Agreement, LMC placed into trust (the “Trust”) an amount equal to 10% of the balance sheet insurance liabilities of SBIC on the date of the Acquisition. Thereafter, the Trust shall be adjusted each quarter, if warranted, to an amount equal to at least 102% of LMC’s obligations under the Agreement. Initial loss liabilities were $16.0 million. The balance of the Trust was $5.1 million at September 30, 2006 and $4.9 million at December 31, 2005.

      b. Reinsurance Assumed

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

      c. Reinsurance Recoverables and Income Statement Effects

        Balances affected by reinsurance transactions are reported gross of reinsurance in the accompanying unaudited condensed consolidated balance sheets. Reinsurance recoverables are comprised of the following amounts at September 30, 2006 and December 31, 2005:

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

	September 30, 2006		December 31, 2005
	(in thousands)
Reinsurance recoverables on unpaid loss and loss adjustment expenses	$	13,607	$	13,745
Reinsurance recoverables on paid losses		412		630
Total reinsurance recoverables	$	14,019	$	14,375

        The effects of reinsurance on unaudited condensed consolidated statements of operations amounts are as follows for the three month and nine month periods ended September 30, 2006 and 2005:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2006			2005			2006		2005
	(in thousands)
Reinsurance assumed:
Written premiums	$	(1,786	)	$	2,059		$	5,460	$	6,188
Earned premiums		(1,127	)		2,035			4,272		5,435
Losses and loss adjustment expenses       incurred		(1,218	)		1,590			2,033		4,000
Reinsurance ceded:
Written premiums	$	3,798		$	6,083		$	11,897	$	17,901
Earned premiums		4,126			6,617			12,088		18,136
Losses and loss adjustment expenses       incurred		405			(57	)		1,238		4,083

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, 2006 and 2005:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2006			2005			2006			2005
	(in thousands)
Beginning balance:
Unpaid loss and loss adjustment expense	$	169,336		$	103,896		$	142,211		$	68,228
Reinsurance recoverables		(13,620	)		(15,343	)		(13,745	)		(12,582	)
Net		155,716			88,553			128,466			55,646
Incurred related to:
Current period		31,306			29,181			92,168			76,436
Prior periods		(3,477	)		(2,086	)		(13,877	)		(2,086	)
Total incurred		27,829			27,095			78,291			74,350
Paid related to:
Current period		(7,877	)		(7,902	)		(17,052	)		(14,765	)
Prior periods		(4,630	)		(1,241	)		(18,667	)		(8,726	)
Total paid		(12,507	)		(9,143	)		(35,719	)		(23,491	)
Unpaid loss and loss adjustment       expense, net of reinsurance recoverables		171,038			106,505			171,038			106,505
Reinsurance recoverables		13,607			14,621			13,607			14,621
Unpaid loss and loss adjustment       expense	$	184,645		$	121,126		$	184,645		$	121,126

        Loss and loss adjustment expenses are net of the release of loss reserves totaling approximately $3.5 million and $13.9 million in the three month and nine month periods ended September 30, 2006, respectively. These reserve releases reflect the better-than-expected impacts on losses related primarily to the Company’s California book of business 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

- 13 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3-month LIBOR rate plus 400 basis points, subject to certain limitations. Interest expense totaled $285,000 and $813,000 for the three month and nine month periods ended September 30, 2006, respectively, and $233,000 and $641,000 for the three month and nine month periods ended September 30, 2005, 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, 2006, SBIC had a liability for guaranty fund and other assessments of $2.1 million and a guaranty fund receivable of $3.3 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.        As previously reported, in June 2004, the Company was notified of a claim for damages brought by an individual against PointSure. In April 2005, a complaint against PointSure in connection with this matter was filed in the Superior Court of Washington for King County. The complaint alleged breach and unjust enrichment related to the termination of an alleged contract between PointSure and the plaintiff and sought a judgment awarding damages to the plaintiff in an amount to be proven at trial, plus attorneys’ fees and costs. In July 2006, the court granted plaintiff’s motion to file an amended complaint adding SIH and SBIC to the complaint. In October 2006, the parties agreed to settle the case. A one-time pre-tax charge of $305,000 related to the settlement of this case was included in net income for the three months and nine months ended September 30, 2006.

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

9. Follow-on Public Offering

        On February 1, 2006, the Company closed a follow-on public offering of 3,910,000 shares of common stock, including the underwriters’ over-allotment option to purchase 510,000 shares of 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. The Company contributed $50.0 million of the net proceeds to SBIC, which is using the capital to expand its business in its core markets and to new territories. The remaining proceeds will be used for general corporate purposes, including supporting the growth of PointSure. The use of proceeds from the offering does not represent a material change from the use of proceeds described in the prospectus that was included in the related Registration Statement on Form S-1. Except for the contribution of proceeds to SBIC, no proceeds or expenses were paid to the Company’s directors, officers, ten percent shareholders or affiliates.

10. Share-Based Payment Arrangements

        At September 30, 2006, the Company had outstanding stock options and nonvested 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 Board of Directors reserved an initial total of 776,458 shares of common stock under the 2003 Plan and 1,047,755 shares of common stock under the 2005 Plan, plus an automatic annual increase on the first day of each fiscal year beginning in 2006 and ending in 2015 equal to the lesser of: (i) 2% of the shares of common stock

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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

outstanding on the last day of the immediately preceding fiscal year or; (ii) such lesser number of shares as determined by the Board of Directors. At September 30, 2006, the Company reserved 776,458 shares of common stock for issuance under the 2003 Plan, of which options to purchase 487,683 shares had been granted, and 1,375,978 shares for issuance under the 2005 Plan, of which 667,563 shares had been granted. In January 2006, the Compensation Committee of the Board of Directors terminated the ability to grant future stock options awards under the 2003 Plan. Therefore, the Company anticipates that all future awards will be made under the 2005 Plan.

        The 2005 Plan provides for the grant of incentive or non-qualified stock options, restricted stock, restricted stock units, deferred stock units, performance awards, or any combination of the foregoing. The Board of Directors has the authority to determine all matters relating to awards granted under the Stock Option Plans, including designation as incentive or nonqualified stock options, the selection of individuals to be granted options, the number of shares subject to each grant, the exercise price, the term and vesting period, if any. Options to purchase the Company’s common stock are granted at prices at or above the fair value of the common stock on the date of grant, generally vest 25% per year on each of the first four anniversaries of the vesting start date, and expire 10 years from the date of grant. Options granted to non-employee directors generally vest one-third on the first anniversary of the grant date and the remaining two-thirds monthly over the next 24 months. Nonvested stock issued to employees and directors generally vests on the third anniversary of the grant date, assuming the holder is still employed by or providing service to the Company and satisfies all other conditions of the grant. All stock options granted to employees are incentive stock options, while options granted to non-employee directors are non-qualified stock options.

        The Company issues new shares of common stock upon exercise of stock options or award of nonvested shares.

      a. Stock Options

        The fair values of stock options granted during the three month and nine month periods ended September 30, 2006 and 2005 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,
	2006			2005			2006			2005
Expected term (years)		6.3			7.0			6.2			7.0
Expected stock price volatility		26.0	%		21.7	%		26.1	%		15.5	%
Risk-free interest rate		5.02	%		4.11	%		4.75	%		3.96	%
Expected dividend yield		–			–			–			–
Estimated fair value per option	$	5.86		$	4.15		$	6.37		$	3.09

��       For 2006, the expected term of options was determined using the “simplified method,” which averages an award’s weighted average vesting period and its contractual term. For 2006, expected stock price volatility was based on a weighted average of the Company’s historical stock price volatility since the initial public offering of its common stock in January 2005 and the historical volatility of a peer company’s stock for a period of time equal to the expected term of the option. Prior to the adoption of SFAS No. 123R, expected term was based on the Company’s historical experience and future expectations and price volatility was estimated using the Company’s historical volatility. The risk-free interest rate is based on the yield of U.S. Treasury securities with an equivalent remaining term. The Company has not paid dividends in the past and does not plan to pay any dividends in the near future.

        The assumptions used to calculate the fair value of options granted are evaluated and revised, as necessary, to reflect market conditions and the Company’s historical experience and future expectations. The calculated fair value is recognized as compensation cost in the Company’s financial statements over the requisite service period of the entire award. Compensation cost is recognized only for those options expected to vest, with forfeitures estimated at the date of grant and evaluated and adjusted periodically to reflect the Company’s historical experience and future expectations. Any change in the forfeiture assumption is accounted for as a change in estimate, with the cumulative effect of the change on periods previously reported being reflected in the financial statements of the period in which the change is made.

- 15 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

        The following table summarizes stock option activity for the nine months ended September 30, 2006:

	Shares Subject to Options			Weighted Average Exer- cise Price per Share		Weighted Average Re- maining Con- tractual Life (years)		Aggregate Intrinsic Value (in thousands)
Outstanding at December 31, 2005		804,524		$	8.13		8.3	$	–
Granted		124,350			17.42		–		–
Forfeited		(5,360	)		8.17		–		–
Exercised		(4,382	)		7.40		–		–
Cancelled		(478	)		6.54		–		–
Outstanding at September 30, 2006		918,654			9.39		7.9		4,204
Exercisable at September 30, 2006		416,503			7.34		7.4		2,762

        The aggregate intrinsic values in the table above are before applicable income taxes and are based on the Company’s closing stock price of $13.97 on September 30, 2006. As of September 30, 2006, total unrecognized stock-based compensation cost related to nonvested stock options was approximately $1.3 million, which is expected to be recognized over a weighted average period of approximately 32.0 months. No stock options were exercised during the three months ended September 30, 2006.

        As of September 30, 2006, there were 708,415 shares of common stock available for issuance of future share-based awards. The following table presents additional information regarding options outstanding as of September 30, 2006:

	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		481,922		7.2	$	6.54		336,100	$	6.54
10.50-12.54		312,482		8.3		10.60		80,403		10.68
15.60-18.40		124,250		9.5		17.42		–		–
		918,654		7.9		9.39		416,503		7.34

      b. Nonvested Stock

        The following table summarizes nonvested stock activity for the nine months ended September 30, 2006:

	Number of Shares		Weighted Average Grant Date Fair Value
Outstanding at December 31, 2005		6,000	$	11	.40
Granted		223,875		17	.59
Vested		–		–
Forfeited		–		–
Outstanding at September 30, 2006		229,875		17	.42

        As of September30, 2006, there was $3.3 million of total unrecognized compensation cost related to nonvested stock granted under the 2005 Plan. That cost is expected to be recognized over a weighted-average period of 29.4 months. No shares vested during the quarter ended September30, 2006.

- 16 -

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 SEC, including our Annual Report on Form 10-K for the year ended December 31, 2005 filed with the SEC on March 29, 2006.

        The discussion under the heading “Risk Factors” 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.

- 17 -

        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 2005 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 44 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. December 31, 2011 is the date that the parties will look to see whether the insurance liabilities with respect to KEIC’s insurance policies in effect at the date of the Acquisition have increased or decreased from the $16.0 million amount existing 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 indemnify LMC in the amount of the decrease. To support LMC’s obligations under the adverse development cover agreement, 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 agreement. 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 agreement. The amount on deposit in the trust account at September 30, 2006 was approximately $5.1 million. If LMC is placed into receivership and the amount held in the collateralized reinsurance trust is inadequate to satisfy the obligations of

- 18 -

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, net investment income and net realized gains and losses from investments, and service income.

      Premiums Earned

        Gross premiums written include all premiums billed and unbilled by an insurance company during a specified policy period. Premiums are earned over the terms of the related policies. At the end of each accounting period, the portions of premiums that are not yet earned are included in unearned premiums and are realized as revenue in subsequent periods over the remaining terms of the policies. Our policies typically have terms of 12 months. Thus, for example, for a policy that is written on July 1, 2005, one-half of the premiums would be earned in 2005 and the other half would be earned in 2006.

        Premiums earned are the earned portion of our net premiums written. Net premiums written is the difference between gross premiums written and premiums ceded or paid to reinsurers (ceded premiums written). Our gross premiums written is the sum of both direct premiums and assumed premiums before the effect of ceded reinsurance. Assumed premiums are premiums that we have received from 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 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 plan. Premiums from the Washington USL&H Assigned Risk Plan are included in both direct premiums written and ceded premiums written.

      Net Investment Income and Realized Gains and Losses on Investments

        We invest our statutory surplus and the funds supporting our insurance liabilities (including unearned premiums and unpaid loss and loss adjustment expense) in cash, cash equivalents, 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.

      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, 2006 and 2005, approximately 65.8% and 86.7%, respectively, of our claims service income was generated by contracts we have with LMC to provide claims handling services for the 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 the policies written by the Eagle Entities prior to the Acquisition. The fee income we receive for providing these services approximates our costs and will substantially decrease over the next several years as transactions related to the Eagle Entities diminish.

        Our expenses consist primarily of:

      Loss and Loss Adjustment Expenses

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

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      Underwriting, Acquisition and Insurance Expenses

        We refer to the expenses that we incur to underwrite risks as underwriting, acquisition and insurance expenses. Underwriting expenses consist of commission expenses, premium taxes and fees and other underwriting expenses incurred in writing and maintaining our business. Commissions, premium taxes and fees, and the portion of other underwriting expenses that is associated with the acquisition of new and renewal business are initially deferred and are recognized as expenses as the related premium is earned.

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

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

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

      Interest Expense

        Included in other expense is interest expense we incur on $12.0 million of surplus notes that our insurance subsidiary issued in May 2004. Interest is based on the three-month LIBOR rate, plus 400 basis points, and is paid quarterly in arrears.

Results of Operations

      Three Month and Nine Month Periods Ended September 30, 2006 and 2005

        Gross Premiums Written. Gross premiums written for the three months ended September 30, 2006 totaled $42.8 million, an increase of $3.3 million, or 8.4%, from $39.5 million in the same period of 2005. For the nine months ended September 30, 2006, gross premiums written totaled $149.9 million, an increase of $9.4 million, or 6.7%, from $140.5 million in the same period of 2005. As of September 30, 2006, our in-force premium totaled $196.8 million and we had 573 customers compared to $174.9 million in-force and 428 customers at September 30, 2005. Our in-force premium increased 5.6% in the quarter ended September 30, 2006 and 8.1% in the nine months then ended. Customer counts increased by 6.9% in the third quarter of 2006 and 22.4% in the first nine months of 2006.

        California continues to be our largest market, accounting for approximately 57.0% of our in-force premiums at September 30, 2006. Gross premiums written in California for the three months ended September 30, 2006 accounted for approximately 49.1% of the total premiums written in the quarter, down from approximately 59.7% for the same period of 2005. Gross premiums written in California during the first nine months of 2006 accounted for 53.6% of total premiums written in the period, down from approximately 59.6% in the same period of 2005. This reduction is part of our plan to further diversify our book of business. As of September 30, 2006, our in-force book of business was split as follows among our three primary market segments: state act – 59.5%, ADR – 25.8% and maritime – 14.7%. At September 30, 2005, our in-force book of business was split as follows: state act – 55.1%, ADR – 29.0% and maritime – 15.9%.

        On March 24, 2006, the California Workers’ Compensation Insurance Rating Bureau (the “WCIRB”), an industry-backed private organization that provides statistical analysis, submitted a filing with the California Insurance Commissioner recommending a 16.4% decrease in advisory pure premium rates on new and renewal policies effective July 1, 2006. Pure premium is that portion of an insurance premium necessary to cover the cost of paying claims, such as medical and indemnity costs and allocated and unallocated loss adjustment expenses. The filing was based on an analysis of loss experience valued as of December 31, 2005 and was made in response to continued reductions in workers’ compensation claim costs in California as a result of reform legislation enacted primarily in 2003 and 2004. On May 31, 2006, the Commissioner recommended a 16.4% decrease in rates effective July 1, 2006. Such decisions of the California Insurance Commissioner are advisory only and insurance companies may choose whether or not to adopt the new rates. On May 31, 2006, we filed new rates reflecting an average reduction of 5.8% from prior rates for new and renewal workers’ compensation insurance policies written in California on or after July 1, 2006. The filing was approved on June 21, 2006. This was the sixth California rate reduction we have filed since October 1, 2003, resulting in a net cumulative reduction of our California rates of approximately 41.8%, and since October 1, 2005, our California rates have been reduced by 16.9%.

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        On September 14, 2006, the WCIRB amended a previous filing with the California Insurance Commissioner to recommend a 6.3% decrease in advisory pure premium rates on new and renewal policies effective on or after January 1, 2007. The filing was based on a review of loss and loss adjustment experience through June 30, 2006 and was made in response to continued reductions in California workers’ compensation claim costs. On November 2, 2006, the California Insurance Commissioner recommended a 9.5% decrease in workers’ compensation advisory pure premium rates for policies incepting on or after January 1, 2007. Rate reductions have also been proposed in other states in which we operate. At this time, we are unable to predict the impact that the proposed rate reductions, if approved and adopted by us, might have on our future financial position and results of operations.

        Net Premiums Written. Net premiums written for the three months ended September 30, 2006 totaled $39.0 million, an increase of $5.6 million, or 16.8%, from $33.4 million in the same period of 2005. For the nine months ended September 30, 2006, net premiums written totaled $138.0 million, an increase of $15.4 million, or 12.6%, from $122.6 million in the same period of 2005. The increases in net premiums written for the three month and nine month periods ended September 30, 2006 are reflective of similar increases in gross premiums written, offset by 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, 2006, ceded written premiums totaled $3.8 million (8.9% of gross premiums written) compared to $6.1 million (15.4% of gross premiums written) in the same period of 2005. Ceded written premiums for the nine months ended September 30, 2006 totaled $11.9 million (7.9% of gross premiums written) compared to $17.9 million (12.7% of gross premiums written) in the same period of 2005. In 2005, certain of our reinsurance contracts provided for the ceding of premiums on a direct premiums written basis, while others provided for ceding on a direct premiums earned basis. Our current reinsurance contracts, which we entered into on October 1, 2005, provide for the ceding of premiums on a gross premiums earned basis. This, coupled with changes in our deductibles and retention limits, accounts for the reductions in the ceded premiums written percentages noted above.

        As further described below under “Liquidity and Capital Resources,” on October 1, 2006, we entered into new reinsurance agreements that provide for reinsurance coverage up to $75.0 million per loss occurrence, subject to certain limitations, as opposed to the $50.0 million limit of coverage provided under our October 1, 2005 to October 1, 2006 treaty year reinsurance program.

        Net Premiums Earned. Net premiums earned for the three months ended September 30, 2006 totaled $47.8 million, an increase of $7.1 million, or 17.4%, over $40.7 million in the same period of 2005. For the nine months ended September 30, 2006, net premiums earned totaled $133.6 million, an increase of $24.1 million, or 22.0%, from $109.5 million in the same period of 2005. As previously discussed, these increases are due to the increase in net premiums written in 2005 and 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. Net premiums earned in the first nine months of 2006 reflect a reduction of approximately $1.8 million related to our retrospectively rated policies, reflective of improved loss ratios that generate return premiums. Retrospectively rated policies currently account for approximately 30.0% of our book of business.

        Net Investment Income. Net investment income for the three months ended September 30, 2006 totaled $4.0 million, an increase of $1.9 million, or 90.5%, over $2.1 million in the same period of 2005. For the nine months ended September 30, 2006, net investment income totaled $10.8 million, an increase of $5.6 million, or 107.7%, from $5.2 million in the same period of 2005. These increases are due primarily to the addition of $57.6 million of net proceeds from the follow-on offering in February 2006, continued positive cash flow from operations and the higher interest rate environment. Our yield on average invested assets for the three months ended September 30, 2006 was approximately 4.2% compared to approximately 3.5% for the same period in 2005. For the nine months ended September 30, 2006, our yield on average invested assets was 4.3% compared to approximately 3.8% for the same period in 2005.

        Service Income. Service income for the three months ended September 30, 2006 totaled $528,000, a decrease of $36,000, or 6.4%, from $564,000 in the same period of 2005. For the nine months ended September 30, 2006, service income totaled $1.6 million, a decrease of $0.3 million, or 15.8%, from $1.9 million in the same period of 2005. Our service income results primarily from service arrangements we have with LMC and other companies for claims processing services, policy administration and administrative services 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 as a result of the run off of our predecessor’s business.

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Approximately 46.4% of our service income in the three-month period ended September 30, 2006 came from third party claims administration services that we provide to independent, unrelated companies, compared to 18.5% in the same period of 2005. For the nine-month period ended September 30, 2006, approximately 34.2% of our service income came from third party claims administration services that we provide to independent, unrelated companies, compared to approximately 13.3% in the same period of 2005.

        Other Income. Other income for the three months ended September 30, 2006 totaled $508,000, a decrease of $366,000, or 41.9%, from $874,000 in the same period of 2005. For the nine months ended September 30, 2006, other income totaled $2.1 million, a decrease of $0.8 million, or 27.6%, from $2.9 million in the same period of 2005. Other income results primarily from the operations of PointSure, our wholesale insurance broker and third party claims administrator subsidiary. The decrease in other income for the three month and nine month periods ended September 30, 2006 resulted primarily from a decrease in PointSure’s agency and direct billed commission income from SeaBright due to the direct appointment in 2005 and 2006 of PointSure agents by SeaBright, thereby reducing the amount of commissions SeaBright paid to PointSure in 2006 compared to 2005 for those same agents. PointSure’s agency and direct billed commission income totaled approximately $508,000 and $2.1 million for the three month and nine month period ended September 30, 2006, respectively, compared to $871,000 and $2.9 million in the same periods of 2005, respectively, representing a decrease of $363,000, or 41.7% and $0.8 million or 27.6%, respectively. Most of this income is passed through as commission expense to brokers and producers.

        Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses for the three months ended September 30, 2006 totaled $27.8 million, an increase of $0.7 million, or 2.6%, from $27.1 million in the same period of 2005. For the nine months ended September 30, 2006, loss and loss adjustment expenses totaled $78.3 million, an increase of $3.9 million, or 5.2%, from $74.4 million in the same period of 2005. 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, 2006 was 57.2% compared to 65.3% for the same period in 2005. Our net loss ratio for the nine months ended September 30, 2006 was 57.4% compared to 66.2% for the same period in 2005. Paid losses for the three month and nine month period ended September 30, 2006 totaled $12.5 million and $35.7 million, respectively, compared to $9.1 million and $23.5 million in the same periods of 2005, respectively.

        Loss and loss adjustment expenses for the three month and nine month periods ended September 30, 2006 are net of the release of prior accident years’ loss reserves totaling approximately $3.5 million and $13.9 million, respectively. The reserve releases reflect the better-than-expected paid loss trends related primarily to the Company’s California book of business as a result of reform legislation enacted there primarily in 2003 and 2004. The recorded loss reserves at September 30, 2006 represent management’s estimate of amounts the Company expects to pay in connection with policies it has written. Reserves are reviewed quarterly and adjustments are made as necessary to reflect management’s current expectations in light of developing trends.

        As of September 30, 2006, we had recorded a receivable of approximately $3.4 million for adverse loss development under the adverse development cover agreement 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, 2006, we have access to approximately $5.1 million under the collateralized reinsurance trust in the event that LMC fails to satisfy its obligations under the adverse development cover agreement.

        Underwriting Expenses. Underwriting expenses for the three months ended September 30, 2006 totaled $9.7 million, an increase of $1.6 million, or 19.8%, from $8.1 million in the same period of 2005. For the nine months ended September 30, 2006, underwriting expenses totaled $28.7 million, an increase of $5.6 million, or 24.2%, from $23.1 million in the same period of 2005. Our net underwriting expense ratio for the three months ended September 30, 2006, which is calculated by dividing underwriting, acquisition and insurance expenses less other service income by premiums earned, was 20.2%, compared to 19.7% for the same period in 2005. For the nine months ended September 30, 2006, our net underwriting expense ratio was 21.4%, compared to 20.9% for the same period of 2005. The increases in the net underwriting expense ratio resulted primarily from an increase in staffing costs. The number of employees grew from 144 at September 30, 2005 to 174 at September 30, 2006, representing an increase of 20.8%.

        Other Expenses. Other expenses for the three months ended September 30, 2006 totaled $2.2 million, an increase of $0.8 million, or 57.1%, over $1.4 million in the same period of 2005. For the nine months ended September 30, 2006, other expenses totaled $5.7 million, an increase of $1.1 million, or 23.9%, from $4.6 million in the same period of 2005. The increase in other expenses resulted primarily from compensation costs associated with

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the implementation of SFAS No. 123R, which totaled approximately $468,000 for the three months and $1.1 million for the nine months ended September 30, 2006, offset by a reduction in amortization expense of approximately $34,000 in the three months and $237,000 in the nine months ended September 30, 2006 related to intangible assets we acquired from the predecessor and other reductions. Other expenses for the three months and nine months 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, 2006 was 30.2%, compared to 34.3% for the same period in 2005. For the nine months ended September 30, our effective tax rate was 30.4% in 2006 and 31.6% in 2005. The reductions in our effective tax rate are primarily attributable to an increase in the proportion of tax-exempt municipal securities in our portfolio. At September 30, 2006, approximately 55.0% of our portfolio was invested in tax-exempt municipal securities, compared to approximately 53.3% at September 30, 2005.

        Net Income. Net income was $9.1 million for the three months ended September 30, 2006, compared to $5.1 million for the same period in 2005, representing an increase of $4.0 million, or 78.4%. Net income for the nine months ended September 30, 2006 totaled $24.4 million, an increase of $12.4 million, or 103.3%, from $12.0 million in the same period of 2005. The increase in net income for the three and nine months ended September 30, 2006 resulted primarily from increases in premiums earned and investment income for the period and the release of loss reserves, offset by increases in loss and loss adjustment expenses and underwriting, acquisition and insurance expenses.

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, 2006 has an effective duration of 5.1 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, 2006, our investment portfolio was made up almost entirely of investment grade fixed income securities with fair values subject to fluctuations in interest rates. While we have structured our investment portfolio to provide an appropriate matching of maturities with anticipated claim payments, if we decide or are required in the future to sell securities in a rising interest rate environment, we would expect to incur losses from such sales.

        Our 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, 2005 through October 1, 2006, our reinsurance program provided reinsurance coverage up to $50.0 million per loss occurrence, subject to retentions, annual aggregate deductibles and other limitations. On October 1, 2006, we entered into new reinsurance contracts that are effective through October 1, 2007. The new program provides reinsurance coverage up to $75.0 million per loss occurrence, subject to retentions, annual aggregate deductibles and other limitations. Our reinsurance programs are more fully described in note 5.a. to the condensed consolidated financial statements in Part I, Item 1 of this quarterly report and in the reinsurance agreements. 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 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, 2005, 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.

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

        Our unaudited consolidated net cash provided by operating activities for the nine months ended September 30, 2006 was $59.9 million, compared to $57.6 million for the same period in 2005. Net cash provided by operations in the nine months ended September 30, 2006 resulted primarily from net income of $24.4 million and increases in unpaid loss and loss adjustment expense of $42.4 million and amortization of deferred policy acquisition costs of $21.1 million, offset by policy acquisition costs deferred of $22.8 million, unearned premiums net of deferred premiums and premiums receivable of $3.5 million and deferred federal income taxes of $3.1 million, all as a result of the growth of our business.

        We used net cash of $103.6 million for investing activities in the nine months ended September 30, 2006, compared to $130.6 million for the same period in 2005. The difference between periods is primarily attributable to a reduction in funds available for investing activities. In 2005, we invested net proceeds totaling approximately $80.4 million resulting from the sale of 8,625,000 shares of common stock in our initial public offering. In 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 described below.

        For the nine months ended September 30, 2006, financing activities provided cash of $57.6 million, compared to $80.8 million in the same period in 2005. As described below, 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, including the underwriters’ over-allotment option to purchase 510,000 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. We contributed $50.0 million of the net proceeds to SBIC, which is using the capital to expand its business in its core markets and to new territories. The remaining proceeds will be used for general corporate purposes, including supporting the growth of PointSure.

Contractual Obligations and Commitments

        The following table identifies our contractual obligations by payment due period as of September 30, 2006:

	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		184,645		26,404		88,999		26,589		42,653
Operating lease obligations		3,389		971		1,867		495		56
Total	$	200,034	$	27,375	$	90,866	$	27,084	$	54,709

        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, 2006 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, 2006, we had no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

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Critical Accounting Policies, Estimates and Judgments

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

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

      Unpaid Loss and Loss Adjustment Expenses

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

      Reinsurance Recoverables

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

      Adverse Development Cover Agreement

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

      Deferred Policy Acquisition Costs

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

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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 statement of operations in the period that includes the enactment date.

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

      Goodwill and Other Intangible Assets

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

      Retrospective Premiums

        Retrospective premiums for primary and reinsured risks are included in income as earned on a pro rata basis over the effective period of the respective policies. Earned premiums on retrospectively rated policies are based on the Company’s estimate of loss experience as of the measurement date. Unearned premiums are deferred and include that portion of premiums written that is applicable to the unexpired period of the policies in force and estimated adjustments of premiums on policies that have retrospective rating endorsements.

      Earned But Unbilled Premiums

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

      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 or cost; our intent and ability to retain the investment for a period of time sufficient to allow for an anticipated recovery in value; specific credit issues related to the issuer; and current economic conditions. In general, we focus on those securities whose fair values were less than 80% of their amortized cost or cost, as appropriate, for six or more consecutive months. Other-than-temporary impairment losses result in permanent reductions of the carrying amount of the underlying investments. 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.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

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Credit Risk

        Credit risk is the potential economic loss principally arising from adverse changes in the financial condition of a specific debt issuer. We address this risk by investing primarily in fixed-income securities which are rated “A” or higher by Standard & Poor’s. We also independently, and through our outside investment 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 $372.3 million at September 30, 2006 that are subject to interest rate risk. We manage the exposure to interest rate risk through a disciplined asset/liability matching and capital management process. In the management of this risk, the characteristics of duration, credit and variability of cash flows are critical elements. These risks are assessed regularly and balanced within the context of the liability and capital position.

        The table below summarizes our interest rate risk. It illustrates the sensitivity of the fair value of fixed-income investments to selected hypothetical changes in interest rates as of September 30, 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.

Hypothetical Change in Interest Rates	Estimated Change in Fair Value			Fair Value		Hypothetical Percentage Increase (Decrease) in Shareholders’ Equity
	($ in thousands)
200 basis point increase	$	(31,381	)	$	340,929		(8.4	)%
100 basis point increase		(15,518	)		356,792		(4.2	)%
No change		–			372,310		–
100 basis point decrease		15,172			387,482		4.1	%
200 basis point decrease		29,997			402,307		8.1	%

Item 4. Controls and Procedures

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

PART II — OTHER INFORMATION

Item 1A. Risk Factors

        You should carefully consider the risks described below and in the Company’s Annual Report on Form 10-K filed with the SEC on March 29, 2006, together with all of the other information included in this quarterly report. The risks and uncertainties described below are not the only ones facing the Company. If any of the following risks actually occurs, our business, financial condition or operating results could be harmed. Any of the risks described below could result in a significant or material adverse effect on our financial condition or results of operations, and a corresponding decline in the market price of our common stock. You could lose all or part of your investment. The risks discussed below also include forward-looking statements and our actual results may differ substantially from those discussed in those forward-looking statements. Please refer to the discussion under the heading “Cautionary Statement” in Part I, Item 2.

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        The following risk factors have been updated to reflect developments that occurred during the quarter ended September 30, 2006.

Risks Related to Our Business

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

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

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

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

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

• approve or reject our policy coverage and endorsements;

• place limitations on our investments and dividends;

• set standards of solvency to be met and maintained;

• regulate rates pertaining to our business;

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

• require us to comply with medical privacy laws; and

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

        In September 2006, we were notified by the Illinois Division of Insurance that our insurance subsidiary was due for a routine comprehensive examination of its 2005 statutory annual statement. We are in the process of gathering and providing information in response to this notification. The field work portion of the comprehensive financial examination began in October 2006.

        Our ability to transact business with our affiliates and to enter into mergers, acquisitions and divestitures involving our insurance company subsidiary is limited by the requirements of the insurance holding company laws of Illinois and California. To comply with these laws, we are required to file notices with the Illinois Division of Insurance and the California Department of Insurance to seek their respective approvals at least 30 days before engaging in any intercompany transactions, such as sales, purchases, exchanges of assets, loans, extensions of credit, cost sharing arrangements and extraordinary dividends or other distributions to stockholders. Under these holding company laws, any change of control transaction also requires prior notification and approval. Because these governmental agencies may not take action or give approval within the 30 day period, these notification and approval requirements may subject us to business delays and additional business expense. If we fail to give these notifications, we may be subject to significant fines and penalties and damaged working relations with these governmental agencies.

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

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medical care through a network of doctors chosen by the employer. The implementation of these reforms affects the manner in which we coordinate medical care costs with employers and the manner in which we oversee treatment plans. However, the reforms are subject to continuing opposition in the California legislature, in the courts and by ballot initiatives, any of which could overturn or substantially amend the reforms and regulatory rules applicable to the legislation. We cannot predict the ultimate impact of the reforms.

        Our business is also affected by federal laws, including the USL&H Act, which is administered by the Department of Labor, and the Merchant Marine Act of 1920, or Jones Act. The USL&H Act contains various provisions affecting our business, including the nature of the liability of employers of longshoremen, the rate of compensation to an injured longshoreman, the selection of physicians, compensation for disability and death and the filing of claims. Currently, builders of recreational boats over 65 feet in length are subject to the USL&H Act. A proposed amendment to the USL&H Act would eliminate builders of recreational boats from the reach of the USL&H Act. If this proposed amendment is adopted, we expect that we could lose a total of approximately $1.7 million in annual direct written premiums from policies currently providing USL&H Act coverage. The proposed amendment would not have a material impact on our policies providing coverage under the Jones Act, which gives certain employees at sea the right to sue their employers if such employees are injured. Moreover, changes in federal tax laws could also impact our business.

        In addition, we are impacted by the Terrorism Risk Insurance Act of 2002, as extended and amended by the Terrorism Risk Insurance Extension Act of 2005 (collectively referred to in this quarterly report as the “Terrorism Risk Act”) and by the Gramm-Leach-Bliley Act of 2002 related to disclosure of personal information. The Terrorism Risk Act requires that commercial property and casualty insurance companies offer coverage for certain acts of terrorism and has established a federal assistance program through the end of 2007 to help insurers cover claims arising out of such acts. The Terrorism Risk Act only covers certified acts of terrorism, and the U.S. Secretary of the Treasury must declare the act to be a “certified act of terrorism” for it to be covered under this federal program. In addition, no federal compensation will be paid under the Terrorism Risk Act unless aggregate insured losses from the act for the entire insurance industry exceed certain threshold amounts ($5.0 million for terrorism losses occurring prior to April 1, 2006, $50.0 million for terrorism losses occurring from April 1, 2006 to December 31, 2006, and $100.0 million for terrorism losses occurring in 2007). Under this program, the federal government covers 90% of the losses from covered certified acts of terrorism (85% for terrorism losses occurring in 2007) on commercial risks in the United States only, in excess of the applicable deductible amount. This deductible is calculated based on a percentage of an affiliated insurance group’s prior year direct earned premiums on commercial lines policies (except for certain excluded lines such as commercial auto) covering risks in the United States. This deductible amount is 17.5% of such premiums for losses occurring in 2006 and 20.0% of such premiums for losses occurring in 2007. The Terrorism Risk Act is scheduled to expire on December 31, 2007 and may not be renewed, or if it is renewed, it may provide reduced protection against the financial impact of acts of terrorism by, among other things, increasing the aggregate loss event trigger and the amount of statutory deductible insurers would be required to pay.

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

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

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

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

        On March 24, 2006, the WCIRB submitted a filing with the California Insurance Commissioner recommending a 16.4% decrease in advisory pure premium rates on new and renewal policies effective July 1, 2006. Pure premium is that portion of an insurance premium necessary to cover the cost of paying claims, such as medical and indemnity costs and allocated and unallocated loss adjustment expenses. The filing was based on an analysis of loss experience valued as of December 31, 2005 and was made in response to continued reductions in workers’ compensation claim costs in California as a result of reform legislation enacted primarily in 2003 and 2004. On May 31, 2006, the Commissioner recommended a 16.4% decrease in rates effective July 1, 2006. Such decisions of the California Insurance Commissioner are advisory only and insurance companies may choose whether or not to adopt the new rates. On May 31, 2006, we filed new rates reflecting an average reduction of 5.8% from prior rates for new and renewal workers’ compensation insurance policies written in California on or after July 1, 2006. The filing was approved on June 21, 2006. This was the sixth California rate reduction we have filed since October 1, 2003, resulting in a net cumulative reduction of our California rates of approximately 41.8%.

        On September 14, 2006, the WCIRB amended a previous filing with the California Insurance Commissioner to recommend a 6.3% decrease in advisory pure premium rates on new and renewal policies effective on or after January 1, 2007. The filing was based on a review of loss and loss adjustment experience through June 30, 2006 and was made in response to continued reductions in California workers’ compensation claim costs. On November 2, 2006, the California Insurance Commissioner recommended a 9.5% decrease in workers’ compensation advisory pure premium rates for policies incepting on or after January 1, 2007. Rate reductions have also been proposed in other states in which we operate. At this time, we are unable to predict the impact that the proposed rate reductions, 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 SIH’s 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 SIH’s common stock. Our use of the proceeds from the offering does not represent a change in the use of proceeds described in the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2006 filed with the SEC on August 14, 2006.

        We did not purchase any of our equity securities during the nine months ended September 30, 2006.

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 13, 2006
	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)