Eastern Insurance (EIHI) 10-Q 2007 Q3 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

for the Quarterly Period Ended September 30, 2007,

or

¨ Transition report pursuant to Section 13 or 15(d) of the Exchange Act

for the Transition Period from            to            

No. 001-32899

(Commission File Number)

EASTERN INSURANCE HOLDINGS, INC.

(Exact name of Registrant as specified in its charter)

PENNSYLVANIA	20-2653793
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

25 Race Avenue, Lancaster, Pennsylvania	17603
(Address of principal executive offices)	(Zip Code)

(717) 396-7095

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

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 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No.  ¨

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

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  x

Indicate by check mark if the Registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

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

COMMON STOCK	Number of Shares Outstanding as of November 7, 2007
(No par Value)	10,625,622
(Title of Class)	(Outstanding Shares)

TABLE OF CONTENTS

		Page
PART I - FINANCIAL INFORMATION		3
Item 1.	Financial Statements (Unaudited)	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	47
Item 4.	Controls and Procedures	47
PART II - OTHER INFORMATION		47
Item 1.	Legal Proceedings	47
Item 1A.	Risk Factors	47
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47
Item 3.	Defaults Upon Senior Securities	48
Item 4.	Submission of Matters to Vote of Security Holders	48
Item 5.	Other Information	48
Item 6.	Exhibits	48

2

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except share data)

	September 30, 2007			December 31, 2006
ASSETS
Investments:
Fixed income securities, at estimated fair value (amortized cost, $206,510; $201,226)	$	208,729		$	204,444
Convertible bonds, at estimated fair value (amortized cost, $13,265; $—)		14,989			—
Equity securities, at estimated fair value (cost, $18,517; $17,027)		19,934			18,219
Equity call options, at estimated fair value (cost, $—; $2,230)		—			3,318
Other long-term investments		10,975			11,604
Total investments		254,627			237,585
Cash and cash equivalents		41,296			50,703
Accrued investment income		2,299			2,236
Premiums receivable (net of allowance, $558; $558)		34,952			23,225
Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses		27,395			27,525
Deferred acquisition costs		7,457			4,501
Deferred income taxes, net		4,038			2,696
Federal income taxes recoverable		1,148			—
Intangible assets		6,806			8,110
Goodwill		5,140			5,140
Other assets		8,004			6,485
Total assets	$	393,162		$	368,206
LIABILITIES
Reserves for unpaid losses and loss adjustment expenses	$	133,910		$	126,467
Unearned premium reserves		50,041			34,600
Advance premium		1,312			1,755
Accounts payable and accrued expenses		9,761			7,785
Ceded reinsurance balances payable		7,026			5,623
Benefit plan liabilities		288			324
Segregated portfolio cell dividend payable		10,693			7,962
Federal income taxes payable		—			1,902
Junior subordinated debentures		8,007			8,044
Total liabilities	$	221,038		$	194,462
Commitments and contingencies (Note 11)
SHAREHOLDERS’ EQUITY
Series A preferred stock, par value $0, auth. shares—5,000,000; no shares issued and outstanding		—			—
Common capital stock, par value $0, auth. shares—20,000,000; issued—11,597,723 and 11,351,048, respectively; outstanding – 10,728,422 and 11,351,048, respectively		—			—
Unearned ESOP compensation		(6,539	)		(7,101	)
Additional paid in capital		109,727			108,502
Treasury stock, at cost (869,301 shares)		(13,226	)		—
Retained earnings		79,754			69,483
Accumulated other comprehensive income, net		2,408			2,860
Total shareholders’ equity		172,124			173,744
Total liabilities and shareholders’ equity	$	393,162		$	368,206

See accompanying notes to unaudited consolidated financial statements.

3

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME

For the Three and Nine Months Ended September 30, 2007 and 2006

(Unaudited, in thousands, except per share data)

	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2007		2006		2007			2006
REVENUE
Net premiums earned	$	34,264	$	26,678	$	95,226		$	45,859
Net investment income		3,882		2,974		10,100			5,269
Net realized investment gains		590		711		2,321			1,632
Other revenue		179		179		517			202
Total revenue		38,915		30,542		108,164			52,962
EXPENSES
Losses and loss adjustment expenses incurred		21,459		17,432		57,968			29,820
Acquisition and other underwriting expenses		4,097		1,709		11,266			4,141
Other expenses		6,452		5,241		17,977			10,223
Amortization of intangibles		434		511		1,303			588
Policyholder dividend expense		95		113		349			184
Segregated portfolio dividend expense		1,554		1,521		2,946			1,646
Total expenses		34,091		26,527		91,809			46,602
Income before income taxes		4,824		4,015		16,355			6,360
Income tax expense		1,263		1,713		5,329			2,611
Net income	$	3,561	$	2,302	$	11,026		$	3,749
Other comprehensive income (loss)
Unrealized holding gains arising during period, net of tax of $866, $1,211, $568 and $895		1,608		2,249		1,054			1,662
Amortization of unrecognized benefit plan amounts, net of tax of $3, $—, $8, and $-		5		—		15			—
Less: Reclassification adjustment for gains included in net income, net of tax of $121, $14, $585, and $109		224		26		1,086			202
Other comprehensive income (loss)		1,379		2,223		(47	)		1,460
Comprehensive income	$	4,940	$	4,525	$	10,979		$	5,209

Earnings per share (See Note 4):	Three Months Ended September 30				Nine Months Ended September 30
	2007		2006		2007		2006
Net income	$	3,561	$	2,302	$	11,026	$	2,613
Basic earnings per share	$	0.35	$	0.22	$	1.06	$	0.25
Diluted earnings per share	$	0.34	$	0.21	$	1.02	$	0.24

See accompanying notes to unaudited consolidated financial statements.

4

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

For the Three and Nine Months Ended September 30, 2007

(Unaudited, in thousands, except share data)

Three Months Ended September 30, 2007

	Outstanding Shares
	Series A Preferred Stock	Common Capital Stock		Common Capital Stock		Unearned ESOP Compensation			Additional Paid-In Capital		Treasury Stock			Retained Earnings			Accumulated Other Comprehensive Income Net of Tax		Total
Balance, July 1, 2007	—	11,320,340		$	—	$	(6,728	)	$	109,303	$	(4,156	)	$	76,773		$	1,029	$	176,221
ESOP shares released							189			107										296
Issuance of stock awards										317										317
Repurchase of common stock		(591,918	)									(9,070	)							(9,070	)
Shareholder dividend															(580	)				(580	)
Net income															3,561					3,561
Other comprehensive loss, net of tax																		1,379		1,379
Balance, September 30, 2007	—	10,728,422		$	—	$	(6,539	)	$	109,727	$	(13,226	)	$	79,754		$	2,408	$	172,124

Nine Months Ended September 30, 2007

	Outstanding Shares
	Series A Preferred Stock	Common Capital Stock		Common Capital Stock		Unearned ESOP Compensation			Additional Paid-In Capital		Treasury Stock			Retained Earnings			Accumulated Other Comprehensive Income Net of Tax			Total
Balance, January 1, 2007	—	11,351,048		$	—	$	(7,101	)	$	108,502	$	—		$	69,483		$	2,860		$	173,744
Adoption of SFAS 155															405			(405	)		—
ESOP shares released							562			298											860
Issuance of stock awards		246,675								927											927
Repurchase of common stock		(869,301	)									(13,226	)								(13,226	)
Shareholder dividend															(1,160	)					(1,160	)
Net income															11,026						11,026
Other comprehensive loss, net of tax																		(47	)		(47	)
Balance, September 30, 2007	—	10,728,422			—	$	(6,539	)	$	109,727	$	(13,226	)	$	79,754		$	2,408		$	172,124

See accompanying notes to unaudited consolidated financial statements

5

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

For the Three and Nine Months Ended September 30, 2006

(Unaudited, in thousands, except share data)

Three Months Ended September 30, 2006

	Outstanding Shares
	Series A Preferred Stock	Common Capital Stock	Common Capital Stock		Unearned ESOP Compensation			Additional Paid-In Capital		Retained Earnings		Accumulated Other Comprehensive Income Net of Tax		Total
Balance, July 1, 2006	—	11,351,048	$	—	$	(7,446	)	$	108,355	$	62,652	$	141	$	163,702
Net proceeds from stock offering
Unearned compensation
ESOP shares released						188			73						261
Issuance of common stock
Net income											2,302				2,302
Other comprehensive loss, net of tax													2,223		2,223
Balance, June 30, 2006	—	11,351,048	$	—	$	(7,258	)	$	108,428	$	64,954	$	2,364	$	168,488

Nine Months Ended September 30, 2006

	Outstanding Shares
	Series A Preferred Stock	Common Capital Stock	Common Capital Stock		Unearned ESOP Compensation			Additional Paid-In Capital		Retained Earnings		Accumulated Other Comprehensive Income Net of Tax		Total
Balance, January 1, 2006	—	—	$	—	$	—		$	—	$	61,205	$	904	$	62,109
Net proceeds from stock offering		7,475,000							69,597						69,597
Unearned compensation						(7,475	)								(7,475	)
ESOP shares released						217			77						294
Issuance of common stock		3,876,048							38,754						38,754
Net income											3,749				3,749
Other comprehensive loss, net of tax													1,460		1,460
Balance, June 30, 2006	—	11,351,048	$	—	$	(7,258	)	$	108,428	$	64,954	$	2,364	$	168,488

See accompanying notes to unaudited consolidated financial statements

6

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Nine Months Ended September 30, 2007 and 2006

(Unaudited, in thousands)

	2007			2006
Cash flows from operating activities:
Net income	$	11,026		$	3,749
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		280			94
Net amortization of bond premium/discount		736			361
Gain on sale of investments		(2,292	)		(1,390	)
Unrealized loss on equity call options		—			(242	)
Unrealized gain on convertible bonds		(29	)		—
Equity in income of limited partnerships		(413	)		(169	)
Recognition of deferred gain on sale of building		—			(87	)
Deferred tax (benefit) provision		(1,323	)		132
Stock compensation		1,786			294
Intangible asset amortization		1,303			588
Changes in assets and liabilities:
Accrued investment income		(63	)		219
Premiums receivable		(11,727	)		(4,456	)
Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses		130			2,955
Deferred acquisition costs		(2,956	)		(3,526	)
Other assets		(1,805	)		(234	)
Reserves for unpaid losses and loss adjustment expenses		7,443			(181	)
Unearned and advance premium		14,999			9,422
Ceded reinsurance balances payable		1,403			—
Accounts payable and accrued expenses		1,615			2,788
Segregated portfolio cell dividend payable		2,731			(1,566	)
Benefit plan liabilities		(57	)		(72	)
Federal income taxes recoverable/payable		(3,050	)		367
Net cash provided by operating activities		19,737			9,046
Cash flows from investing activities:
Purchase of fixed income securities		(96,167	)		(45,367	)
Purchase of equity securities		(11,299	)		(702	)
Purchase of other long-term investments		(500	)		(2,240	)
Proceeds from sale of fixed income securities		30,990			26,659
Proceeds from maturities/calls of fixed income securities		49,417			12,844
Proceeds from equity securities		10,907			1,225
Proceeds from other long-term investments		1,876			—
Change in unsettled investment purchases and sales		230			—
Acquisition of EHC, net of cash received		—			(14,149	)
Principal payments received on mortgage loans		10			14
Purchase of equipment, net		(222	)		(22	)
Net cash used in investing activities		(14,758	)		(21,738	)
Cash flows from financing activities:
Proceeds from initial public offering, net of expenses		—			62,122
Shareholder dividend		(1,160	)		—
Repurchase of common stock		(13,226	)		—
Repayment of long-term debt		—			(1,723	)
Net cash (used in) provided by financing activities		(14,386	)		60,399
Net (decrease) increase in cash and cash equivalents		(9,407	)		47,707
Cash and cash equivalents, beginning of period		50,703			4,699
Cash and cash equivalents, end of period	$	41,296		$	52,406
Supplemental disclosure of cash flow information:
Cash paid for income taxes	$	9,300		$	485
Cash paid for interest	$	455		$	—

See accompanying notes to unaudited consolidated financial statements.

7

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

(Unaudited, dollars in thousands except share and per share data)

1. Background and Nature of Operations

Eastern Insurance Holdings, Inc. (“EIHI”) was formed by Eastern Life and Health Insurance Company (“ELH”), formerly Educators Mutual Life Insurance Company, for the purpose of converting from a mutual life and health insurance company to a stock life and health insurance company. On June 16, 2006, EIHI completed its common stock offering and ELH completed its conversion from a mutual company to a stock company and became a wholly-owned subsidiary of EIHI. In the common stock offering, EIHI sold 7,475,000 shares of its common stock at a price of $10.00 per share, raising gross proceeds of $74.8 million. Direct expenses of the offering were $5.2 million and were recorded as a direct reduction to additional paid-in capital.

Immediately after the common stock offering and conversion, EIHI purchased all of the outstanding common stock of Eastern Holding Company, Ltd. (“EHC”) for a purchase price of $78.9 million (See Note 3).

EIHI is an insurance holding company offering workers’ compensation and group benefits insurance products through its wholly-owned subsidiaries. The accompanying unaudited interim consolidated financial statements include the accounts of EIHI and its wholly-owned subsidiaries (collectively, the “Company”), EHC and ELH, and EHC’s wholly-owned subsidiaries, Eastern Alliance Insurance Company (“Eastern Alliance”), Allied Eastern Indemnity Company (“Allied Eastern”), Employers Alliance, Inc. (“Employers Alliance”), Eastern Re Ltd., S.P.C. (“Eastern Re”), Global Alliance Holdings, Ltd. (“Global Alliance”), Global Alliance Statutory Trust I (“Trust I”), and Eastern Services Corporation (“Eastern Services”).

Effective June 16, 2006, EHC was redomesticated from the Cayman Islands to the United States of America. As a result of the redomestication, EHC is subject to federal income tax on a prospective basis.

The Company operates in five segments: workers’ compensation insurance, segregated portfolio cell reinsurance, group benefits insurance, specialty reinsurance, and corporate/other. See Note 9 for a description of each segment.

2. Significant Accounting Policies

Basis of Presentation

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments, being normal, recurring adjustments, necessary for a fair presentation of the financial position and results of operations of the Company for the periods presented have been included. The results of operations for an interim period are not necessarily indicative of the results for an entire year. These financial statements should be read in conjunction with the Company’s audited financial statements and notes thereto as of and for the year ended December 31, 2006 included in the Company’s Annual Report on Form 10-K, which was filed with the U.S. Securities and Exchange Commission on April 2, 2007.

The consolidated statements of income and comprehensive income for the nine months ended September 30, 2006 represent the results of operations of the group benefits insurance segment for the nine months ended September 30, 2006 and the results of operations of the workers’ compensation insurance segment, segregated portfolio cell reinsurance segment and specialty reinsurance segment for the period from June 17, 2006 to September 30, 2006. The corporate/other segment for the nine months ended September 30, 2006 represents the results of operations of ELH’s corporate activities for the nine months ended September 30, 2006 and the results of operations of Employers Alliance, EIHI, EHC, Global Alliance, and Eastern Services for the period from June 17, 2006 to September 30, 2006. Basic and diluted earnings per share for the nine months ended September 30, 2006 is computed by dividing consolidated net income for the period from June 17, 2006 to September 30, 2006 by the weighted average number of shares outstanding for the respective period.

All inter-company transactions and related account balances have been eliminated in consolidation.

Certain amounts in the prior year consolidated financial statements have been reclassified to conform to the current year presentation.

Use of Estimates

The preparation of the unaudited interim consolidated financial statements requires management to make estimates and assumptions that affect the amount of reported assets and liabilities and disclosures of contingent assets and liabilities as of the date of the unaudited interim consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. The most significant estimates in the unaudited interim consolidated financial statements include reserves for unpaid losses and loss adjustment expenses, earned but unbilled premium, deferred acquisition costs, return premiums under reinsurance contracts, and current and deferred income taxes. Actual results could differ from these estimates.

8

Cash and Cash Equivalents

The Company considers all investments with original maturity dates of three months or less to be cash equivalents for purposes of the consolidated statements of cash flows. The carrying amount of cash equivalents approximates their fair value.

Investments

Fixed Income Securities

The Company’s investments in fixed income securities are classified as available-for-sale and are carried at estimated fair value, with unrealized gains and losses reported in accumulated other comprehensive income (loss), net of tax. Fixed income securities include publicly traded and private placement bonds. The estimated fair value of publicly traded bonds is determined based on quoted market prices obtained through an independent pricing service or independent broker. The estimated fair value of private placement bonds is determined using valuation models, taking into consideration the securities’ coupon rate, maturity date, and other pertinent features.

Premiums or discounts are amortized using the effective interest method. Realized gains or losses are based on amortized cost and are computed using the specific identification method. The Company monitors its fixed income securities for unrealized losses that appear to be other-than-temporary. The Company performs a detailed review of these securities to determine the underlying cause of the unrealized loss and whether the security is impaired. At the time a security is determined to be other-than- temporarily impaired, the Company reduces the book value of the security to the current estimated fair value and records a realized loss in the consolidated statements of operations and comprehensive income (loss). Any subsequent increase in the security’s estimated fair value would be reported as an unrealized gain.

Convertible Bond Securities

The Company adopted Statement of Financial Accounting Standards No. 155 (“SFAS 155”), “Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140”, on January 1, 2007. Prior to January 1, 2007, the Company accounted for its convertible bond securities in accordance with SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” and bifurcated the equity call option, or embedded derivative, from the convertible bond security, or host contract. Under SFAS 133, the change in the fair value of the equity call option was reported as a realized gain in the Company’s consolidated statements of operations and comprehensive income (loss) and the change in the fair value of the convertible bond security was reported as an unrealized gain or loss in accumulated other comprehensive income (loss), net of tax. Upon adoption of SFAS 155, the Company elected to fair value its convertible bond securities, and future changes in the fair value of the Company’s convertible bond securities will be reported as a realized gain or loss in the consolidated statements of operations and comprehensive income (loss). The adoption of SFAS 155 was reported as a cumulative effect adjustment to beginning shareholders’ equity and resulted in a reclassification between retained earnings and accumulated other comprehensive income of $405. The carrying value of the Company’s convertible bond securities did not change as a result of adopting SFAS 155.

SFAS 155 prohibits restatement of prior years’ financial statements. As a result, the Company’s consolidated balance sheet as of December 31, 2006 has not been adjusted to reflect the adoption of SFAS 155. The following table provides the impact to the Company’s consolidated balance sheet as of December 31, 2006 under SFAS 155 (unaudited, in thousands).

	As Reported		Adjustment			Balance Under SFAS 155
Fixed income securities	$	204,444	$	(10,227	)	$	194,217
Convertible bonds	$	—	$	13,545		$	13,545
Equity call options	$	3,318	$	(3,318	)	$	—
Retained earnings	$	69,483	$	405		$	69,888
Accumulated other comprehensive income, net	$	2,860	$	(405	)	$	2,455

Equity Securities

The Company’s investments in equity securities are classified as available-for-sale and are carried at estimated fair value, with unrealized gains and losses reported in accumulated other comprehensive income (loss), net of tax. The estimated fair value of equity securities is determined based on quoted market prices obtained through an independent pricing service or independent broker.

Realized gains or losses are based on cost and are computed using the specific identification method. The Company monitors its equity securities for unrealized losses that appear to be other-than-temporary. The Company performs a detailed review of these securities to determine the underlying cause of the unrealized loss and whether the security is impaired. At the time a security is determined to be other-than-temporarily impaired, the Company reduces the cost of the security to the current estimated fair value and records a realized loss in the consolidated statements of operations and comprehensive income (loss). Any subsequent increase in the security’s estimated fair value would be reported as an unrealized gain.

9

Other Long-Term Investments

Other long-term investments consist primarily of investments in limited partnerships. Investments in limited partnerships are reported in the consolidated financial statements using the equity method. Changes in the value of the Company’s proportionate share of its limited partnership investments are included in net investment income in the consolidated statements of operations and comprehensive income (loss).

Premiums

Premiums generated by the Company’s workers’ compensation insurance segment, including estimates of additional premiums resulting from audits of insureds’ records, are generally recognized as written upon inception of the policy. Premiums written are primarily earned on a daily pro rata basis over the terms of the policies to which they relate. Accordingly, unearned premiums represent the portion of premiums written which is applicable to the unexpired portion of the policies in force. Workers’ compensation premiums are determined based upon the payroll of the insured, the applicable premium rates and, where applicable, an experience based modification factor. An audit of the policyholders’ records is conducted after policy expiration, to make a final determination of applicable premiums. Included in net premiums earned is an estimate for earned but unbilled final audit premiums. The Company estimates earned but unbilled premiums by tracking, by policy, how much additional premium is billed in final audit invoices as a percentage of payroll exposure to estimate the probable additional amount that it has earned, but not yet billed, as of the balance sheet date. Earned but unbilled premiums accrued as of September 30, 2007 and December 31, 2006 totaled $1.4 million and $1.5 million, respectively.

Premiums generated by the Company’s group benefits insurance segment are generally billed on a monthly basis with premiums being earned in the month in which the coverage is provided. Unearned premiums represent those premiums that have been received but for which the coverage period has not expired. Advance premiums represent those premiums that have been received in advance of the coverage period. Premiums receivable represent only those premiums that have been billed to policyholders for coverage periods through the balance sheet date.

Reinsurance premiums assumed by the Company’s specialty reinsurance segment are estimated based on information provided by the ceding company. The information used in establishing these estimates is reviewed and subsequent adjustments are recorded in the period in which they are reported. These premiums are earned over the terms of the related reinsurance contracts.

Other Revenue

Other revenue primarily consists of service revenue related to claims adjusting and risk management services. Claims adjusting and risk management service revenue is earned over the term of the related contracts in proportion to the actual services rendered.

Losses and Loss Adjustment Expenses

A liability is established for the estimated unpaid losses and loss adjustment expenses (“LAE”) of the Company’s workers’ compensation insurance segment under the terms of, and with respect to, its policies and agreements and includes amounts determined on the basis of claims adjusters’ evaluations and an amount based on past experience for losses incurred but not reported.

The Company discounts its reserves for unpaid losses and LAE for worker’s compensation claims on a non-tabular basis, using a discount rate of 3%, based upon regulatory guidelines. The reserves for unpaid losses and LAE have been reduced for the effects of discounting by approximately $3.5 million and $3.3 million as of September 30, 2007 and December 31, 2006, respectively.

A liability is established for the estimated unpaid losses and LAE of the Company’s group benefits insurance segment as follows:

• The liability for reported but unpaid long-term disability claims is calculated using the 1987 Commissioners Group Disability Table. The long-term disability reserves are discounted based on the expected rate of return of ELH’s fixed income portfolio in the year that the claim was incurred. The discount rate for claims incurred in 2007 and 2006 was 5.25% and 4.75%, respectively. The liability for incurred but not reported claims is estimated on a policy-by-policy basis, taking into consideration average monthly premium, policy elimination periods, and an expected loss ratio.

• The liability for reported but unpaid and incurred but not reported dental and short-term disability claims is estimated using statistical claim development models, taking into consideration historical claim severity and frequency patterns and changes in benefit structures that may impact the amount at which claims are ultimately settled. For the most recent incurral months, which usually consist of the last six months, the liability is estimated by applying an expected loss ratio to net premiums earned, less claim payments through the balance sheet date.

10

• The liability for reported but unpaid term life claims represent those claims reported to the Company as of the balance sheet date for which payment has not yet been made. Term life incurred but not reported claims are estimated based on historical patterns of claims incurred as a percent of in-force premium as of the balance sheet date.

• The liability for life premium waiver reserves represents the present value of future life insurance benefits under those term life insurance policies for which premium has been waived due to the insured’s disability. The liability for life premium waiver reserves is calculated using the 1970 Intercompany Group Life Disability Table. The liability for life premium waiver reserves is discounted using a rate of 3%, which is built into the valuation table.

A liability is established for the estimated unpaid losses and LAE of the Company’s specialty reinsurance segment based on information provided by the ceding company. Premiums and reported claims data provided by the ceding company is utilized by management to estimate the ultimate losses and LAE, including an amount for incurred but not reported claims.

The methods used to estimate the reserve for unpaid losses and LAE are reviewed periodically and any adjustments resulting therefrom are reflected in current operations.

Management believes that its reserves for unpaid losses and LAE are adequate as of September 30, 2007. However, estimating the ultimate liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management’s informed estimates and judgments using data currently available. If the Company’s ultimate losses, net of reinsurance, prove to differ substantially from the amounts recorded as of September 30, 2007, the related adjustments could have a material adverse effect on the Company’s financial condition, results of operations or liquidity.

Reinsurance

In the ordinary course of business, the Company assumes and cedes reinsurance with other insurance companies. These arrangements provide greater diversification of business and minimize the net loss potential arising from large claims. Ceded reinsurance contracts do not relieve the Company of its obligation to its insureds. Premiums and claims under the Company’s reinsurance contracts are accounted for on a basis consistent with those used in accounting for the underlying policies reinsured and the terms of the reinsurance contracts. The Company has certain reinsurance contracts that provide for return premium based on the actual loss experience of the written and reinsured business. The Company estimates the amounts to be recorded for return premium based on the terms set forth in the reinsurance agreements and the expected loss experience.

The reinsurance recoverable for unpaid losses and LAE includes the balances due from reinsurance companies for unpaid losses and LAE that are expected to be recovered from reinsurers, based on contracts in force.

Policy Acquisition Costs

Policy acquisition costs consist primarily of commissions and premium taxes that vary with and are primarily related to the production of premium. Acquisition costs are deferred and amortized over the period in which the related premiums are earned. Deferred acquisition costs are limited to the estimated amounts recoverable after providing for losses and loss adjustment expenses that are expected to be incurred based upon historical and current experience. Anticipated investment income is considered in determining recoverability.

The Company’s group benefits insurance policies are cancelable and are not guaranteed renewable. In addition, the group benefits insurance policies provide coverage on a month-to-month basis with most policies’ coverage effective on the first day of each month. As a result, most of the Company’s group benefits insurance premiums are earned as of the balance sheet date. Based on the nature of the Company’s group benefits insurance policies, costs related to the acquisition of new and renewal business are expensed as incurred.

Amortization of policy acquisition costs totaled $1.3 million and $3.4 million for the three and nine months ended September 30, 2007, respectively, and $1.4 million and $4.5 million for the three and nine months ended September 30, 2006.

Income Taxes

Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using enacted tax rates and laws that are expected to be in effect when the difference is reversed. A valuation allowance is recorded against gross deferred tax assets if it is more likely than not that all or some portion of the benefits related to the deferred tax assets will not be realized.

Eastern Alliance, Allied Eastern and ELH are generally not subject to state income taxes; rather, they are subject to state premium tax in the jurisdictions in which they write business. Employers Alliance and Eastern Services are subject to Pennsylvania state income tax.

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The Company includes income tax-related interest and penalties as a component of income tax expense. The Company did not incur any income tax-related interest or penalties during the three and nine months ended September 30, 2007 and 2006.

Eastern Re is an exempt entity under the Companies Law of the Cayman Islands; however, Eastern Re’s earnings and profits are subject to federal income tax subsequent to June 16, 2006, as a result of the redomestication of EHC.

Policyholder Dividends

The Company issues certain workers’ compensation insurance policies with dividend payment features. These policyholders share in the operating results of their respective policies in the form of dividends. Dividends to policyholders are accrued during the period in which the related premiums are earned and are determined based on the terms of the individual policies. As of September 30, 2007 and December 31, 2006, the Company accrued policyholder dividends payable of $809 and $598, respectively, which are included in accounts payable and accrued expenses on the consolidated balance sheets.

Assessments

The Company is subject to state guaranty fund assessments in the Commonwealth of Pennsylvania, which provide for the payment of covered claims or to meet other insurance obligations from insurance company insolvencies. The Company’s assessments consist primarily of charges from the Workers’ Compensation Security Fund of Pennsylvania (“Security Fund”). The Security Fund serves as a guaranty fund to provide claim payments for those workers entitled to workers’ compensation benefits when the insurance company originally providing the benefits was placed into liquidation by a court. Security Fund assessments are established on an actuarial basis to provide an amount sufficient to pay the outstanding and anticipated claims in a timely manner, to meet the costs of the Pennsylvania Insurance Department (the “Insurance Department”) to administer the fund and to maintain a minimum balance in the fund of $500 million. If the Security Fund determines that the balance in the Security Fund is less than $500 million based on the actuarial study, then an assessment equal to one percent of direct premiums written is made to all companies licensed to write workers’ compensation in Pennsylvania. The Company recognizes a liability and the related expense for the assessments when premiums covered under the Security Fund are written; when an assessment from the Security Fund has been imposed or it is probable that an assessment will be imposed; and the amount of the assessment is reasonably estimable. As of September 30, 2007 and December 31, 2006, the Company recorded an accrual of $778 and $0, respectively, related to the anticipated assessment from the Security Fund.

Goodwill and Intangible Assets

Goodwill represents the excess of cost over the fair value of net 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.”

Treasury Stock

The Company records the repurchase of shares of its common stock using the cost method. Under the cost method, treasury stock is recorded based on the actual cost of the shares repurchased.

Stock-Based Compensation

The Company adopted the Eastern Insurance Holdings, Inc. 2006 Stock Incentive Plan (the “Stock Incentive Plan”) on December 18, 2006. Under the terms of the Stock Incentive Plan, stock awards may be made in the form of incentive stock options, non-qualified stock options or restricted stock. The Company accounts for stock-based compensation in accordance with SFAS 123R, “Share-Based Payment”. In accordance with SFAS 123R, the Company records compensation expense based on the fair value of the stock award on the grant date using the straight-line attribution method.

Employee Stock Ownership Plan

The Company recognizes compensation expense related to its employee stock ownership plan (“ESOP”) equal to the product of the number of shares earned, or committed to be released, during the period, and the average price of the Company’s common stock during the period. The estimated fair value of unearned ESOP shares is calculated based on the average price of the Company’s common stock for the period. For purposes of calculating earnings per share, the Company includes the weighted average of ESOP shares committed to be released for the period.

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Suspense shares, allocated shares, shares committed to be released, average price per share and stock compensation expense as of and for the three and nine months ended September 30, 2007 and 2006 were as follows (unaudited, in thousands, except share data):

	As of and for the Three Months Ended September 30,				As of and for the Nine Months Ended September 30,
	2007		2006		2007		2006
Suspense shares		710,125		747,500		710,125		747,500
Allocated shares		37,375		—		37,375		—
Shares committed to be released		18,841		18,841		56,216		21,708
Average price per share	$	15.68	$	13.87	$	15.30	$	13.54
Stock compensation expense	$	296	$	261	$	860	$	294

As of September 30, 2007 and December 31, 2006, the estimated fair value of unearned ESOP shares were $10.1 million and $10.3 million, respectively.

Recent Accounting Pronouncements

SFAS 159

In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115.” SFAS 159 permits entities to elect to measure certain financial instruments at fair value with changes in fair value being reported in earnings. SFAS 159 can be applied on an instrument-by-instrument basis and is effective for all eligible financial instruments as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Retrospective application to prior years’ financial statements is not permitted. For eligible financial instruments existing at the effective date, and for which an entity elects the fair value option, the first remeasurement to fair value must be recorded as a cumulative effect adjustment to beginning retained earnings. The Company is currently evaluating the impact of adopting SFAS 159 on its consolidated financial condition and results of operations.

SFAS 157

In September 2006, the FASB issued SFAS 157, “Fair Value Measurements”. SFAS 157 clarifies the definition of fair value for purposes of financial reporting, specifies the methods to be used to measure fair value, and requires expanded disclosures related to fair value and financial instruments measured at fair value. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. Early application is encouraged, provided an entity has not yet issued financial statements for the fiscal year, including interim financial statements. Management is currently evaluating the impact of SFAS 157 on its current fair value disclosures. The Company expects that SFAS 157 will not have a material effect on its consolidated financial condition or results of operations.

FIN 48

In July 2006, the FASB issued FASB Interpretation No. 48,” Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”), which provides criteria 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 Company adopted FIN 48 on January 1, 2007. The adoption of FIN 48 had no effect on the Company’s consolidated financial condition or results of operations. The Company has no uncertain tax positions as of September 30, 2007. All tax years subsequent to December 31, 2002 remain subject to examination by the Internal Revenue Service.

3. Intangible Assets

The acquisition of EHC resulted in the identification of certain intangible assets. The allocation of the purchase price in excess of the fair value of EHC’s net assets acquired to intangible assets totaled $9.2 million. As of September 30, 2007 and December 31, 2006, intangible assets consisted of the following (unaudited, in thousands):

	September 30, 2007				December 31, 2006
Intangible Assets with Finite Life	Balance		Accumulated Amortization		Balance		Accumulated Amortization
Agency relationships (15 year amortization period)	$	1,750	$	376	$	1,750	$	165
Renewal rights (15 year amortization period)		6,398		2,016		6,398		923
	$	8,148	$	2,392	$	8,148	$	1,088
Intangible Assets with Infinite Life
State insurance licenses		1,050		—		1,050		—
Total intangible assets	$	9,198	$	2,392	$	9,198	$	1,088

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Amortization expense totaled $434 and $1,303 for the three and nine months ended September 30, 2007 and $511 and $588 for the three and nine months ended September 30, 2006, respectively.

4. Earnings Per Share

Basic earnings per share are computed by dividing net income for the three and nine months ended September 30, 2007 and 2006 by the weighted average number of shares outstanding for the respective period. Diluted earnings per share are computed by dividing net income for the three and nine months ended September 30, 2007 and 2006 by the weighted average number of shares outstanding for the period, including dilutive potential common shares outstanding for the period. Stock warrants of 306,099 and restricted stock awards of 30,187 and 23,528, respectively, for the three and nine months ended September 30, 2007 have been included as dilutive potential common shares outstanding. For the three and nine months ended September 30, 2007, there were 846,752 and 853,411 stock options and restricted stock awards that were not included in the Company’s earnings per share calculation because to do so would have been anti-dilutive. Consolidated net income, basic shares outstanding, diluted shares outstanding, basic earnings per share and diluted earnings per share for the three and nine months ended September 30, 2007 and 2006 were as follows (unaudited, in thousands, except share and per share data):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
Consolidated net income	$	3,561	$	2,302	$	11,026	$	2,613
Basic shares outstanding		10,105,204		10,615,836		10,435,468		10,614,402
Diluted shares outstanding		10,441,490		10,921,935		10,765,095		10,920,501
Basic earnings per share	$	0.35	$	0.22	$	1.06	$	0.25
Diluted earnings per share	$	0.34	$	0.21	$	1.02	$	0.24

5. Share Repurchase

On February 15, 2007, the Company’s Board of Directors authorized the repurchase of up to 5 percent, or 567,552 shares, of the Company’s issued and outstanding shares of common stock. On August 2, 2007, the Company’s Board of Directors authorized the repurchase of additional shares of the Company’s outstanding common stock up to an aggregate of 1,046,500 shares, which represents the total number of shares of common stock for which awards may be granted under the Company’s Stock Incentive Plan. On September 27, 2007, the Company’s Board of Directors increased the share repurchase authorization to 2,046,500 shares. The share repurchases will be held as treasury stock and are available for issuance in connection with the Company’s Stock Incentive Plan. As of September 30, 2007, the Company repurchased 869,301 shares at a cost of $13,226, representing a weighted average cost of $15.22 per share. The Company repurchased an additional 102,800 shares at a cost of $1.6 million, through November 6, 2007.

6. Stock-Based Compensation

Awards under the Stock Incentive Plan may be made in the form of incentive stock options, nonqualified stock options, restricted stock or any combination to employees and non-employee directors. At adoption, the Stock Incentive Plan initially limited to 299,000 the number of shares that may be awarded as restricted stock, and to 500,000 the number of shares for which incentive stock options may be granted. The total number of shares initially authorized in the Stock Incentive Plan was 1,046,500 shares, with an annual increase equal to 1% of the shares outstanding at the end of each year. The Stock Incentive Plan provides that stock options and restricted stock awards may include vesting restrictions and performance criteria at the discretion of the Compensation Committee of the Board of Directors. The term of options may not exceed ten years for incentive stock options, and ten years and one month for nonqualified stock options, and the option price may not be less than fair market value on the date of grant. During 2007, grants of 355,672 non-qualified stock options, 278,516 incentive stock options and 246,675 restricted stock awards were made to employees and non-employee directors. A total of 3,924 stock options were forfeited during the nine months ended September 30, 2007. There were no stock options forfeited during the three months ended September 30, 2007. The stock options and restricted stock awards vest over a five year period and are not subject to performance criteria. No stock options have vested as of September 30, 2007 and, accordingly, no stock options granted under the Stock Incentive Plan have been exercised as of September 30, 2007. Upon exercise, it is anticipated that new shares will be issued to the option holder.

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Total stock-based compensation expense recognized in the consolidated statement of operations and comprehensive income for the three and nine months ended September 30, 2007 is shown in the following table (unaudited, in thousands):

	Three Months Ended September 30, 2007		Nine Months Ended September 30, 2007
Stock compensation expense related to:
Stock options	$	137	$	403
Restricted stock		180		524
Total related tax benefit		91		265
Total unrecognized compensation expense	$	5,328	$	5,328

As of September 30, 2007, total unrecognized stock compensation expense related to non-vested stock options and restricted stock totaled $2.3 million and $3.0 million, respectively, which is expected to be recognized over a weighted average period of approximately 51.0 months. As of September 30, 2007, all stock options and restricted stock are unvested.

The fair values of stock options granted during the three and nine months ended September 30, 2007 were determined on the dates of grant using a lattice-based binomial option valuation model with the following assumptions:

	2007
Expected terms (years)		9.76
Expected stock price volatility		35.00	%
Risk-free interest rate		4.52	%
Expected dividend yield		3.00	%
Weighted average fair value per option	$	5.06

The expected life shown above was imputed based upon the combination of vesting provisions and the termination, retirement and early exercise assumptions input to the binomial option valuation model. As trading in the Company’s stock began in June 2006, the expected stock price volatility reflects a weighting of the average historical volatility over a 10-year period for 17 comparable companies and the average 6-month implied volatility for those comparable companies with listed options. A yield curve of risk free interest rates was developed for each valuation date based on quoted prices of US Treasury STRIPs.

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 expense in the Company’s consolidated statements of operations and comprehensive income over the requisite service period of the entire award. Compensation expense 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.

The following table summarizes stock option activity for the three and nine months ended September 30, 2007 (unaudited):

Three Months Ended September 30, 2007

	Shares Subject to Options	Weighted Average Exercise Price per Share		Weighted Average Remaining Contractual Life (years)	Aggregate Intrinsic Value (in thousands)
Outstanding at July 1, 2007	612,764	$	14.35	9.51	$	944
Granted	17,500		15.14
Forfeited	—		—
Exercised	—		—
Cancelled	—		—
Outstanding at September 30, 2007	630,264	$	14.37	9.30	$	690
Exercisable at September 30, 2007	—		—	—		—

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Nine Months Ended September 30, 2007

	Shares Subject to Options		Weighted Average Exercise Price per Share		Weighted Average Remaining Contractual Life (years)	Aggregate Intrinsic Value (in thousands)
Outstanding at January 1, 2007	—			—	—		—
Granted	634,188		$	14.37
Forfeited	(3,924	)		14.35
Exercised	—			—
Cancelled	—			—
Outstanding at September 30, 2007	630,264		$	14.37	9.30	$	690
Exercisable at September 30, 2007	—			—	—		—

The aggregate intrinsic value in the table above is before applicable income taxes, and is based on the Company’s closing stock price of $15.46 on September 30, 2007.

As of September 30, 2007, there were 117,236 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, 2007 (unaudited):

	Number Outstanding	Weighted Average Remaining Contractual Life (years)	Weighted Average Exercise Price per Share
Range of Exercise Prices
$14.35	608,840	9.26	$	14.35
$14.50	3,924	9.27	$	14.50
$14.86	7,500	9.72	$	14.86
$15.22	5,000	9.88	$	15.22
$15.47	5,000	9.92	$	15.47
Outstanding at September 30, 2007	630,264	9.30	$	14.37

The following table summarizes restricted stock activity for the three and nine months ended September 30, 2007 (unaudited):

Three Months Ended September 30, 2007

	Number of Shares	Weighted Average Remaining Contractual Life (years)
Outstanding at July 1, 2007	246,675	9.51
Granted	—
Forfeited	—
Exercised	—
Cancelled	—
Outstanding at September 30, 2007	246,675	9.26
Exercisable at September 30, 2007	—	—

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Nine Months Ended September 30, 2007

	Number of Shares	Weighted Average Remaining Contractual Life (years)
Outstanding at January 1, 2007	246,675	9.51
Granted	—
Forfeited	—
Exercised	—
Cancelled	—
Outstanding at September 30, 2007	246,675	9.26
Exercisable at September 30, 2007	—	—

7. Reserves for Unpaid Losses and Loss Adjustment Expenses

The following table provides a summary of the activity in the Company’s reserves for unpaid losses and LAE, excluding term life premium waiver reserves, for the three and nine months ended September 30, 2007 and 2006 (unaudited in thousands):

��

	Three Months Ended September 30,						Nine Months Ended September 30,
	2007			2006			2007			2006
Balance, beginning of period	$	125,650		$	114,877		$	121,397		$	38,730
Reinsurance recoverables on unpaid losses and LAE		24,663			27,147			24,236			23,912
Net balance, beginning of period		100,987			87,730			97,161			14,818
Net reserves acquired through acquisition of EHC		—			—			—			73,554
Purchase accounting adjustments on acquisition date		—			2,390			—			2,432
Incurred related to:
Current year		20,791			18,609			60,834			33,164
Prior year		862			(799	)		(2,167	)		(2,795	)
Total incurred before purchase accounting adjustments		21,653			17,810			58,667			30,369
Purchase accounting adjustments		(155	)		(269	)		(692	)		(311	)
Total incurred		21,498			17,541			57,975			30,058
Paid related to:
Current year		10,180			9,132			24,519			18,523
Prior year		7,540			4,583			25,852			8,393
Total paid		17,720			13,715			50,371			26,916
Net balance, end of period		104,765			93,946			104,765			93,946
Reinsurance recoverables on unpaid losses and LAE		24,261			26,052			24,261			26,052
Balance, end of period	$	129,026		$	119,998		$	129,026		$	119,998
Total reserves for unpaid for losses and loss adjustment expenses	$	133,910		$	125,302		$	133,910		$	125,302
Less: Term life premium waiver reserves		4,807			5,111			4,807			5,111
Less: Other		77			193			77			193
Balance, end of period	$	129,026		$	119,998		$	129,026		$	119,998

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Incurred losses by segment were as follows for the three and nine months ended September 30, 2007 (unaudited, in thousands):

Three Months Ended September 30, 2007

	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Group Benefits Insurance Segment		Specialty Reinsurance Segment		Total
Incurred related to:
Current year, gross of discount	$	8,641		$	4,535		$	6,000	$	1,725	$	20,901
Current period discount		(60	)		(50	)		—		—		(110	)
Prior year, gross of discount		(2,252	)		(1,133	)		206		4,056		877
Accretion of prior period discount		(23	)		8			—		—		(15	)
Total incurred before purchase accounting adjustments		6,306			3,360			6,206		5,781		21,653
Purchase accounting adjustments		(137	)		(26	)		—		8		(155	)
Total incurred	$	6,169		$	3,334		$	6,206	$	5,789	$	21,498

Nine Months Ended September 30, 2007

	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Group Benefits Insurance Segment			Specialty Reinsurance Segment		Total
Incurred related to:
Current year, gross of discount	$	25,449		$	12,204		$	18,785		$	5,844	$	62,282
Current period discount		(979	)		(469	)		—			—		(1,448	)
Prior year, gross of discount		(4,500	)		(2,158	)		(1,091	)		4,418		(3,331	)
Accretion of prior period discount		787			377			—			—		1,164
Total incurred before purchase accounting adjustments		20,757			9,954			17,694			10,262		58,667
Purchase accounting adjustments		(621	)		(106	)		—			35		(692	)
Total incurred	$	20,136		$	9,848		$	17,694		$	10,297	$	57,975

The Company’s results of operations include (unfavorable) favorable development on prior year reserves of $(862) and $2.2 million for the three and nine months ended September 30, 2007, respectively, compared to favorable development of $799 and $2.8 million for the same periods in 2006, respectively.

The favorable reserve development in the workers’ compensation insurance segment for the three and nine months ended September 30, 2007 relates primarily to a decrease in the prior accident period loss development factors used to estimate losses and LAE. The decrease in accident period loss development factors relates primarily to significant prior year claim settlements during 2007 for amounts at, or less than, previously established case and IBNR reserves. In the aggregate, the claims were closed at amounts lower than the provision established for IBNR claims.

The unfavorable reserve development in the group benefits insurance segment for the three months ended September 30, 2007 primarily reflects the impact of changes in the long-term disability tabular reserves during the third quarter of 2007. The favorable reserve development for the nine months ended September 30, 2007 primarily reflects better than expected claim experience in the dental and short-term disability lines.

The favorable reserve development in the segregated portfolio cell reinsurance segment for the three and nine months ended September 30, 2007 relates primarily to a decrease in the prior accident period loss development factors used to estimate losses and LAE. The decrease in accident period loss development factors relates primarily to significant prior year claim settlements during 2007 for amounts at, or less than, previously established case and IBNR reserves. In the aggregate, the claims were closed at amounts lower than the provision established for IBNR claims.

The unfavorable reserve development in the specialty reinsurance segment for the three and nine months ended September 30, 2007 is related to an increase in reported claims from the ceding company during the third quarter of 2007. Approximately 65% of the unfavorable loss reserve development in 2007 relates to the EIA liability product. Aggregate case reserves and paid losses as reported by the ceding company increased 22.4% during the third quarter of 2007 for all underwriting years included in the reinsurance treaty.

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8. Reinsurance

Effective June 30, 2007, the Company terminated the coinsurance agreement between ELH and London Life Reinsurance Company and the related stop loss reinsurance agreement between ELH and London Life International Reinsurance Corporation. These agreements were terminated as a result of A.M. Best upgrading its financial strength rating of ELH from “B++” (Very Good) to “A-” (Excellent). The termination of these agreements did not have any impact on the Company’s financial condition or results of operations. The Company recognized fees related to these agreements totaling $0 and $30 for the three and nine months ended September 30, 2007 and $15 and $45 for the three and nine months ended September 30, 2006, respectively.

9. Segment Information

The Company’s current operations are organized into the five following business segments. As a result of the acquisition of EHC, the Company has three new business segments: worker’s compensation insurance, segregated portfolio cell reinsurance and specialty reinsurance.

Workers’ Compensation Insurance

Workers’ compensation insurance is underwritten through Eastern Alliance and Allied Eastern, both Pennsylvania domiciled insurance companies, which provide insurance coverage to businesses in rural and suburban Pennsylvania, Maryland and Delaware. Eastern Alliance and Allied Eastern distribute their products and services through a network of independent agents. Fronting fees earned by Eastern Alliance and Allied Eastern on the segregated portfolio cell reinsurance business are reported in the workers’ compensation insurance segment.

Segregated Portfolio Cell Reinsurance

The Company provides a variety of services to self-insured workers’ compensation plans including program design, fronting, claims adjusting, investment management, and cell rental services at Eastern Re. The primary insurance coverage for the segregated portfolio cell program is underwritten by Eastern Alliance and Allied Eastern and ceded 100% to Eastern Re. Eastern Re currently provides cell rental facilities and Eastern Alliance and Allied Eastern provide fronting services to 13 customers. Fronting fees earned by Eastern Alliance and Allied Eastern on the segregated portfolio cell reinsurance business are reported in the workers’ compensation insurance segment. Outstanding loss reserves and unearned premiums under the segregated portfolio cell programs are collateralized by letters of credit provided by the segregated portfolio dividend participants.

Group Benefits Insurance

Group benefits insurance, which includes dental, short and long-term disability, and term life insurance products are underwritten through ELH. The group benefits insurance products are primarily marketed to small and medium sized businesses, primarily in the Mid-Atlantic, Southeast, and Midwest regions of the United States. ELH distributes its products through a network of independent producers.

Specialty Reinsurance

Specialty reinsurance is underwritten through Eastern Re. Eastern Re assumes business through its participation in reinsurance treaties with an unaffiliated insurance company related to an underground storage tank insurance program, referred to as “EnviroGuard,” and a non-hazardous waste transportation product, referred to as “EIA Liability” (“EIA”). The EnviroGuard program provides coverage to underground tank owners for third party off-site bodily injury and property damage claims as well as clean-up coverage and first party on-site claims. The EIA program provides commercial automobile liability coverage for non-hazardous waste haulers.

Corporate/Other

The corporate/other segment consists of the operating results of Employers Alliance. This segment also includes the operations of EIHI, EHC, Eastern Services and Global Alliance and certain eliminations necessary to reconcile the segment information to the consolidated statements of operations and comprehensive income (loss).

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The following table represents the segment results for the three months ended September 30, 2007 (unaudited, in thousands):

	Workers’ Compensation Insurance		Segregated Portfolio Cell Reinsurance		Group Benefits Insurance		Specialty Reinsurance			Corporate/ Other			Total
Revenue:
Net premiums earned	$	15,217	$	6,078	$	9,064	$	3,905		$	—		$	34,264
Net investment income		1,100		334		795		379			1,274			3,882
Net realized investment gains		133		22		422		—			13			590
Other revenue		—		—		—		121			58			179
Total revenue		16,450		6,434		10,281		4,405			1,345			38,915
Expenses:
Losses and loss adjustment expenses incurred		6,160		3,336		6,174		5,789			—			21,459
Acquisition and other underwriting expenses		1,107		1,924		1,389		1,132			(1,455	)		4,097
Other expenses		2,271		187		1,197		181			2,616			6,452
Amortization of intangibles		—		—		—		—			434			434
Policyholder dividend expense		95		—		—		—			—			95
Segregated portfolio dividend expense		—		987		—		—			567			1,554
Total expenses		9,633		6,434		8,760		7,102			2,162			34,091
Income (loss) before income taxes		6,817		—		1,521		(2,697	)		(817	)		4,824
Income tax expense (benefit)		1,938		—		291		(1,207	)		241			1,263
Net income (loss)		4,879	$	—	$	1,230	$	(1,490	)	$	(1,058	)	$	3,561
Total assets	$	204,981	$	50,400	$	111,000	$	50,038		$	(23,257	)	$	393,162

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The following table represents the segment results for the nine months ended September 30, 2007 (unaudited, in thousands):

	Workers’ Compensation Insurance		Segregated Portfolio Cell Reinsurance		Group Benefits Insurance		Specialty Reinsurance			Corporate/ Other			Total
Revenue:
Net premiums earned	$	40,876	$	17,010	$	26,578	$	10,762		$	—		$	95,226
Net investment income		3,475		967		2,365		1,154			2,139			10,100
Net realized investment gains (losses)		744		181		1,347		(5	)		54			2,321
Other revenue		—		—		—		525			(8	)		517
Total revenue		45,095		18,158		30,290		12,436			2,185			108,164
Expenses:
Losses and loss adjustment expenses incurred		20,125		9,850		17,696		10,297			—			57,968
Acquisition and other underwriting expenses		2,683		5,093		4,159		2,861			(3,530	)		11,266
Other expenses		5,867		395		3,969		539			7,207			17,977
Amortization of intangibles		—		—		—		—			1,303			1,303
Policyholder dividend expense		349		—		—		—			—			349
Segregated portfolio dividend expense		—		2,820		—		—			126			2,946
Total expenses		29,024		18,158		25,824		13,697			5,106			91,809
Income (loss) before income taxes		16,071		—		4,466		(1,261	)		(2,921	)		16,355
Income tax expense (benefit)		4,836		—		1,309		(704	)		(112	)		5,329
Net income (loss)	$	11,235	$	—	$	3,157	$	(557	)	$	(2,809	)	$	11,026
Total assets	$	204,981	$	50,400	$	111,000	$	50,038		$	(23,257	)	$	393,162

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The following table represents the segment results for the three months ended September 30, 2006 (unaudited, in thousands):

For the Three Months Ended September 30, 2006

	Workers’ Compensation Insurance		Segregated Portfolio Cell Reinsurance		Group Benefits Insurance		Specialty Reinsurance		Corporate/ Other			Total
Revenue:
Net premiums earned	$	10,726	$	5,404	$	8,263	$	2,285	$	—		$	26,678
Net investment income		956		234		790		351		643			2,974
Net realized investment gains (losses)		9		315		367		23		(3	)		711
Other revenue		—		—		—		136		43			179
Total revenue		11,691		5,953		9,420		2,795		683			30,542
Expenses:
Losses and loss adjustment expenses incurred		7,663		2,823		5,009		1,938		(1	)		17,432
Acquisition and other underwriting expenses		458		1,197		1,251		194		(1,391	)		1,709
Other expenses		1,602		66		1,513		167		1,893			5,241
Amortization of intangibles		—		—		—		—		511			511
Policyholder dividend expense		113		—		—		—		—			113
Segregated portfolio dividend expense		—		1,867		—		—		(346	)		1,521
Total expenses		9,836		5,953		7,773		2,299		666			26,527
Income before income taxes		1,855		—		1,647		496		17			4,015
Income tax expense		759		—		613		173		168			1,713
Net income (loss)	$	1,096	$	—	$	1,034	$	323	$	(151	)	$	2,302
Total assets	$	143,703	$	44,176	$	111,934	$	42,914	$	25,651		$	368,378

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The following table represents the segment results for the nine months ended September 30, 2006, which reflects the results of operations of EIHI and ELH for the nine months ended September 30, 2006 and the results of operations of EHC for the period from June 17, 2006 to September 30, 2006 (unaudited, in thousands):

For the Nine Months Ended September 30, 2006

	Workers’ Compensation Insurance		Segregated Portfolio Cell Reinsurance		Group Benefits Insurance		Specialty Reinsurance			Corporate/ Other			Total
Revenue:
Net premiums earned	$	11,825	$	6,180	$	25,243	$	2,611		$	—		$	45,859
Net investment income		1,110		277		2,734		430			718			5,269
Net realized investment gains (losses)		9		315		1,318		(7	)		(3	)		1,632
Other revenue		—		—		—		147			55			202
Total revenue		12,944		6,772		29,295		3,181			770			52,962
Expenses:
Losses and loss adjustment expenses incurred		8,418		3,295		15,959		2,180			(32	)		29,820
Acquisition and other underwriting expenses		443		1,379		3,824		190			(1,695	)		4,141
Other expenses		1,820		69		4,758		192			3,384			10,223
Amortization of intangibles		—		—		—		—			588			588
Policyholder dividend expense		184		—		—		—			—			184
Segregated portfolio dividend expense		—		2,029		—		—			(383	)		1,646
Total expenses		10,865		6,772		24,541		2,562			1,862			46,602
Income (loss) before income taxes		2,079		—		4,754		619			(1,092	)		6,360
Income tax expense (benefit)		828		—		1,684		216			(117	)		2,611
Net income (loss)	$	1,251	$	—	$	3,070	$	403		$	(975	)	$	3,749
Total assets	$	143,703	$	44,176	$	111,934	$	42,914		$	25,651		$	368,378
	��

10. Quarterly Dividends

The Company paid quarterly dividends totaling $580 and $1,160 to shareholders for the three and nine months ended September 30, 2007.

On September 26, 2007, the Company announced the payment of a quarterly dividend to shareholders of record at the close of business on October 1, 2007. The dividend was approved by the Pennsylvania Insurance Department and was paid on October 15, 2007, totaling $580. Any future dividends must also be approved by the Pennsylvania Insurance Department through June 16, 2009.

11. Commitments and Contingencies

Legal Proceedings

The Company is subject to legal proceedings and claims that arise in the ordinary course of its business and have not been finally adjudicated. Although there can be no assurance as to the ultimate disposition of these matters, it is the opinion of the Company’s management, based upon the information available at this time, that the expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the Company’s results of operations or financial condition.

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

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the unaudited interim consolidated financial statements of Eastern Insurance Holdings, Inc. (the “Company”) and the related notes thereto included in Item 1 of this Part 1. The information contained in this quarterly report is not a complete description of the Company’s business or the risks associated with an investment in the Company’s common stock. You should carefully review and consider the various disclosures made by the Company in this quarterly report and in the Company’s Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission on April 2, 2007.

The Company’s results of operations for the nine months ended September 30, 2007 include the financial results of the workers’ compensation insurance, segregated portfolio cell reinsurance, group benefits insurance, specialty reinsurance and corporate/other segments. As the acquisition of Eastern Holding Company, Ltd. (“EHC”) was not consummated until June 16, 2006, the Company’s results of operations for the nine months ended September 30, 2006 include the financial results of the group benefits insurance segment and EIHI’s and ELH’s corporate activities for the nine months ended September 30, 2006 and the financial results of the workers’ compensation insurance segment, segregated portfolio cell reinsurance segment, specialty reinsurance segment, and EHC’s corporate activities for the period from June 17, 2006 to September 30, 2006.

Forward-looking Statements

The Company may from time to time make written or oral “forward-looking statements,” including statements contained in the Company’s filings with the U.S. Securities and Exchange Commission (including this Quarterly Report on Form 10-Q and the exhibits hereto), in its reports to shareholders and in other communications by the Company, which are made in good faith by the Company pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements include statements with respect to the Company’s beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, that are subject to significant risks and uncertainties, and are subject to change based on various factors (some of which are beyond the Company’s control). The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause the Company’s financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements:

• the ability to carry out business plans;

• future economic conditions in the regional and national markets in which the Company competes that are less favorable than expected;

• the effect of legislative, judicial, economic, demographic and regulatory events in the states in which the Company does business;

• the ability to obtain licenses and enter new markets successfully and capitalize on growth opportunities either through mergers or the expansion of the Company’s producer network;

• financial market conditions, including, but not limited to, changes in interest rates and the stock markets causing a reduction of investment income or investment gains, an acceleration of the amortization of deferred policy acquisition costs, reduction in the value of the Company’s investment portfolio or a reduction in the demand for the Company’s products;

• the impact of acts of terrorism and acts of war;

• the effects of terrorist related insurance legislation and laws;

• changes in general economic conditions, including inflation, unemployment, interest rates and other factors;

• the cost, availability and collectability of reinsurance;

• estimates and adequacy of loss reserves and trends in losses and loss adjustment expenses;

• heightened competition, including specifically the intensification of price competition, increased underwriting capacity and the entry of new competitors and the development of new products by new and existing competitors;

• the effects of mergers, acquisitions and dispositions;

• changes in the coverage terms selected by insurance customers, including higher deductibles and lower limits;

• changes in the underwriting criteria that the Company uses resulting from competitive pressures;

• the Company’s inability to obtain regulatory approval of, or to implement, premium rate increases;

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• the potential impact on the Company’s reported net income that could result from the adoption of future accounting standards issued by the FASB or other standard setting bodies;

• the Company’s inability to carry out marketing and sales plans, including, among others, development of new products or changes to existing products and acceptance of the new or revised products in the market;

• unanticipated changes in industry trends and ratings assigned by nationally recognized rating organizations;

• adverse litigation or arbitration results; and

• adverse changes in applicable laws, regulations or rules governing insurance holding companies and insurance companies, and tax or accounting matters including limitations on premium levels, increases in minimum capital and reserves, and other financial viability requirements, and changes that affect the cost of, or demand for our products.

The Company cautions that the foregoing list of important factors is not exclusive. Readers are also cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date of this report. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company.

Overview

The Company reported net income of $3.6 million and $11.0 million for the three and nine months ended September 30, 2007, respectively, reflecting positive operating results in the workers’ compensation insurance and group benefits insurance segments. The workers’ compensation insurance segment reported a combined ratio of 63.3% and 71.0% and the group benefits insurance segment reported a combined ratio of 96.6% and 97.2% for the three and nine months ended September 30, 2007, respectively. The specialty reinsurance segment reported a net loss of $1.5 million and $557,000 for the three and nine months ended September 30, 2007, respectively, reflecting unfavorable development on prior accident year reserves. The results of the corporate/other segment primarily reflect the impact of the Company’s stock compensation plans and intangible asset amortization.

Workers’ Compensation Insurance

Direct premiums written for the nine months ended September 30, 2007 were 5.6% higher than direct premiums written for the same period in 2006. The increase in direct premiums written primarily reflects new business sales, a favorable renewal retention rate and expansion into Maryland and Delaware. These factors more than offset renewal rate decreases and overall pricing competition resulting from current market conditions.

Segregated Portfolio Cell Reinsurance

The segregated portfolio cell reinsurance segment has thirteen programs as of September 30, 2007. Of the thirteen programs, two are in run-off. Fee based revenue generated by this segment for the nine months ended September 30, 2007 decreased compared with the same period in 2006. The decrease in fee based revenue was a result of a decrease in assumed premium during 2007. Assumed premium decreased due to the continuation of soft market conditions which resulted in decreased new business production and renewal rate decreases, partially offset by favorable retention rates.

Group Benefits Insurance

The results of the group benefits insurance segment for the three and nine months ended September 30, 2007 reflect the impact of new business sales and an improved renewal retention rate from 2006 to 2007. The expense ratio for the three and nine months ended September 30, 2007 improved 5.0 percentage points and 3.4 percentage points, respectively, compared to the same period in 2006. The improvement in the expense ratio was offset by an increase in the loss ratio of 7.5 percentage points and 3.4 percentage points for the three and nine months ended September 30, 2007, respectively, compared to the same period in 2006. The increase in the loss ratio primarily reflects the impact of a higher loss ratio on new dental business.

Specialty Reinsurance

The specialty reinsurance segment’s results reflect the activity related to the Company’s reinsurance contracts with an unaffiliated insurance company. There were no material changes in the Company’s reinsurance contracts during the nine months ended September 30, 2007. During the third quarter of 2007, the Company experienced a significant increase in the amount of reported claims from the ceding company, which had an unfavorable impact on its 2007 financial results. The increase in the reported claims resulted in unfavorable reserve development on prior accident years of $4.1 million.

Principal Revenue and Expense Items

The Company derives its revenue primarily from net premiums earned, including assumed premiums earned, net investment income and net realized investment gains.

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Direct and net premiums written. Direct premiums written is the sum of both direct premiums and assumed premiums before the effect of ceded reinsurance. Direct premiums written include all premiums billed during a specified policy period. Net premiums written is the difference between direct premiums written and premiums ceded or paid to reinsurers (ceded premiums written). In the specialty reinsurance segment, assumed premiums are premiums that are received from another company under a reinsurance agreement, which are reported to the Company directly from the broker on a quarterly basis. In the segregated portfolio cell reinsurance segment, assumed premiums are derived from insurance contracts written by EAIG and ceded to the segregated portfolio cells at Eastern Re.

Net premiums earned.Net premiums earned are the earned portion of the Company’s net premiums written. Premiums are earned over the term of the related policies. At the end of each accounting period, the portion of the premiums that are not yet earned are included in unearned premiums and are realized as revenue in subsequent periods over the remaining term of the policy. The Company’s workers’ compensation policies typically have a term of twelve months. Thus, for example, for a policy that is written on July 1, 2006, one-half of the premiums would be earned in 2006 and the other half would be earned in 2007. Workers’ compensation premiums are determined based upon the payroll of the insured, the applicable premium rates and, where applicable, an experience based modification factor. An audit of the policyholders’ records is conducted after policy expiration, to make a final determination of applicable premiums. Included with net premiums earned is an estimate for earned but unbilled final audit premiums. The Company can estimate earned but unbilled premiums because it keeps track, by policy, of how much additional premium is billed in final audit invoices as a percentage to estimate the probable additional amount that it has earned but not yet billed as of the balance sheet date. The majority of the Company’s group benefits insurance policies are billed on a monthly basis with premiums being earned in the month in which coverage is provided. As a result, there is minimal unearned premium related to the group benefits insurance policies as of the balance sheet date.

Net investment income and realized gains and losses on investments. The Company invests its surplus and the funds supporting its insurance liabilities (including unearned premiums and unpaid losses and loss adjustment expenses) in cash, cash equivalents, fixed income securities, convertible bonds, equity securities, and other long-term investments. Investment income includes interest earned on invested assets. Realized gains and losses on invested assets are reported separately from net investment income. The Company recognizes realized gains when invested assets are sold for an amount greater than their cost or amortized cost (in the case of fixed income securities) and recognizes 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 cost or amortized cost.

Other revenue. Other revenue includes claim administration and risk management fees earned by Employers Alliance and cell rental fees earned by the specialty reinsurance segment. There are other revenue items that the Company recognizes on a segmental basis that are eliminated in consolidation. Such items consist primarily of fees paid by the segregated portfolio cells to other entities within the consolidated group. The segregated portfolio cells recognize an expense for such items (included as part of its ceding commission) and a corresponding revenue item is recognized by the affiliate providing the service. For segment reporting purposes, such revenue items primarily include fronting fees paid by the segregated portfolio cells to EAIG, claims administration and risk management fees paid by the segregated portfolio cells to Employers Alliance and cell rental fees paid by the segregated portfolio cells to Eastern Re. For segment reporting purposes, such fees are recognized ratably over the period in which the service is provided, which generally corresponds to the earned portion of net premiums written for the underlying policies.

The Company’s expenses consist primarily of:

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

Acquisition and other underwriting expenses.In the workers’ compensation and group benefits insurance segments, expenses incurred to underwrite risks are referred to as acquisition and other underwriting expenses, which consist primarily of commission expenses, premium taxes and fees and other underwriting expenses incurred in acquiring, writing and administering the Company’s business as well as required payments to the Pennsylvania Workers’ Compensation Security Fund (the “Security Fund”). The Security Fund assesses workers’ compensation insurers doing business in Pennsylvania for the purpose of providing funds to cover obligations to policyholders of insolvent insurance companies. In the specialty reinsurance and segregated portfolio cell reinsurance segments, acquisition and other underwriting expenses consist of ceding commissions earned under the respective reinsurance agreements. Ceding commissions received by EAIG are netted against other underwriting expenses.

Other expenses.Other expenses consist of general administrative expenses such as salaries, rent, office supplies, depreciation and all other operating expenses not otherwise classified separately. Other expenses also include interest expense related primarily to the Company’s junior subordinated debt.

Income tax expense. EIHI and certain of its subsidiaries pay federal, state and local income taxes. Income tax expense includes an amount for both current and deferred income taxes. Current income tax expense includes an amount for the Company’s current year federal income tax liability and any adjustments related to differences between the prior year federal income tax estimate and the actual income tax expense reported in the tax return. Deferred tax expense represents the change in the Company’s net deferred tax asset, exclusive of the tax effect related to changes in unrealized gains and losses in the Company’s investment portfolio and changes in the unrecognized amounts related to the Company’s benefit plan liabilities.

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Key Financial Measures

The Company evaluates its insurance operations by monitoring certain key measures of growth and profitability. The Company measures growth by monitoring changes in direct premiums written and net premiums written. The Company measures underwriting profitability by examining loss, expense and combined ratios. On a segmental basis, the Company measures a segment’s operating results by examining net income, diluted earnings per share, and return on average equity.

Loss ratio.The loss ratio is the ratio (expressed as a percentage) of losses and loss adjustment expenses incurred to net premiums earned and measures the underwriting profitability of a company’s insurance business. The Company measures the loss ratio on an accident year and calendar year loss basis to measure underwriting profitability. An accident year loss ratio measures losses and loss adjustment expenses for insured events occurring in a particular year, regardless of when they are reported, as a percentage of net premiums earned during that year. A calendar year loss ratio measures losses and loss adjustment expenses for insured events occurring during a particular year and the change in loss reserves from prior accident years as a percentage of net premiums earned during that year.

Expense ratio. The expense ratio is the ratio (expressed as a percentage) of the sum of the acquisition and other underwriting expenses and other expenses to net premiums earned, and measures the Company’s operational efficiency in producing, underwriting and administering its insurance business.

Combined ratio.The combined ratio is the sum of the loss ratio and the expense ratio and measures the Company’s overall underwriting profit. If the combined ratio is below 100%, the Company is making an underwriting profit. If the Company’s combined ratio is at or above 100%, the Company is not profitable without investment income and may not be profitable if investment income is insufficient.

Net premiums written to statutory surplus ratio.The net premiums written to statutory surplus ratio represents the ratio of net premiums written to statutory surplus. This ratio measures the Company’s insurance subsidiaries exposure to pricing errors in its current book of business. The higher the ratio, the greater the impact on surplus should pricing prove inadequate.

Net income, diluted earnings per share, and return on average equity.The Company uses net income and diluted earnings per share to measure its profits and return on average equity to measure its effectiveness in utilizing shareholders’ equity to generate net income. In determining return on average equity for a given year, net income is divided by the average of the beginning and ending shareholders’ equity for that year.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with U.S. GAAP requires both the use of estimates and judgment relative to the application of appropriate accounting policies. The Company is required to make estimates and assumptions in certain circumstances that affect amounts reported in the consolidated financial statements and related footnotes. The Company evaluates these estimates and assumptions on an on-going basis based on historical developments, market conditions, industry trends and other information that is believed to be reasonable under the circumstances. There can be no assurance that actual results will conform to the estimates and assumptions and that reported results of operations will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. The Company believes the following policies are the most sensitive to estimates and judgments.

Reserve for Losses and Loss Adjustment Expenses

The Company establishes reserves for unpaid losses and LAE for its workers’ compensation, segregated portfolio cell reinsurance, group benefits insurance, and specialty reinsurance products, which are estimates of future payments of reported and unreported claims for losses and related expenses. The adequacy of the Company’s reserves for unpaid losses and LAE are inherently uncertain because the ultimate amount that the Company may pay under many of the claims incurred as of the balance sheet date will not be known for many years. Establishing reserves continues to be a complex and imprecise process, requiring the use of informed estimates and judgments. The Company’s estimates and judgments may be revised as additional experience and other data becomes available and are reviewed, as new or improved methodologies are developed, or as current laws change. Any such revisions could result in future changes in estimates of losses or reinsurance recoverable and would be reflected in the Company’s results of operations in the period in which the estimates are changed. Estimating the ultimate claims liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management’s informed estimates and judgments using data currently available. If ultimate losses, net of reinsurance, prove to be substantially higher than the amounts recorded as of September 30, 2007, the related adjustments could have a material adverse effect on the Company’s financial condition, results of operations or liquidity.

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The Company’s reserves for unpaid losses and LAE in its workers’ compensation insurance, segregated portfolio cell reinsurance, group benefits insurance, and specialty reinsurance segments as of September 30, 2007 and December 31, 2006 are summarized below (unaudited, in thousands):

September 30, 2007	Workers’ Compensation Insurance			Segregated Portfolio Cell Reinsurance			Group Benefits Insurance		Specialty Reinsurance			Total
Case/tabular reserves	$	19,758		$	9,583		$	12,586	$	11,132		$	53,059
Case incurred development, IBNR, and unallocated LAE reserves		27,120			13,862			4,428		13,286			58,696
Amount of discount		(2,376	)		(1,172	)		—		—			(3,548	)
Net reserves		44,502			22,273			17,014		24,418			108,207
Reinsurance recoverables on unpaid losses and LAE		2,863			2,527			19,110		—			24,500
Purchase accounting adjustments		1,078			187			—		(62	)		1,203
Reserves for unpaid losses and LAE	$	48,443		$	24,987		$	36,124	$	24,356		$	133,910

December 31, 2006	Workers’ Compensation Insurance			Segregated Portfolio Cell Reinsurance			Group Benefits Insurance		Specialty Reinsurance			Total
Case/tabular reserves	$	18,057		$	8,216		$	13,397	$	8,985		$	48,655
Case incurred development, IBNR, and unallocated LAE reserves		25,910			13,992			4,143		10,523			54,568
Amount of discount		(2,183	)		(1,125	)		—		—			(3,308	)
Net reserves		41,784			21,083			17,540		19,508			99,915
Reinsurance recoverables on unpaid losses and LAE		1,475			2,893			20,289		—			24,657
Purchase accounting adjustments		1,699			293			—		(97	)		1,895
Reserves for unpaid losses and LAE	$	44,958		$	24,269		$	37,829	$	19,411		$	126,467

“Other Than Temporary” Investment Impairments

Unrealized investment gains or losses on investments carried at fair value, net of applicable income taxes, are reflected directly in shareholders’ equity as a component of comprehensive income (loss) and, accordingly, have no effect on net income. When, in the opinion of management, a decline in the fair value of an investment below its cost or amortized cost is considered to be “other-than-temporary,” such investment is written-down to its fair value. The amount written-down is recorded in earnings as a realized loss on investments. Generally, the determination of other-than-temporary impairment includes, in addition to other relevant factors, a presumption that if the market value is below cost by a significant amount for a period of time, a write-down is necessary. Notwithstanding this presumption, the determination of other-than-temporary impairment requires judgment about future prospects for an investment and is therefore a matter of inherent uncertainty. For the nine months ended September 30, 2007, the Company did not experience any declines in investment securities that were determined to be other-than-temporary. As of September 30, 2007, the Company held securities with gross unrealized losses of $478,000, of which $193,000 were in an unrealized loss position for more than 12 months. Adverse investment market conditions, or poor operating results of underlying investments, could result in impairment charges in the future. The Company generally applies the following standards in determining whether the decline in fair value of an investment is other-than-temporary:

Equities. If an equity security has a market value below 80% of cost and remains below 80% of cost for more than three months, a review of the financial condition and prospects of the issuer is performed to determine if the decline in market value is other-than-temporary. A specific determination is made for any such security. Other equity securities in an unrealized loss position not meeting these quantitative thresholds are evaluated considering, among other things, the magnitude and reasons for the decline and the prospects for the fair value of the securities to recover in the near term. If the decline in market value is judged to be other-than-temporary, then the cost basis of the security is written down to realizable value and the amount of the write down is accounted for as a realized loss. Realizable value is defined as the quoted market price of the security.

Fixed income securities. A fixed income security generally is written down if the Company is unable to hold or otherwise intends to sell a security with an unrealized loss, or if it is probable that it will be unable to collect all amounts due according to the contracted terms of a debt security not impaired at acquisition. A fixed maturity security review for collectability is done if any of the following situations occur:

• A review of the financial condition and prospects of the issuer indicates that the security should be evaluated;

• Moody’s or Standard & Poor’s rate the security below investment grade; or

• The security has a market value below 80% of amortized cost due to deterioration in credit quality.

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Deferred Acquisition Costs

Certain direct policy acquisition costs consisting of commissions, premium taxes, fronting fees and certain other direct underwriting costs are deferred and amortized as the underlying policy premiums are earned. As of September 30, 2007 and December 31, 2006, deferred policy acquisition costs and the related unearned premium reserves were as follows (unaudited, in thousands):

	September 30, 2007		December 31, 2006
Workers’ compensation insurance segment:
Deferred policy acquisition costs	$	2,272	$	1,232
Unearned premium reserves	$	31,736	$	21,336
Segregated portfolio cell reinsurance segment:
Deferred policy acquisition costs	$	3,063	$	1,496
Unearned premium reserves	$	11,148	$	6,330
Group benefits insurance segment:
Deferred policy acquisition costs	$	—	$	—
Unearned premium reserves	$	82	$	80
Specialty reinsurance segment:
Deferred policy acquisition costs	$	2,122	$	1,773
Unearned premium reserves	$	7,075	$	6,854

Deferred Income Taxes

The temporary differences between the tax and book bases of assets and liabilities are recorded as deferred income taxes. Management evaluates the recoverability of the net deferred tax asset based on historical trends of generating taxable income or losses, as well as expectations of future taxable income or loss. Management expects that the net deferred tax asset is fully recoverable. If this assumption were to change, any amount of the net deferred tax asset that the Company could not expect to recover would be provided for as an allowance and would be reflected as an increase in income tax expense in the period in which it was established.

Reinsurance Recoverables

Amounts recoverable from the Company’s reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Amounts paid for reinsurance contracts are expensed over the contract period during which insured events are covered by the reinsurance contracts. Reinsurance balances recoverable on paid and unpaid loss and loss adjustment expenses are reported separately as assets, instead of being netted with the appropriate liabilities, because reinsurance does not relieve the Company of its legal liability to its policyholders. Reinsurance balances recoverable are subject to credit risk associated with the particular reinsurer. Additionally, the same uncertainties associated with estimating unpaid losses and loss adjustment expenses affect the estimates for the ceded portion of these liabilities. The Company continually monitors the financial condition of its reinsurers.

Recent Accounting Pronouncements

SFAS 159

In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115.” SFAS 159 permits entities to elect to measure certain financial instruments at fair value with changes in fair value being reported in earnings. SFAS 159 can be applied on an instrument-by-instrument basis and is effective for all eligible financial instruments as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Retrospective application to prior years’ financial statements is not permitted. For eligible financial instruments existing at the effective date, and for which an entity elects the fair value option, the first remeasurement to fair value must be recorded as a cumulative effect adjustment to beginning retained earnings. The Company is currently evaluating the impact of adopting SFAS 159 on its consolidated financial condition and results of operations.

SFAS 157

In September 2006, the FASB issued SFAS 157, “Fair Value Measurements”. SFAS 157 clarifies the definition of fair value for purposes of financial reporting, specifies the methods to be used to measure fair value, and requires expanded disclosures related to fair value and financial instruments measured at fair value. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. Early application is encouraged, provided an entity has not yet issued financial statements for the fiscal year, including interim financial statements. Management is currently evaluating the impact of SFAS 157 on its current fair value disclosures. The Company expects that SFAS 157 will not have a material effect on its consolidated financial condition or results of operations.

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FIN 48

In July 2006, the FASB issued FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”), which provides criteria 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 Company adopted FIN 48 on January 1, 2007. The adoption of FIN 48 had no effect on the Company’s consolidated financial condition or results of operations. The Company has no uncertain tax positions as of September 30, 2007. All tax years subsequent to December 31, 2002 remain subject to examination by the Internal Revenue Service.

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THREE MONTHS ENDED SEPTEMBER 30, 2007 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2006

RESULTS OF OPERATIONS

The major components of consolidated revenue were as follows for the three months ended September 30, 2007 and 2006 (in thousands):

	2007		2006
Net premiums written	$	35,655	$	29,920
Net premiums earned	$	34,264	$	26,678
Net investment income		3,882		2,974
Net realized investment gains		590		711
Other revenue		179		179
Consolidated revenue	$	38,915	$	30,542

The increase in consolidated revenue reflects premium growth in the workers’ compensation insurance, group benefits insurance, and specialty reinsurance segments and an increase in investment income.

The components of consolidated net income (loss), by segment, for the three months ended September 30, 2007 and 2006 were as follows (in thousands):

	2007			2006
Workers’ compensation insurance	$	4,879		$	1,096
Segregated portfolio cell reinsurance		—			—
Group benefits insurance		1,230			1,034
Specialty reinsurance		(1,490	)		323
Corporate/other		(1,058	)		(151	)
Consolidated net income	$	3,561		$	2,302

The increase in consolidated net income primarily reflects a 28.4 percentage point decrease in the workers’ compensation insurance segment’s combined ratio, offset by the unfavorable reserve development on prior accident periods in the specialty reinsurance segment. The decrease in the workers’ compensation insurance segment’s combined ratio reflects a calendar period loss ratio of 40.5% for the three months ended September 30, 2007, compared to a calendar period loss ratio of 71.4% for the same period in 2006. The 2007 workers’ compensation insurance loss ratio reflects favorable reserve development on prior accident years of $2.3 million, or 15.1 percentage points, while the 2006 workers’ compensation insurance loss ratio was increased 12.9 percentage points related to purchase accounting adjustments .

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WORKERS’ COMPENSATION INSURANCE

The following table represents the operations of the workers’ compensation insurance segment for the three months ended September 30, 2007 and 2006 (unaudited, in thousands):

	2007			2006
Revenue:
Direct premiums written	$	25,510		$	22,546
Reinsurance premiums assumed		293			48
Ceded premiums written		(7,410	)		(8,125	)
Net premiums written		18,393			14,469
Change in unearned premiums		(3,176	)		(3,743	)
Net premiums earned		15,217			10,726
Net investment income		1,100			956
Net realized investment gains		133			9
Total revenue	$	16,450		$	11,691
Expenses:
Losses and loss adjustment expenses	$	6,160		$	7,663
Acquisition and other underwriting expenses		1,107			458
Other expenses		2,271			1,602
Policyholder dividend expense		95			113
Total expenses	$	9,633		$	9,836
Income before income taxes		6,817			1,855
Income tax expense		1,938			759
Net income	$	4,879		$	1,096

Net Income

The increase in net income reflects a decrease in the loss ratio and a reduction in the impact of purchase accounting charges in 2007 compared to 2006, partially offset by an increase in the expense ratio. Purchase accounting charges reduced net income in 2006 by $1.3 million compared to negligible purchase accounting adjustments in 2007.

The workers’ compensation insurance ratios were as follows for the three months ended September 30, 2007 and 2006:

	2007		2006
Loss and LAE ratio	40.5	%	71.4	%
Expense ratio	22.2	%	19.2	%
Policyholders’ dividend ratio	0.6	%	1.1	%
Combined ratio	63.3	%	91.7	%

Premiums

The increase in direct premiums written reflects favorable premium renewal retention rates and a decrease in the impact of purchase accounting charges recorded in 2007 compared to 2006, partially offset by a decrease in alternative market business production and renewal rate decreases of 3.9% in 2007. The premium renewal retention rate was 90.0% in 2007. Direct premiums written for the three months ended September 30, 2006 include a reduction of $2.8 million related to purchase accounting adjustments compared to no purchase accounting adjustments for the three months ended September 30, 2007. Alternative market direct written premium, before purchase accounting adjustments, was $5.7 million for the three months ended September 30, 2007 compared to $6.5 million for the same period in 2006.

Losses and Loss Adjustment Expenses

The decrease in the calendar period loss ratio reflects an increase in favorable loss reserve development on prior accident years for the three months ended September 30, 2007 compared to the same period in 2006, a decrease in the 2007 year-to-date accident period loss ratio from 62.0% to 60.0% during the third quarter of 2007 and a decrease in the impact of purchase accounting adjustments recorded in 2007 compared to 2006. Favorable loss reserve development on prior accident periods of $2.3 million and $600,000 was recorded for the three months ended September 30, 2007 and 2006, respectively. The favorable reserve development and the decrease in the 2007 accident period loss ratio relates primarily to a decrease in the current and prior accident period loss development factors used to estimate losses and LAE. The decrease in accident period loss development factors relates primarily to significant prior year claim settlements during 2007 for amounts at, or less than, previously established case and IBNR reserves. This decrease had the effect of lowering loss development factors as of September 30, 2007. For the three months ended September 30, 2007, the Company closed 69, or 13.9%, of the 495 open lost time claims as of December 31, 2006. In the aggregate, the claims were closed at amounts lower than the provision established for IBNR claims. Management believes that the realization of the benefits of its return-to-work

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controls coupled with strong economies in its underwriting territories during 2005, 2006, and 2007 enabled it to record losses and LAE that were lower than the amount reserved for claim settlements. The calendar period loss ratio of 71.4% in 2006 includes a current accident period loss ratio of 62.0% and 12.9 points related to purchase accounting adjustments recorded to net premiums earned and losses and loss adjustment expenses. Purchase accounting adjustments in 2007 had a negligible impact on the 2007 loss ratio. For the three months ended September 30, 2007 and 2006, there were no claims that exceeded the Company’s $500,000 reinsurance retention.

Acquisition and Other Underwriting Expenses

The increase in the expense ratio primarily reflects a reduction in the fee based revenue from the segregated portfolio cell reinsurance segment in 2007 compared to 2006. Fee based revenue from the segregated portfolio reinsurance cell segment is netted against acquisition and other underwriting expenses. Acquisition and other underwriting expenses also include agent commissions, estimated premium taxes and the estimated Security Fund assessment. The estimated premium taxes and Security Fund assessment are equal to 2.0% and 1.0% of direct premiums written, respectively.

Policyholder Dividends

Policyholder dividends represent payments to customers who purchased participating policies that produced favorable loss ratios. For the three months ended September 30, 2007 and 2006, 10.1% and 9.7%, respectively, of all policies were written on a dividend policy basis.

Net Investment Income

The increase in net investment income reflects an increase in the invested asset base. The average yield on the fixed income portfolio was 4.48% as of September 30, 2007, compared to an average yield of 4.46% as of September 30, 2006.

Net Realized Gains

Net realized gains in 2007 primarily reflect sales activity on equity securities.

Tax Expense

The effective tax rate for the three months ended September 30, 2007 was 28.4%. The primary difference between the statutory tax rate of 35% and the effective tax rate relates to a prior year tax return adjustment recorded during the third quarter of 2007 and tax exempt income on municipal securities.

SEGREGATED PORTFOLIO CELL REINSURANCE

The following table represents the operations of the segregated portfolio cell reinsurance segment for the three months ended September 30, 2007 and 2006 (unaudited, in thousands):

	2007				2006
Revenue:
Reinsurance premiums assumed	$	5,718			$	5,293
Ceded premiums written		(786	)			(268	)
Net premiums written		4,933				5,025
Change in unearned premiums		1,145				379
				��
Net premiums earned		6,078				5,404
Net investment income		334				234
Net realized investment gains		22				315
Total revenue	$	6,434			$	5,953
Expenses:
Losses and loss adjustment expenses	$	3,336			$	2,823
Acquisition and other underwriting expenses		1,924				1,197
Other expenses		187				66
Segregated portfolio dividend expense (1)		987				1,867
Total expenses	$	6,434			$	5,953
Net income (1)	$	—			$	—

(1) The workers’ compensation insurance, specialty reinsurance and corporate/other segments provide services to the segregated portfolio cell reinsurance segment. The fees paid by the segregated portfolio cell reinsurance segment for these services are included in the revenue of the segment providing the service. The segregated portfolio cell reinsurance segment records the fees associated with these services as ceding expense, which is included in its underwriting expenses. The difference between total revenue for the segregated portfolio cell reinsurance segment for each period and the sum of losses and loss adjustment expenses, underwriting expenses, policyholder dividend expenses and other expenses is accrued as a segregated portfolio dividend expense. As a result, the segregated portfolio cell reinsurance segment has no net income for the period presented in this table.

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The segregated portfolio cell reinsurance ratios were as follows for the three months ended September 30, 2007 and 2006:

	2007		2006
Loss and LAE ratio	54.9	%	52.2	%
Expense ratio	34.7	%	23.4	%
Combined ratio	89.6	%	75.6	%

Premiums

The increase in reinsurance premiums assumed reflects a reduction in the impact of purchase accounting charges in 2007 compared to 2006 partially offset by premium renewal retention rate decreases of 1.6% and a decrease in overall production from 2006 to 2007. Purchase accounting adjustments reduced reinsurance premiums assumed by $1.2 million for the three months ended September 30, 2006 compared to no purchase accounting adjustments in 2007. New business production was $625,000 for the three months ended September 30, 2007 compared to $789,000 for the same period in 2006. The premium renewal retention rate was 89.9% for the three months ended September 30, 2007.

Net premiums written for the three months ended September 30, 2006 include an increase of $508,000 related to the amortization of purchase accounting adjustments.

Losses and Loss Adjustment Expenses

The increase in the calendar year loss ratio from 2006 to 2007 relates to purchase accounting adjustments recorded in 2006 that reduced the calendar period loss ratio by 5.3 percentage points compared to negligible purchase accounting adjustments in 2007 partially offset by an increase in favorable loss reserve development in 2007 compared to 2006. Favorable loss reserve development recorded on prior accident years was $1.1 million for the three months ended September 30, 2007 compared to $611,000 for the same period in 2006. The favorable loss reserve development on prior accident years relates primarily to a decrease in the prior period loss development factors used to estimate losses and loss adjustment expenses. The decrease in accident period loss development factors relates primarily to significant prior year claim settlements during 2007 for amounts at, or less than, previously established case and IBNR reserves. This decrease had the effect of lowering loss development factors as of September 30, 2007.

Acquisition and Other Underwriting Expenses

The increase in the expense ratio from 2006 to 2007 relates primarily to purchase accounting adjustments recorded for the three months ended September 30, 2006 that reduced the expense ratio by 9.2 points compared to no purchase accounting adjustments in 2007. The expense ratio, without regard to the aforementioned purchase accounting adjustments, is consistent with the contractual ceding commissions for the three months ended September 30, 2006.

Segregated Portfolio Dividend Expense

The segregated portfolio dividend expense represents the amount of net income or loss in a specific period that may be payable to the segregated portfolio dividend participants.

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GROUP BENEFITS INSURANCE

The following table represents the operations of the group benefits insurance segment for the three months ended September 30, 2007 and 2006 (unaudited, in thousands):

	2007			2006
Revenue:
Direct premiums written	$	9,737		$	8,882
Ceded premiums written		(672	)		(618	)
Net premiums written		9,065			8,264
Change in unearned premiums		(1	)		(1	)
Net premiums earned		9,064			8,263
Net investment income		795			790
Net realized investment gains		422			367
Total revenues		10,281			9,420
Expenses:
Losses and loss adjustment expenses		6,174			5,009
Acquisition and other underwriting expenses		1,389			1,251
Other expenses		1,197			1,513
Total expenses		8,760			7,773
Income before income taxes		1,521			1,647
Income tax expense		291			613
Net income	$	1,230		$	1,034

Net Income

The increase in net income primarily reflects an increase in net premiums earned and a decrease in the expense ratio and the effective tax rate, offset by an increase in the loss ratio.

The group benefits insurance ratios were as follows for the three months ended September 30, 2007 and 2006:

	2007		2006
Loss and LAE ratio	68.1	%	60.6	%
Expense ratio	28.5	%	33.5	%
Combined ratio	96.6	%	94.1	%

Premiums

The increase in direct premiums written reflects the impact of new business sales and an improvement in the renewal retention rate. New business sales totaled $7.9 million for the nine months ended September 30, 2007, compared to $2.6 million for the same period in 2006. The renewal retention rate for the nine months ended September 30, 2007 improved 8.0 percentage points, from 76.8% in 2006 to 84.9% in 2007.

New business sales for the three months ended September 30, 2007 totaled $1.9 million, compared to $1.1 million for the same period in 2006. The renewal retention rate for the three months ended September 30, 2007 totaled 88.6%, compared to 81.9% for the same period in 2006.

Net premiums earned, by line of business, for the three months ended September 30, 2007 and 2006 were as follows (in thousands):

	2007		2006
Dental	$	5,564	$	4,810
Short-term disability		1,657		1,602
Long-term disability		413		468
Term life		1,430		1,383
Total	$	9,064	$	8,263

Net Investment Income

Net investment income remained consistent from 2006 to 2007. Net investment income includes the change in interest of other long-term investments, which decreased $26,000 for the three months ended September 30, 2007, compared to a decrease of $50,000 for the same period in 2006. The average yield on the group benefits insurance segment’s fixed income portfolio was 5.24% as of September 30, 2007, compared to 5.65% as of September 30, 2006. The decrease in the yield primarily reflects the maturity of higher coupon securities and the reinvestment of proceeds in lower yielding securities. The decrease in the yield was offset by an increase in the average balance of the fixed income portfolio from 2006 to 2007.

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Net Realized Investment Gains

The increase in net realized investment gains primarily reflects gains recognized on the sale of convertible bond securities, totaling $230,000, during the third quarter of 2007, offset by a decrease in the change in the fair value of convertible bond securities from 2006 to 2007. The increase in the fair value of convertible bond securities totaled $192,000 for the three months ended September 30, 2007, compared to an increase of $332,000 for the same period in 2006.

Losses and Loss Adjustment Expenses

The increase in losses and loss adjustment expenses reflects an increase in the calendar period loss ratio and the increase in net premiums earned from 2006 to 2007. The calendar period loss ratios, by line of business, for the three months ended September 30, 2007 and 2006 were as follows:

	2007		2006
Dental	68.7	%	62.6	%
Short-term disability	64.7	%	82.9	%
Long-term disability	61.4	%	(23.4	)%
Term life	70.2	%	54.0	%
Total group benefits	68.1	%	60.6	%

Dental

The increase in the calendar period loss ratio reflects an accident period loss ratio of 73.4% for the three months ended September 30, 2007, compared to 69.8% for the same period in 2006, and a decrease in favorable development on prior period reserves from 2006 to 2007, totaling $87,000. Favorable development reduced the calendar period loss ratio by 4.7 percentage points for the three months ended September 30, 2007, compared to 7.2 percentage points for the same period in 2006.

The increase in the accident period loss ratio from 2006 to 2007 primarily reflects a higher loss ratio on new business.

Short-term Disability

The decrease in the calendar period loss ratio reflects an accident period loss ratio of 74.2% for the three months ended September 30, 2007, compared to 85.5% for the same period in 2006 and an increase in favorable development on prior period reserves from 2006 to 2007, totaling $116,000. Favorable development reduced the calendar period loss ratio by 9.5 percentage points for the three months ended September 30, 2007, compared to 2.6 percentage points for the same period in 2006.

The decrease in the accident period loss ratio from 2006 to 2007 primarily reflects an 11.8% reduction in claim severity.

Long-term Disability

The increase in the loss ratio from 2006 to 2007 primarily reflects the termination of a large claim in 2006 with an outstanding reserve totaling $382,000 and a refinement in the calculation of the long-term disability tabular reserves during the third quarter of 2006. Excluding the impact of the termination of the large claim, the loss ratio for the three months ended September 30, 2006 would have been 58.3%.

The long-term disability line continued to experience favorable claim results during the third quarter of 2007, as reported reserves decreased $97,000, reflecting lower claim severity and the termination of prior period claims.

Term Life

The increase in the term life loss ratio reflects an increase in the death claim loss ratio, from 58.2% for the three months ended September 30, 2006 to 72.4% for the same period in 2007. In addition, premium waiver claim reserves decreased $32,000 in 2007, compared to a decrease of $59,000 in 2006.

Acquisition and Other Underwriting Expenses

The increase in acquisition and other underwriting expenses primarily reflects the increase in direct premiums written.

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Other Expenses

The decrease in other expenses primarily reflects the impact of expense reduction initiatives in 2006 and a revision in the allocation methodology of corporate salaries between the Company’s workers’ compensation insurance and group benefits insurance segments. The allocation methodology revision was implemented effective July 1, 2007 and reflects the continued integration of the Company’s operations.

Tax Expense

The decrease in tax expense reflects the reduction in pre-tax income and a decrease in the effective tax rate from 37.2% in 2006 to 19.1% in 2007. The 2007 effective tax rate primarily reflects the release of a contingency reserve that decreased tax expense by $200,000. The 2006 effective tax rate primarily reflects a prior year tax return adjustment that increased tax expense by $59,000.

SPECIALTY REINSURANCE

The following table represents the operations of the specialty reinsurance segment for the three months ended September 30, 2007 and 2006 (unaudited, in thousands):

	2007			2006
Revenue:
Reinsurance premiums assumed	$	3,263		$	2,163
Change in unearned premiums		641			122
Net premiums earned	$	3,905		$	2,285
Net investment income		379			351
Net realized investment gains		—			23
Other revenue		121			136
Total revenue	$	4,405		$	2,795
Expenses:
Losses and loss adjustment expenses	$	5,789		$	1,938
Acquisition and other underwriting expenses		1,132			194
Other expenses		181			167
Total expenses	$	7,102		$	2,299
(Loss) income before income taxes		(2,697	)		496
Income tax (benefit) expense		(1,207	)		173
Net (loss) income	$	(1,490	)	$	323

Net (Loss) Income

The decrease in net income to a net loss reflects the impact of after-tax unfavorable loss reserve development on prior accident years of $2.7 million partially offset by a reduction in the impact of purchase accounting charges in 2007 compared to 2006. Purchase accounting charges reduced net income in 2006 by $757,000 compared to no purchase accounting adjustments in 2007.

The specialty reinsurance ratios were as follows for the three months ended September 30, 2007 and 2006:

	2007		2006
Loss and LAE ratio	148.2	%	84.8	%
Expense ratio	33.6	%	15.8	%
Combined ratio	181.8	%	100.6	%

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Reinsurance Premiums Assumed

The increase in reinsurance premiums assumed relates to a reduction of the impact of purchase accounting charges in 2006 compared to 2007 partially offset by a decrease in production in the EIA liability product due to competitive pricing pressures. Purchase accounting adjustments reduced reinsurance premiums assumed by $1.5 million for the three months ended September 30, 2006 compared to no purchase accounting adjustments in 2007. Reinsurance premiums earned, by line of business, were as follows for the three months ended September 30, 2007 and 2006 (in thousands):

	2007		2006
EnviroGuard	$	3,582	$	2,728
EIA liability		148		1,073
Other		175		—
Purchase accounting adjustments		—		(1,516	)
Total assumed premiums earned	$	3,905	$	2,285

Losses and Loss Adjustment Expenses

The increase in the calendar period loss and loss adjustment expense ratio is related to an increase in reported claims from the ceding company during the third quarter of 2007. Unfavorable loss reserve development on prior accident years was $4.1 million and $279,000 for the three months ended September 30, 2007 and 2006, respectively. Approximately 65% of the unfavorable loss reserve development in 2007 relates to the EIA liability product. A review of the EIA liability detailed claim reports indicated significant case reserve increases on prior year claims. During 2007, EIA liability claim counts with total gross (before application of the applicable quota share percentage) incurred values greater than $1 million increased from 8 claims to 11 claims. EIA liability claim counts with total gross incurred values greater than $100,000 increased from 62 claims to 80 claims during 2007, an increase of 29.0%. Aggregate case reserves and paid losses as reported by the ceding company increased 22.4% during the third quarter of 2007 for all underwriting years included in the reinsurance treaty. The 2007 accident period loss and LAE ratios for EnviroGuard and EIA liability were 42.0% and 75.0%, respectively.

Acquisition and Other Underwriting Expenses

The increase in the expense ratio is related to a reduction in the impact of purchase accounting adjustments in 2007 compared to 2006. Purchase accounting adjustments reduced acquisition and other underwriting expenses by $946,000 in 2006 compared to no purchase accounting adjustments in 2007. As part of its quota share reinsurance agreement with the primary insurer, Eastern Re pays the primary insurer a ceding commission based on assumed premiums. For the three months ended September 30, 2007 and 2006, the ceding commission paid to the primary insurer was 30%.

Net Investment Income

Net investment income increased due to an increase in the size of the invested asset base. The average yield on the fixed income portfolio was 4.70% as of September 30, 2007, compared to an average yield of 4.47% as of September 30, 2006.

Tax Expense

The effective tax rate for the three months September 30, 2007 was 44.8%. The difference between the statutory rate of 35.0% and the effective tax rate relates to a prior year tax return adjustment recorded during the third quarter of 2007.

CORPORATE/OTHER

The corporate/other segment results for the three months ended September 30, 2007 include the impact of the Company’s stock incentive plans and ESOP and the amortization of intangible assets. Stock compensation expense and intangible asset amortization totaled $613,000 and $434,000 for the three months ended September 30, 2007, respectively. The corporate/other segment results for the three months ended September 30, 2006 include stock compensation expense of $261,000 and intangible asset amortization of $511,000.

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NINE MONTHS ENDED SEPTEMBER 30, 2007 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2006

RESULTS OF OPERATIONS

The major components of consolidated revenue were as follows for the nine months ended September 30, 2007 and 2006 (in thousands):

	2007		2006
Net premiums written	$	107,836	$	48,043
Net premiums earned	$	95,226	$	45,859
Net investment income		10,100		5,269
Net realized investment gains		2,321		1,632
Other revenue		517		202
Consolidated revenue	$	108,164	$	52,962

The increase in consolidated revenue primarily reflects the acquisition of EHC on June 16, 2006.

The components of consolidated net income, by segment, for the nine months ended September 30, 2007 and 2006 were as follows (in thousands):

	2007			2006
Workers’ compensation insurance	$	11,235		$	1,251
Segregated portfolio cell reinsurance		—			—
Group benefits insurance		3,157			3,070
Specialty reinsurance		(557	)		403
Corporate/other		(2,809	)		(975	)
Consolidated net income	$	11,026		$	3,749

The increase in consolidated net income primarily reflects the acquisition of EHC on June 16, 2006.

WORKERS’ COMPENSATION INSURANCE

The following table represents the operations of the workers’ compensation insurance segment for the nine months ended September 30, 2007 and 2006 (unaudited, in thousands):

	2007			2006
Revenue:
Direct premiums written	$	78,391		$	24,071
Reinsurance premiums assumed		1,078			51
Ceded premiums written		(29,393	)		(8,783	)
Net premiums written		50,076			15,339
Change in unearned premiums		(9,199	)		(3,514	)
Net premiums earned		40,876			11,825
Net investment income		3,475			1,110
Net realized investment gains		744			9
Total revenue	$	45,095		$	12,944
Expenses:
Losses and loss adjustment expenses	$	20,125		$	8,418
Acquisition and other underwriting expenses		2,683			443
Other expenses		5,867			1,820
Policyholder dividend expense		349			184
Total expenses	$	29,024		$	10,865
Income before income taxes		16,071			2,079
Income tax expense		4,836			828
Net income	$	11,235		$	1,251

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Net Income

The increase in net income reflects the acquisition of EHC on June 16, 2006, an increase in favorable loss reserve development on prior accident years, and a reduction in the impact of purchase accounting charges in 2007. Net income for the nine months ended September 30, 2007 and 2006 includes after-tax favorable loss reserve development on prior accident periods of $2.9 million and $390,000, respectively. Net income for the nine months ended September 30, 2006 includes an after-tax charge of $1.5 million related to the amortization of purchase accounting adjustments compared to negligible purchase accounting charges in 2007.

The workers’ compensation insurance ratios were as follows for the nine months ended September 30, 2007 and 2006:

	2007		2006
Loss and LAE ratio	49.2	%	71.2	%
Expense ratio	20.9	%	19.1	%
Policyholders’ dividend ratio	0.9	%	1.6	%
Combined ratio	71.0	%	91.9	%

Premiums

The increase in direct premiums written reflects the acquisition of EHC on June 16, 2006. Direct premiums written for traditional business and alternative markets were $55.4 million and $23.0 million, respectively, for the nine months ended September 30, 2007. Direct premiums written for the nine months ended September 30, 2007 include the impact of renewal rate decreases of 3.9%, a premium renewal retention rate of 90.0%, a reduction of $1.2 million related to the amortization of purchase accounting adjustments and audit premiums of $1.6 million.

Losses and Loss Adjustment Expenses

The decrease in the calendar period loss ratio reflects an increase in favorable loss reserve development on prior accident years for the nine months ended September 30, 2007 compared to the same period in 2006, a decrease in the 2007 year-to-date accident period loss ratio from 62.0% to 60.0% during the third quarter of 2007 and a decrease in the impact of purchase accounting adjustments recorded in 2007 compared to 2006. Favorable loss reserve development on prior accident periods of $4.5 million and $600,000 was recorded for the nine months ended September 30, 2007 and September 30, 2006, respectively. The favorable loss reserve development on prior accident years and the decrease in the 2007 accident period loss ratio during the third quarter relates primarily to a decrease in the current and prior accident period loss development factors used to estimate losses and LAE. The decrease in accident period loss development factors relates primarily to significant prior year claim settlements during 2007 for amounts at, or less than, previously established case and IBNR reserves. This decrease had the effect of lowering loss development factors as of September 30, 2007. For the nine months ended September 30, 2007, the Company closed 211, or 42.6%, of the 495 open lost time claims as of December 31, 2006. In the aggregate, the claims were closed at amounts lower than the provision established for IBNR claims. Management believes that the realization of the benefits of its return-to-work controls coupled with strong economies in its underwriting territories during 2005, 2006, and 2007 enabled it to record losses and LAE that were lower than the amount reserved for claim settlements. The calendar period loss ratio of 71.2% for the nine months ended September 30, 2006 includes a current accident period loss ratio of 62.0% and 12.9 points related to purchase accounting adjustments recorded to premiums earned and loss and loss adjustment expenses. Purchase accounting adjustments in 2007 had a negligible impact on the 2007 loss ratio. For the nine months ended September 30, 2007, there was one claim that exceeded the Company’s $500,000 reinsurance retention. There were no claims that exceeded the Company’s $500,000 reinsurance retention for the nine months ended September 30, 2006.

Acquisition and Other Underwriting Expenses

The increase in the expense ratio primarily reflects a reduction in fee based revenue from the segregated portfolio cell reinsurance segment in 2007 compared to 2006. Fee based revenue from the segregated portfolio reinsurance cell segment is netted against acquisition and other underwriting expenses. Acquisition and other underwriting expenses also include agent commissions, estimated premium taxes and the estimated Security Fund assessment. The estimated premium taxes and Security Fund assessment are equal to 2.0% and 1.0% of direct premiums written, respectively.

Policyholder Dividends

The increase in policyholder dividend expense reflects the acquisition of EHC on June 16, 2006. Policyholder dividends represent payments to customers who purchased participating policies that produced favorable loss ratios. For the nine months ended September 30, 2007 and 2006, 10.1% and 9.7%, respectively, of all policies were written on a dividend policy basis.

Net Investment Income

The increase in investment income reflects the acquisition of EHC on June 16, 2006. The average yield on the fixed income portfolio was 4.48% as of September 30, 2007, compared to an average yield of 4.46% as of September 30, 2006.

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Net Realized Gains

Net realized gains primarily reflect sales activity on equity securities.

Tax Expense

The effective tax rate for the nine months ended September 30, 2007 was 30.1%. The primary difference between the statutory tax rate of 35% and the effective tax rate relates to a prior year tax return adjustment recorded during the third quarter of 2007, tax exempt income on municipal securities, and rehabilitation tax credits.

SEGREGATED PORTFOLIO CELL REINSURANCE

The following table represents the operations of the segregated portfolio cell reinsurance segment for the nine months ended September 30, 2007 and 2006 (unaudited, in thousands):

	2007			2006
Revenue:
Reinsurance premiums assumed	$	22,958		$	5,437
Ceded premiums written		(1,912	)		(382	)
Net premiums written		21,047			5,055
Change in unearned premiums		(4,037	)		1,125
Net premiums earned		17,010			6,180
Net investment income		967			277
Net realized investment gains		181			315
Total revenue	$	18,158		$	6,772
Expenses:
Losses and loss adjustment expenses	$	9,850		$	3,295
Acquisition and other underwriting expenses		5,093			1,379
Other expenses		395			69
Segregated portfolio dividend expense (1)		2,820			2,029
Total expenses	$	18,158		$	6,772
Net income (1)	$	—		$	—

(1) The workers’ compensation insurance, specialty reinsurance and corporate/other segments provide services to the segregated portfolio cell reinsurance segment. The fees paid by the segregated portfolio cell reinsurance segment for these services are included in the revenue of the segment providing the service. The segregated portfolio cell reinsurance segment records the fees associated with these services as ceding expense, which is included in its underwriting expenses. The difference between total revenue for the segregated portfolio cell reinsurance segment for each period and the sum of losses and loss adjustment expenses, underwriting expenses, policyholder dividend expenses and other expenses is accrued as a segregated portfolio dividend expense. As a result, the segregated portfolio cell reinsurance segment has no net income for the period presented in this table.

The segregated portfolio cell reinsurance ratios were as follows for the nine months ended September 30, 2007 and 2006:

	2007		2006
Loss and LAE ratio	57.9	%	53.3	%
Expense ratio	32.3	%	23.4	%
Combined ratio	90.2	%	76.7	%

Reinsurance Premiums Assumed

The increase in reinsurance premiums assumed reflects the acquisition of EHC on June 16, 2006. Reinsurance premiums assumed for the nine months ended September 30, 2007 include the impact of renewal rate decreases of 1.6%, a premium renewal retention rate of 89.9%, a reduction of $781,000 related to the amortization of purchase accounting adjustments, and audit premiums of $572,000.

Net premiums written for the nine months ended September 30, 2007 include an increase of $330,000 related to the amortization of purchase accounting adjustments.

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Losses and Loss Adjustment Expenses

The increase in the calendar year loss ratio from 2006 to 2007 relates to purchase accounting adjustments recorded in 2006 that reduced the calendar period loss ratio by 5.3 points compared to negligible purchase accounting adjustments in 2007 partially offset by an increase in favorable loss reserve development in 2007 compared to 2006. Favorable loss reserve development recorded on prior accident years was $2.2 million for the nine months ended September 30, 2007 compared to $611,000 for the nine months ended September 30, 2006. The favorable loss reserve development on prior accident years relates primarily to a decrease in the prior period loss development factors used to estimate losses and loss adjustment expenses. The decrease in accident period loss development factors relates primarily to significant prior year claim settlements during 2007 for amounts at, or less than, previously established case and IBNR reserves. This decrease had the effect of lowering loss development factors as of September 30, 2007.

Acquisition and Other Underwriting Expenses

The increase in the expense ratio from 2006 to 2007 relates primarily to purchase accounting adjustments recorded for the nine months ended September 30, 2006 that reduced the expense ratio by 9.2 points compared to negligible purchase accounting adjustments in 2007. The expense ratio, without regard to the aforementioned purchase accounting adjustments, is consistent with the contractual ceding commissions for the nine months ended September 30, 2006.

Segregated Portfolio Dividend Expense

The segregated portfolio dividend expense represents the amount of net income or loss in a specific period that may be payable to the segregated portfolio dividend participants.

GROUP BENEFITS INSURANCE

The following table represents the operations of the group benefits insurance segment for the nine months ended September 30, 2007 and 2006 (unaudited, in thousands):

	2007			2006
Revenue:
Direct premiums written	$	28,607		$	27,074
Ceded premiums written		(2,027	)		(1,853	)
Net premiums written		26,580			25,221
Change in unearned premiums		(2	)		22
Net premiums earned		26,578			25,243
Net investment income		2,365			2,734
Net realized investment gains		1,347			1,318
Total revenues		30,290			29,295
Expenses:
Losses and loss adjustment expenses		17,696			15,959
Acquisition and other underwriting expenses		4,159			3,824
Other expenses		3,969			4,758
Total expenses		25,824			24,541
Income before income taxes		4,466			4,754
Income tax expense		1,309			1,684
Net income	$	3,157		$	3,070

Net Income

The increase in net income primarily reflects an increase in net premiums earned and a decrease in the expense ratio and the effective tax rate, offset by an increase in the loss ratio.

The group benefits insurance ratios were as follows for the nine months ended September 30, 2007 and 2006:

	2007		2006
Loss and LAE ratio	66.6	%	63.2	%
Expense ratio	30.6	%	34.0	%
Combined ratio	97.2	%	97.2	%

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Premiums

The increase in direct premiums written reflects the aforementioned impact of new business sales and improvement in the renewal retention rate.

Net premiums earned, by line of business, for the nine months ended September 30, 2007 and 2006 were as follows (in thousands):

	2007		2006
Dental	$	16,097	$	14,699
Short-term disability		4,962		4,865
Long-term disability		1,263		1,456
Term life		4,256		4,223
Total	$	26,578	$	25,243

Net Investment Income

The decrease in net investment income primarily reflects the change in interest of other long-term investments. The interest in other long-term investments decreased $150,000 for the nine months ended September 30, 2007, compared to an increase of $146,000 for the same period in 2006.

The average yield on the group benefits insurance segment’s fixed income portfolio was 5.24% as of September 30, 2007, compared to 5.65% as of September 30, 2006. The decrease in the yield primarily reflects the maturity of higher coupon securities and the reinvestment of proceeds in lower yielding securities. The decrease in the yield was offset by an increase in the average balance of the fixed income portfolio from 2006 to 2007.

Net Realized Investment Gains

The increase in net realized investment gains reflects an increase in gains recognized from the sale of securities, offset by a decrease in the change in fair value of convertible bond securities. Gains recognized on the sale of securities during 2007 primarily reflect the sale of convertible bond securities, an equity portfolio, and an interest in a limited partnership investment, while the gains recognized in 2006 primarily reflect the sale of an equity security totaling $716,000. The fair value of convertible bond securities decreased $72,000 for the nine months ended September 30, 2007, compared to an increase of $241,000 for the same period in 2006.

Losses and Loss Adjustment Expenses

The increase in losses and loss adjustment expenses reflects an increase in the calendar period loss ratio and the increase in net premiums earned from 2006 to 2007. The calendar period loss ratios, by line of business, for the nine months ended September 30, 2007 and 2006 were as follows:

	2007		2006
Dental	69.7	%	64.1	%
Short-term disability	70.2	%	75.3	%
Long-term disability	14.1	%	32.9	%
Term life	61.7	%	55.4	%
Total group benefits	66.6	%	63.2	%

Dental

The increase in the calendar period loss ratio reflects an accident period loss ratio of 71.8% for the nine months ended September 30, 2007, compared to 67.8% for the same period in 2006, and a decrease in favorable development on prior period reserves from 2006 to 2007, totaling $196,000. Favorable development reduced the calendar period loss ratio by 2.1 percentage points for the nine months ended September 30, 2007, compared to 3.6 percentage points for the same period in 2006.

The increase in the accident period loss ratio primarily reflects a higher loss ratio on new business.

Short-term Disability

The decrease in the calendar period loss ratio reflects an accident period loss ratio of 73.4% for the nine months ended September 30, 2007, compared to 82.2% for the same period in 2006, offset by a decrease in favorable development on prior period reserves from 2006 to 2007, totaling $180,000. Favorable development reduced the calendar period loss ratio by 3.2 percentage points for the nine months ended September 30, 2007, compared to 7.0 percentage points for the same period in 2006.

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The decrease in the accident period loss ratio primarily reflects the aforementioned decrease in claim severity.

Long-term Disability

The decrease in the loss ratio from 2006 to 2007 primarily reflects favorable claim results. The reported claim reserve decreased $805,000 for the nine months ended September 30, 2007, compared to $59,000 for the same period in 2006, primarily reflecting a decrease in the number of new claims from 2006 to 2007.

Term Life

The increase in the term life loss ratio primarily reflects the impact of premium waiver claim reserves, which increased $2,000 for the nine months ended September 30, 2007, compared to a decrease of $237,000 for the same period in 2006. The death claim loss ratio increased slightly, from 61.1% in 2006 to 61.6% in 2007.

Acquisition and Other Underwriting Expenses

The increase in acquisition and other underwriting expenses primarily reflects the increase in direct premiums written.

Other Expenses

The decrease in other expenses reflects the impact of expense reduction initiatives in 2006 and the aforementioned revision in the allocation methodology of corporate salaries between the Company’s workers’ compensation insurance and group benefits insurance segments.

Tax Expense

The decrease in tax expense reflects the reduction in pre-tax income and a slight decrease in the effective tax rate from 35.4% in 2006 to 29.3% in 2007. The 2007 effective tax rate reflects the impact of the aforementioned release of the contingency reserve and tax-exempt interest income totaling $38,000.

SPECIALTY REINSURANCE

The following table represents the operations of the specialty reinsurance segment for the nine months ended September 30, 2007 and 2006 (unaudited, in thousands):

	2007			2006
Revenue:
Reinsurance premiums assumed	$	10,133		$	2,430
Change in unearned premiums		628			181
Net premiums earned	$	10,762		$	2,611
Net investment income		1,154			430
Net realized investment losses		(5	)		(7	)
Other revenue		525			147
Total revenue	$	12,436		$	3,181
Expenses:
Losses and loss adjustment expenses	$	10,297		$	2,180
Acquisition and other underwriting expenses		2,861			190
Other expenses		539			192
Total expenses	$	13,697		$	2,562
(Loss) income before income taxes		(1,261	)		619
Income tax (benefit) expense		(704	)		216
Net (loss) income	$	(557	)	$	403

Net (Loss) Income

The decrease in net income to a net loss reflects an increase in the 2007 calendar year loss ratio partially offset by the acquisition of EHC on June 16, 2006 and a reduction of the impact of purchase accounting charges in 2007. Net income for the nine months ended September 30, 2006 includes an after-tax charge of $384,000 related to the amortization of purchase accounting adjustments compared to negligible purchase charges in 2007.

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The specialty reinsurance ratios were as follows for the nine months ended September 30, 2007 and 2006:

	2007		2006
Loss and LAE ratio	95.7	%	83.5	%
Expense ratio	31.6	%	14.6	%
Combined ratio	127.3	%	98.1	%

The increase in reinsurance premiums assumed relates to the acquisition of EHC on June 16, 2006. Reinsurance premiums earned, by line of business, were as follows for the nine months ended September 30, 2007 and 2006 (in thousands):

	2007			2006
EnviroGuard	$	8,772		$	3,070
EIA liability		2,456			1,207
Other		383			—
Purchase accounting adjustments		(849	)		(1,666	)
Total assumed premiums earned	$	10,762		$	2,611

Losses and Loss Adjustment Expenses

The increase in the calendar period loss and loss adjustment expense ratio is related to an increase in reported claims from the ceding company during the third quarter of 2007, particularly as it relates to prior accident years. Unfavorable loss reserve development on prior accident years was $4.4 million and $279,000 for the nine months ended September 30, 2007 and 2006, respectively. Approximately 65% of the unfavorable loss reserve development in 2007 relates to the EIA liability product. A review of the EIA liability detailed claim reports indicated significant case reserve increases on prior year claims. During 2007, EIA liability claim counts with total gross (before application of the applicable quota share percentage) incurred values greater than $1 million increased from 8 claims to 11 claims. EIA liability claim counts with total gross incurred values greater than $100,000 increased from 62 claims to 80 claims during 2007, an increase of 29.0%. Aggregate case reserves and paid losses as reported by the ceding company increased 22.4% during the third quarter of 2007 for all underwriting years included in the reinsurance treaty. The accident period loss and LAE ratio for EnviroGuard and EIA liability were 42.0% and 75.0%, respectively.

Acquisition and Other Underwriting Expenses

The increase in the expense ratio is related to a reduction in the impact of purchase accounting adjustments in 2007 compared to 2006. Purchase accounting adjustments reduced acquisition and other underwriting expenses by $946,000 compared to negligible purchase accounting adjustments in 2007. As part of its quota share reinsurance agreement with the primary insurer, Eastern Re pays the primary insurer a ceding commission based on assumed premiums. For the nine months ended September 30, 2007 and 2006, the ceding commission paid to the primary insurer was 30%.

Net Investment Income

The increase in net investment income is related to the acquisition of EHC on June 16, 2006. The average yield on the fixed income portfolio was 4.70% as of September 30, 2007, compared to an average yield of 4.47% as of September 30, 2006.

Tax Expense

The effective tax rate for the nine months ended September 30, 2007 was 55.8%. The difference between the statutory rate of 35.0% and the effective rate relates to a prior year tax return adjustment recorded during the third quarter of 2007.

CORPORATE/OTHER

The corporate/other segment results for the nine months ended September 30, 2007 include the impact of the Company’s stock incentive plans and ESOP and the amortization of intangible assets. Stock compensation expense and intangible asset amortization totaled $1.8 million and $1.3 million for the nine months ended September 30, 2007, respectively. The corporate/other segment results for the nine months ended September 30, 2006 include the impact of transaction expenses incurred by ELH totaling $303,000, stock compensation expense of $294,000, and intangible asset amortization of $588,000.

CONSOLIDATED FINANCIAL POSITION

Consolidated assets totaled $393.1 million as of September 30, 2007, compared to $368.2 million as of December 31, 2006. The increase in consolidated assets primarily reflects increases in cash and investments, premiums receivable, deferred acquisition costs, and current income taxes. The increase in cash and investments reflects positive cash flows from operations and an increase in the fair

45

value of the Company’s investments. The increase in premiums receivable reflects premium growth in the workers’ compensation insurance segment and the increase in deferred acquisition costs primarily reflects the amortization of purchase accounting adjustments. The Company reported a federal income tax recoverable as of September 30, 2007, compared to a federal income tax payable as of December 31, 2006. The federal income tax recoverable reflects the payment of estimated taxes for 2007, which currently exceed the Company’s estimated federal income tax liability as of September 30, 2007.

Consolidated liabilities totaled $221.0 million as of September 30, 2007, compared to $194.5 million as of December 31, 2006. The increase in consolidated liabilities primarily reflects increases in reserves, unearned premiums, and the segregated portfolio cell dividend payable. The increase in reserves primarily reflects the impact of premium growth in the workers’ compensation segment and the unfavorable loss reserve development in the specialty reinsurance segment. The increase in unearned premiums reflects premium growth in the workers’ compensation and segregated portfolio cell reinsurance segments. The increase in the segregated portfolio cell dividend payable reflects the positive operating results in the segregated portfolio cell reinsurance segment for the nine months ended September 30, 2007.

Consolidated equity totaled $172.1 million as of September 30, 2007, compared to $173.7 million as of December 31, 2006. The decrease primarily reflects share repurchases, shareholder dividends and a decrease in accumulated other comprehensive income, net, partially offset by net income for the nine months ended September 30, 2007.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s principal sources of funds are underwriting operations, investment income, and proceeds from the sale and maturity of investments. The Company’s primary use of funds is to pay claims and operating expenses and to purchase investments.

The Company’s investment portfolio is structured so that investments mature periodically over time in reasonable relation to current expectations of future claim payments. Currently, claim payments are made from operating cash flows, with excess cash invested in investment securities. As securities mature, management intends to invest excess cash with appropriate durations to fund anticipated future claim payments. Management does not anticipate having to sell securities in its investment portfolios to fund claims or operating expenses. In the event the sale of securities becomes necessary, the Company may incur losses on those sales, which would adversely affect its results of operations and could reduce net investment income.

The Company has a $2.6 million line of credit available to provide additional liquidity, if needed. Eastern Re has a $30.0 million letter of credit facility to secure its obligations, if needed.

EIHI’s domestic insurance subsidiaries’ ability to pay dividends to EIHI is limited by the insurance laws and regulations of Pennsylvania. The maximum annual dividends that the domestic insurance entities may pay without prior approval from the Insurance Department is limited to the greater of 10% of statutory surplus or 100% of statutory net income for the most recently filed annual statement. In addition, EIHI and its subsidiaries are prohibited from declaring or paying any dividends or other forms of distribution for the three years after June 16, 2006, the effective date of the conversion/merger transaction, without the prior approval of the Pennsylvania Insurance Commissioner. Eastern Re must receive approval from the Cayman Islands Monetary Authority before it can pay any dividend to EIHI.

CASH FLOWS

Cash flows for the nine months ended September 30, 2007 and 2006 were as follows (unaudited, in thousands):

	2007			2006
Cash flows provided by operating activities	$	19,737		$	9,046
Cash flows used in investing activities		(14,758	)		(21,738	)
Cash flows (used in) provided by financing activities		(14,386	)		60,399
Net (decrease) increase in cash and cash equivalents	$	(9,407	)	$	47,707

The change in cash flows from operating activities reflects the acquisition of EHC and the positive operating results of the workers’ compensation insurance and group benefits insurance segments.

The change in cash flows from investing activities primarily reflects an increase in net investment purchases, offset by the cash paid to acquire EHC in 2006. The increase in net investment purchases reflects the acquisition of EHC and the investment of cash generated from operations.

The cash flows used in financing activities reflects the repurchase of the Company’s common stock and the payment of shareholder dividends.

46

OFF-BALANCE SHEET ARRANGEMENTS

The Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or, as of September 30, 2007, future effect on the Company’s financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company is subject to market risk with respect to its fixed income investment portfolios. The most significant components of market risk affecting the Company are credit risk and interest rate risk. The Company is also subject to equity risk with respect to its investment in equity securities; however, since only a small percentage of the Company’s invested assets are invested in equity securities (approximately 7.8% as of September 30, 2007), the Company does not believe that its exposure to equity risk is significant.

There have been no material changes in the Company’s market risk since December 31, 2006. Additional disclosures related to the Company’s market risk are discussed under “Quantitative and Qualitative Disclosures About Market Risk” in Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 2, 2007.

Item 4. Controls and Procedures

Under the supervision and with the participation of our management, including the President, the Chief Executive Officer, the Chief Financial Officer and the Vice President of Finance, we have evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the President, the Chief Executive Officer, the Chief Financial Officer and the Vice President of Finance have concluded that these disclosure controls and procedures are effective. There were no changes in our internal control over financial reporting during the quarter ended September 30, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings

None

Item 1A. Risk Factors

There are no material changes from the risk factors previously disclosed in the Company’s Form 10-K, SEC File No. 001-32899.

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

Issuer Purchases of Equity Securities

On February 15, 2007, the Company’s Board of Directors authorized the repurchase of up to 5 percent of the Company’s issued and outstanding shares of common stock for the purpose of funding the issuance of stock under the Eastern Insurance Holdings, Inc. 2006 Stock Incentive Plan. On August 2, 2007, the Company’s Board of Directors authorized the repurchase of additional shares of the Company’s outstanding common stock up to an aggregate of 1,046,500 shares, which represents the total number of shares of common stock for which awards may be granted under the Company’s Stock Incentive Plan. On September 27, 2007, the Company’s Board of Directors increased the share repurchase authorization to 2,046,500 shares.

The following table presents information with respect to those purchases of our common stock made during the nine months ended September 30, 2007:

Period	Total number of shares purchased	Average price paid per share		Total number of shares purchases as part of publicly announced plans or programs	Maximum number (or approximate dollar value) of shares that may yet be purchased under the plans or programs
January 1-31, 2007	—		N/A	N/A	N/A
February 1-28, 2007	10,355	$	14.40	10,355	557,197
March 1-31, 2007	61,868	$	14.46	61,868	495,329
April 1-30, 2007	1,100	$	15.00	1,100	494,229

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Period	Total number of shares purchased	Average price paid per share		Total number of shares purchases as part of publicly announced plans or programs	Maximum number (or approximate dollar value) of shares that may yet be purchased under the plans or programs
May 1-31, 2007	29,319	$	14.73	29,319	464,910
June 1-30, 2007	262,578	$	15.22	262,578	202,332
July 1-31, 2007	128,088	$	15.18	128,088	74,244
August 1-31, 2007	243,004	$	15.18	243,004	310,188
September 1-30, 2007	135,689	$	15.49	135,689	1,174,499
Total	872,001	$	15.22	872,001

Item 3. Defaults Upon Senior Securities

None

Item 4. Submission of Matters to Vote of Security Holders

None

Item 5. Other Information

None

Item 6. Exhibits

Exhibits

Exhibit No.	Title
3.1	Articles of Incorporation of Eastern Insurance Holdings, Inc. (Incorporated by reference from Exhibit 3.1 to the Eastern Insurance Holdings, Inc. Registration Statement No. 333-128913 on Form S-1)
3.2	Bylaws of Eastern Insurance Holdings, Inc. (Incorporated by reference from Exhibit 3.2 to the Eastern Insurance Holdings, Inc. Registration Statement No. 333-128913 on Form S-1)
31.1	Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002, (filed herewith)
31.2	Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002, (filed herewith)
32.1	Certification of Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002, (filed herewith)
32.2	Certification of Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002, (filed herewith)

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SIGNATURES

In accordance with the requirements of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	EASTERN INSURANCE HOLDINGS, INC.
	(Registrant)
Dated: November 8, 2007	By:	/s/ Bruce M. Eckert
		Bruce M. Eckert,
		Chief Executive Officer
Dated: November 8, 2007	By:	/s/ Kevin M. Shook
		Kevin M. Shook,
		Treasurer and Chief Financial Officer

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