Eastern Insurance (EIHI) 10-Q 2008 Q3 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

for the Quarterly Period Ended September 30, 2008,

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	x
Non-accelerated filer	¨	Smaller reporting company	¨

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 4, 2008
(No par Value)	9,533,279
(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	40
Item 4.	Controls and Procedures	41
PART II - OTHER INFORMATION		41
Item 1.	Legal Proceedings	41
Item 1A.	Risk Factors	41
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	42
Item 3.	Defaults Upon Senior Securities	43
Item 4.	Submission of Matters to Vote of Security Holders	43
Item 5.	Other Information	43
Item 6.	Exhibits	43

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, 2008			December 31, 2007
ASSETS
Investments:
Fixed income securities, at estimated fair value (amortized cost, $180,714; $202,039)	$	179,961		$	205,785
Convertible bonds, at estimated fair value (amortized cost, $14,292; $14,232)		13,182			15,478
Equity securities, at estimated fair value (cost, $27,623; $19,578)		22,473			20,541
Other long-term investments, at estimated fair value (cost, $10,637; $10,386)		11,524			11,317
Total investments		227,140			253,121
Cash and cash equivalents		49,625			45,940
Accrued investment income		2,114			2,290
Premiums receivable (net of allowance, $567; $558)		36,813			26,846
Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses		28,490			26,303
Deferred acquisition costs		6,679			6,257
Deferred income taxes, net		6,694			1,229
Federal income taxes recoverable		1,979			846
Intangible assets		9,568			6,372
Goodwill		10,908			7,992
Other assets		10,587			8,322
Total assets	$	390,597		$	385,518
LIABILITIES
Reserves for unpaid losses and loss adjustment expenses	$	146,530		$	129,788
Unearned premium reserves		52,356			39,826
Advance premium		1,348			1,380
Accounts payable and accrued expenses		11,823			8,422
Ceded reinsurance balances payable		6,303			6,762
Benefit plan liabilities		315			334
Segregated portfolio cell dividend payable		13,357			13,168
Loan payable		2,427			—
Junior subordinated debentures		—			8,007
Total liabilities	$	234,459		$	207,687
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; outstanding – 9,551,569 and 10,580,858, respectively		—			—
Unearned ESOP compensation		(5,791	)		(6,354	)
Additional paid in capital		111,431			110,166
Treasury stock, at cost (2,051,154 and 1,016,865 shares, respectively)		(32,308	)		(15,589	)
Retained earnings		85,287			86,363
Accumulated other comprehensive (loss) income, net		(2,481	)		3,245
Total shareholders’ equity		156,138			177,831
Total liabilities and shareholders’ equity	$	390,597		$	385,518

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, 2008 and 2007

(Unaudited, in thousands, except per share data)

	For the Three Months Ended September 30,					For the Nine Months Ended September 30,
	2008			2007		2008			2007
REVENUE
Net premiums earned	$	33,118		$	34,264	$	99,363		$	95,226
Net investment income		755			3,108		5,442			9,326
Net realized investment (losses) gains		(4,518	)		590		(4,213	)		2,321
Other revenue		167			179		522			517
Total revenue		29,522			38,141		101,114			107,390
EXPENSES
Losses and loss adjustment expenses incurred		22,517			21,459		62,930			57,968
Acquisition and other underwriting expenses		4,588			4,097		14,224			11,266
Other expenses		6,584			6,452		19,113			17,977
Amortization of intangibles		328			434		984			1,303
Policyholder dividend expense		325			95		253			349
Segregated portfolio dividend expense		29			780		2,602			2,172
Total expenses		34,371			33,317		100,106			91,035
(Loss) income before income taxes		(4,849	)		4,824		1,008			16,355
Income tax (benefit) expense		(1,760	)		1,263		20			5,329
Net (loss) income	$	(3,089	)	$	3,561	$	988		$	11,026
Other comprehensive (loss) income
Unrealized holding (losses) gains arising during period, net of tax of $(2,197), $866, $(3,667) and $568		(4,080	)		1,608		(6,811	)		1,054
Amortization of unrecognized benefit plan amounts, net of tax of $2, $3, $6, and $8		4			5		12			15
Less: Reclassification adjustment for (losses) gains included in net income, net of tax of $(893), $121, $(591), and $585		(1,658	)		224		(1,097	)		1,086
Other comprehensive (loss) income		(2,426	)		1,379		(5,726	)		(47	)
Comprehensive (loss) income	$	(5,515	)	$	4,940	$	(4,738	)	$	10,979

Earnings per share (See Note 4):	Three Months Ended September 30					Nine Months Ended September 30
	2008			2007		2008		2007
Net (loss) income	$	(3,089	)	$	3,561	$	988	$	11,026
Basic earnings per share	$	(0.35	)	$	0.35	$	0.11	$	1.06
Diluted earnings per share	$	(0.35	)	$	0.34	$	0.11	$	1.02

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, 2008

(Unaudited, in thousands, except share data)

Three Months Ended September 30, 2008

	Outstanding Shares																Accumulated Other Comprehensive Income (Loss) Net of Tax
	Series A Preferred Stock	Common Capital Stock		Common Capital Stock		Unearned ESOP Compensation			Additional Paid-In Capital		Treasury Stock			Retained Earnings						Total
Balance, July 1, 2008	—	9,588,946		$	—	$	(5,978	)	$	111,026	$	(31,661	)	$	89,044		$	(55	)	$	162,376
ESOP shares released	—	—			—		187			86		—			—			—			273
Stock compensation expense	—	5,000			—		—			319		—			—			—			319
Repurchase of common stock	—	(42,377	)		—		—			—		(647	)		—			—			(647	)
Shareholder dividend	—	—			—		—			—		—			(668	)		—			(668	)
Net loss	—	—			—		—			—		—			(3,089	)		—			(3,089	)
Other comprehensive loss, net of tax	—	—			—		—			—		—			—			(2,426	)		(2,426	)
Balance, September 30, 2008	—	9,551,569		$	—	$	(5,791	)	$	111,431	$	(32,308	)	$	85,287		$	(2,481	)	$	156,138

Nine Months Ended September 30, 2008

	Outstanding Shares																Accumulated Other Comprehensive Income (Loss) Net of Tax
	Series A Preferred Stock	Common Capital Stock		Common Capital Stock		Unearned ESOP Compensation			Additional Paid-In Capital		Treasury Stock			Retained Earnings						Total
Balance, January 1, 2008	—	10,580,858		$	—	$	(6,354	)	$	110,166	$	(15,589	)	$	86,363		$	3,245		$	177,831
ESOP shares released	—	—			—		563			284		—			—			—			847
Stock compensation expense	—	5,000			—		—			949		—			—			—			949
Excess tax benefit from vested restricted stock	—	—			—		—			32		—			—			—			32
Repurchase of common stock	—	(1,034,289	)		—		—			—		(16,719	)		—			—			(16,719	)
Shareholder dividend	—	—			—		—			—		—			(2,064	)		—			(2,064	)
Net income	—	—			—		—			—		—			988			—			988
Other comprehensive loss, net of tax	—	—			—		—			—		—			—			(5,726	)		(5,726	)
Balance, September 30, 2008	—	9,551,569		$	—	$	(5,791	)	$	111,431	$	(32,308	)	$	85,287		$	(2,481	)	$	156,138

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, 2007

(Unaudited, in thousands, except share data)

Three Months Ended September 30, 2007

	Outstanding Shares																Accumulated Other Comprehensive Income Net of Tax
	Series A Preferred Stock	Common Capital Stock		Common Capital Stock		Unearned ESOP Compensation			Additional Paid-In Capital		Treasury Stock			Retained Earnings					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																Accumulated Other Comprehensive Income Net of Tax
	Series A Preferred Stock	Common Capital Stock		Common Capital Stock		Unearned ESOP Compensation			Additional Paid-In Capital		Treasury Stock			Retained Earnings						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

6

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Nine Months Ended September 30, 2008 and 2007

(Unaudited, in thousands)

	2008			2007
Cash flows from operating activities:
Net income	$	988		$	11,026
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		390			280
Net amortization of bond premium/discount		326			736
Net realized investment losses (gains)		4,212			(2,321	)
Equity in loss (income) of limited partnerships		1,965			(413	)
Deferred tax benefit		(3,437	)		(1,323	)
Stock compensation		1,828			1,786
Intangible asset amortization		984			1,303
Changes in assets and liabilities:
Accrued investment income		340			(63	)
Premiums receivable		(6,797	)		(11,727	)
Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses		(125	)		130
Deferred acquisition costs		(421	)		(2,956	)
Other assets		(259	)		(1,805	)
Reserves for unpaid losses and loss adjustment expenses		7,153			7,443
Unearned and advance premium		9,356			14,999
Ceded reinsurance balances payable		(459	)		1,403
Accounts payable and accrued expenses		2,489			1,615
Segregated portfolio cell dividend payable		189			2,731
Benefit plan liabilities		(36	)		(57	)
Federal income taxes recoverable/payable		(1,483	)		(3,050	)
Net cash provided by operating activities		17,203			19,737
Cash flows from investing activities:
Purchase of fixed income securities		(34,171	)		(96,167	)
Purchase of equity securities		(11,070	)		(11,299	)
Purchase of other long-term investments		(3,000	)		(500	)
Proceeds from sale of fixed income securities		39,907			30,990
Proceeds from maturities/calls of fixed income securities		25,701			49,417
Proceeds from equity securities		4,263			10,907
Proceeds from other long-term investments		820			1,876
Change in unsettled investment purchases and sales		—			230
Acquisition of Employers Security Holding Company, net of cash received		(8,025	)		—
Principal payments received on mortgage loans		7			10
Purchase of equipment, net		(1,192	)		(222	)
Net cash provided by (used in) investing activities		13,377			(14,758	)
Cash flows from financing activities:
Repurchase of common stock		(16,719	)		(13,226	)
Repayment of junior subordinated debentures		(8,007	)		—
Shareholder dividend		(2,064	)		(1,160	)
Excess tax benefit from vested restricted stock		32			—
Net cash used in financing activities		(26,758	)		(14,386	)
Net increase (decrease) in cash and cash equivalents		3,685			(9,407	)
Cash and cash equivalents, beginning of period		45,940			50,703
Cash and cash equivalents, end of period	$	49,625		$	41,296
Supplemental disclosure of cash flow information:
Cash paid for income taxes	$	4,875		$	9,300
Cash paid for interest	$	468		$	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”) is an insurance holding company offering workers’ compensation and group benefits insurance products and reinsurance products through its direct and indirect wholly-owned subsidiaries, Eastern Holding Company, Ltd. (“EHC”), Eastern Services Corporation (“Eastern Services”), Global Alliance Holdings, Ltd. (“Global Alliance”), Global Alliance Statutory Trust I (“Trust I”), Eastern Alliance Insurance Company (“Eastern Alliance”), Allied Eastern Indemnity Company (“Allied Eastern”), Eastern Advantage Assurance Company (“Eastern Advantage”), Eastern Re Ltd., S.P.C. (“Eastern Re”), Eastern Life and Health Insurance Company (“ELH”), and Employers Alliance, Inc. (“Employers Alliance”), collectively referred to as the Company.

On September 29, 2008, EIHI acquired all of the outstanding stock of Employers Security Holding Company (“ESHC”) and its wholly-owned subsidiaries, Employers Security Insurance Company and Affinity Management Services (Note 3). Employers Security Insurance Company (“ESIC”) is an Indiana-domiciled, mono-line workers’ compensation insurance company licensed to write business in Indiana, Illinois and Missouri.

The Company operates in five segments: workers’ compensation insurance, segregated portfolio cell reinsurance, group benefits insurance, specialty reinsurance, and corporate/other. See Note 10 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 statement 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, 2007 included in the Company’s Annual Report on Form 10-K, which was filed with the U.S. Securities and Exchange Commission on March 14, 2008.

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. Net investment income and segregated portfolio dividend expense for the three and nine months ended September 30, 2007 were reduced by $774 to reflect the elimination of an inter-company transaction between the corporate/other and segregated portfolio cell reinsurance segments.

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 (“LAE”), 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.

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

8

prices or, in the absence of quoted market prices, dealer quotes or matrix pricing, all of which are based on observable market-based inputs when available. Adverse credit market conditions have caused some markets to become relatively illiquid, thus reducing the availability of certain data used by the independent pricing services and dealers. 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. When 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 at the balance sheet date 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. Under SFAS 155, the change in fair value of the Company’s convertible bond securities, which meet the definition of a hybrid financial instrument under SFAS 155, is 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 shareholders’ equity, as of January 1, 2007, 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.

Equity Securities

The Company’s investments in equity securities, which consist primarily of index and exchange-traded mutual funds, 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 or independent broker quotes.

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. When a security is determined to be other-than-temporarily impaired, the Company reduces the cost of the security to the current estimated fair value at the balance sheet date 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.

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). The Company reports changes in the value of its limited partnership investments on a month lag (quarter lag for one investment) as a result of the timing of statements being received from the limited partnership. The Company monitors its limited partnership investments for declines in value that may be other-than-temporary. When a limited partnership interest is determined to be other-than-temporarily impaired, the Company reduces its interest in the limited partnership to its current estimated fair value at the balance sheet date. The impairment is recorded as a reduction to 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, 2008 and December 31, 2007 and included in net premiums earned, totaled $1,200 and $1,500, respectively.

9

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 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 (“IBNR”).

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 $4,044 and $3,474 as of September 30, 2008 and December 31, 2007, 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 2008 and 2007 is 3.85% and 5.25%, respectively. The liability for IBNR 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 IBNR 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 three months, the liability is estimated by applying an expected loss ratio to net premiums earned, less claim payments through the balance sheet date.

• 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 IBNR 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 2005 Group Term Life Waiver Reserve Table for claims reported on or after October 1, 2007 and the 1970 Intercompany Group Life Disability Table for claims reported prior to October 1, 2007.

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. Premium and reported claim data provided by the ceding company is utilized by management to estimate the ultimate losses and LAE, including an amount for IBNR claims. As a result of a lag in receiving quarterly premium and reported claim data from the ceding company, the estimated unpaid losses and LAE are based on claim data one quarter in arrears.

The methods used to estimate the reserves 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, 2008. 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, 2008, the related adjustments could have a material adverse effect on the Company’s financial condition, results of operations or liquidity.

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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 LAE 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 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, before the impact of purchase accounting, totaled $1,380 and $(136) for the three months ended September 30, 2008 and 2007, respectively, and $5,093 and $3,410 for the nine months ended September 30, 2008 and 2007, respectively.

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, Eastern Advantage 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.

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.

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 2008 or 2007.

The Company’s federal income tax returns for tax years subsequent to December 31, 2003 are subject to examination by the Internal Revenue Service.

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, 2008 and December 31, 2007, the Company accrued dividends payable of $1,052 and $989, 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

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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, 2008 and December 31, 2007, the Company accrued $881 and $0 related to the Security Fund assessment.

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 on December 18, 2006. Under the terms of the 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.

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, 2008 and 2007 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,
	2008		2007		2008		2007
Suspense shares		635,375		710,125		635,375		710,125
Allocated shares		112,125		37,375		112,125		37,375
Shares committed to be released		18,841		18,841		56,318		56,216
Average price per share	$	14.49	$	15.68	$	15.04	$	15.30
Stock compensation expense	$	273	$	296	$	847	$	860

As of September 30, 2008 and December 31, 2007, the estimated fair value of unearned ESOP shares was $8,709 and $10,477, respectively.

Recent Accounting Pronouncements

SFAS 159

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 159 (“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

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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 adopted SFAS 159 effective January 1, 2008; however, no election was made to measure the Company’s financial instruments at fair value. The adoption of SFAS 159 had no effect on the Company’s consolidated financial condition and results of operations.

SFAS 141R

In December 2007, the FASB issued Statement No. 141R, “Business Combinations” (“SFAS 141R”), which revises the accounting for business combination transactions previously accounted for under SFAS No. 141, “Business Combinations” (“SFAS 141”), and broadens the scope of transactions which should be accounted for under this standard. SFAS 141R retains the fundamental requirements of SFAS 141 in that the acquisition method of accounting is still used, and an acquirer must be identified in all business combinations. SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity is prohibited from applying SFAS 141R prior to that date. The Company is currently in the process of evaluating the impact of SFAS 141R.

SFAS 160

In December 2007, the FASB issued Statement No. 160, “Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51” (“SFAS 160”), which establishes accounting and reporting standards for the non-controlling interests in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 requires that the ownership interests and the net income of the non-controlling interest be equally identified from that of the parent on the face of the financial statements. SFAS 160 also provides consistent accounting principles for changes in a parent controlling ownership interest in a subsidiary, and that any retained non-controlling financial interests in a deconsolidated subsidiary be measured initially at fair value. SFAS 160 applies to fiscal years beginning on or after December 15, 2008, and is applied prospectively, except for presentation and disclosure requirements, which are applied retrospectively for all periods presented. The Company is currently in the process of evaluating the impact of SFAS 160.

SFAS 161

In March 2008, the FASB issued Statement No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS 161”). SFAS 161 amends and expands the disclosure requirements of SFAS 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in derivative agreements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2008. The adoption of SFAS 161 will not affect the Company’s consolidated financial condition or results of operations, but may require additional disclosures if the Company enters into derivative and hedging activities.

SFAS 163

In May 2008, the FASB issued Statement No. 163, “Accounting for Financial Guarantee Insurance Contracts, an interpretation of FASB Statement No. 60” (“SFAS 163”). SFAS 163 clarifies how FASB Statement No. 60 applies to the recognition and measurement of premium revenue and claim liabilities under financial guarantee insurance contracts and requires expanded disclosures about financial guarantee insurance contracts. SFAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods within those fiscal years, except for certain disclosures about an entity’s risk management activities. The Company does not currently write financial guarantee insurance contracts; therefore, the adoption of SFAS 163 will not affect the Company’s consolidated financial condition or results of operations.

3. Acquisition of ESHC

On September 29, 2008, EIHI acquired all of the outstanding stock of ESHC in a transaction valued at $14,820, including the assumption of $2,650 in debt. The acquisition of ESHC resulted in the recognition of certain intangible assets totaling $4,180 (Note 4) and goodwill totaling $2,917. ESHC reported total assets and total liabilities of $25,856 and $19,203, respectively, on the date of the transaction. ESHC’s shareholders’ equity of $6,653 on the date of the transaction was reduced by $10 as a result of purchase accounting adjustments to reflect the fair value of certain acquired assets and liabilities. The most significant purchase accounting adjustments related to the elimination of deferred acquisition costs, an increase to reserves for losses and LAE, and a decrease to unearned premiums. Direct costs related to the acquisition totaling $107 were capitalized and included in goodwill.

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4. Intangible Assets

The Company’s intangible assets consisted of the following as of September 30, 2008 and December 31, 2007(unaudited, in thousands):

	September 30, 2008				December 31, 2007
Intangible Assets with Finite Life	Gross Balance		Accumulated Amortization		Gross Balance		Accumulated Amortization
Agency relationships (15 year amortization period)	$	3,564	$	625	$	1,750	$	447
Renewal rights (15 year amortization period)		8,238		3,184		6,397		2,378
	$	11,802	$	3,809	$	8,147	$	2,825
Intangible Assets with Indefinite Life
State insurance licenses		1,575		—		1,050		—
Total intangible assets	$	13,377	$	3,809	$	9,197	$	2,825

The acquisition of ESHC resulted in the recognition of certain intangible assets, including renewal rights of $1,841, agency relationships of $1,814, and state insurance licenses of $525. The renewal rights and agency relationships will be amortized over their estimated useful lives of 15 years. The state insurance licenses are considered to have an infinite life and will not be amortized.

Amortization expense totaled $328 and $434 for the three months ended September 30, 2008 and 2007, respectively, and $984 and $1,303 for the nine months ended September 30, 2008 and 2007, respectively.

5. Earnings Per Share

Basic earnings per share are computed by dividing net income for the period by the weighted average number of shares outstanding for the respective period. Diluted earnings per share are computed by dividing net income for the period by the weighted average number of shares outstanding for the period, including dilutive potential common shares outstanding for the period. For the three months ended September 30, 2007, stock warrants of 306,099 and restricted stock awards of 30,187 have been included as dilutive potential common shares outstanding. For the nine months ended September 30, 2008 and 2007, stock warrants of 306,099 and restricted stock awards of 47,944 and 23,528, respectively, have been included as dilutive potential common shares outstanding. For the three months ended September 30, 2008 and 2007, there were 1,203,038 and 846,752 stock options and restricted stock awards, respectively, that were not included in the Company’s earnings per share calculation because to do so would have been anti-dilutive. For the nine months ended September 30, 2008 and 2007, there were 848,995 and 853,411 stock options and restricted stock awards, respectively, 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, diluted earnings per share and cash dividends per share for the three and nine months ended September 30, 2008 and 2007 were as follows (unaudited, in thousands, except share and per share data):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2008			2007		2008		2007
Consolidated net income	$	(3,089	)	$	3,561	$	988	$	11,026
Basic shares outstanding		8,776,743			10,105,204		9,017,853		10,435,468
Diluted shares outstanding		8,776,743			10,441,490		9,371,896		10,765,095
Basic earnings per share	$	(0.35	)	$	0.35	$	0.11	$	1.06
Diluted earnings per share	$	(0.35	)	$	0.34	$	0.11	$	1.02
Cash dividends per share	$	0.07		$	0.05	$	0.21	$	0.10

6. Share Repurchase

During 2007, the Company’s Board of Directors authorized the repurchase of up to 2,046,500 shares of the Company’s issued and outstanding shares of common stock. The share repurchases are held as treasury stock and are available for issuance in connection with the Company’s 2006 Stock Incentive Plan. On March 24, 2008, the Company received approval from the Insurance Department to repurchase up to $10,000 of the Company’s issued and outstanding common stock, which is in addition to the 2,046,500 shares authorized in 2007. The Company repurchased 42,377 and 591,918 shares, at a cost of $647 and $9,070, for the three months ended September 30, 2008 and 2007, respectively. The Company repurchased 1,034,289 and 869,301 shares, at a cost of $16,719 and $13,226 for the nine months ended September 30, 2008 and 2007, respectively. The Company purchased an additional 18,290 shares, at a cost of $179, through November 4, 2008.

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7. Fair Value Measurements

The Company adopted Statement No. 157, “Fair Value Measurements” (“SFAS 157”) effective January 1, 2008. 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. The adoption of SFAS 157 had no impact on the Company’s consolidated financial condition or results of operation.

On February 12, 2008, SFAS 157 was amended by FASB Staff Position No. FAS 157-2 (“FSP FAS 157-2”). FSP FAS 157-2 delayed the effective date of SFAS 157 for non-financial assets and non-financial liabilities which are measured at fair value on a nonrecurring basis. Non-financial assets and non-financial liabilities which are measured at fair value on a recurring basis (i.e. at least annually) are not subject to this deferral. This deferral is effective until fiscal years beginning after November 15, 2008 and interim periods within those fiscal years. At that time, provisions of SFAS 157 will apply to non-financial assets and non-financial liabilities which are measured at fair value on a non-recurring basis.

As of September 30, 2008, the Company has no non-financial assets or non-financial liabilities that are measured at fair value on a recurring basis. The Company is currently evaluating the impact of measuring non-financial assets and non-financial liabilities on a non-recurring basis.

SFAS 157 requires assets and liabilities measured at fair value on a recurring basis to be segregated between those assets and liabilities that are valued based on quoted prices (unadjusted) in active markets for identical assets or liabilities, which the reporting entity can access at the measurement date (Level 1), direct or indirect observable inputs other than Level 1 quoted prices (Level 2), or unobservable inputs to the extent that observable inputs are not available (Level 3).

The following is a description of the Company’s categorization of the inputs used in the recurring fair value measurements of its financial assets included in its consolidated balance sheet as of September 30, 2008:

Level 1 – Represents financial assets whose fair value is determined based upon observable unadjusted quoted market prices for identical financial assets in active markets that the Company has the ability to access. An example of a Level 1 input utilized to measure fair value includes the closing price of one share of common stock on an active exchange market. The Company considers U.S. Treasuries and equity securities as Level 1 assets.

Level 2 – Represents financial assets whose fair value is determined based upon: quoted market prices for similar assets in active markets; quoted market prices for identical assets in inactive markets; inputs other than quoted market prices that are observable for the asset such as interest rates or yield curves; or other inputs derived principally from or corroborated from other observable market information. An example of a Level 2 input utilized to measure fair value, specifically for the Company’s fixed income portfolio, is “matrix pricing.” “Matrix pricing” relies on observable inputs from active markets other than quoted market prices including, but not limited to, benchmark securities and yields, latest reported trades, quotes from brokers or dealers, issuer spreads, bids, offers, and other relevant reference data to determine fair value. “Matrix pricing” is used to measure the fair value of fixed income securities where obtaining individual quoted market prices is impractical. The Company considers U.S. Government agencies, municipal bonds, mortgage-backed securities, collateralized mortgage obligations, asset-backed securities, corporate bonds, and convertible bonds as Level 2 assets.

Level 3 – Represents financial assets whose fail value is determined based upon inputs that are unobservable, including the Company’s own determinations of the assumptions that a market participant would use in pricing the asset. The Company considers its limited partnership investments as Level 3 assets.

The following table provides a summary of the fair value measurements of the Company’s fixed income securities, convertible bonds, and equity securities, as of September 30, 2008, excluding the segregated portfolio cell segment (unaudited, in thousands):

			Fair Value Measurements at Reporting Date Using
	9/30/08		Level 1		Level 2		Level 3
Fixed income securities - available for sale	$	155,543	$	10,635	$	144,908	$	—
Convertible bonds		13,182		—		13,182		—
Equity securities - available for sale		18,385		18,385		—		—
Total	$	187,110	$	29,020	$	158,090	$	—

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The Company’s investments in fixed income securities, convertible bonds, and equity securities are valued through the use of a nationally recognized pricing service. The Company believes the scope of work performed when using data from outside parties is sufficient to validate the prices such that it does not rely upon these independent pricing services as experts, nor would it seek indemnification from them in the event the prices provided were deemed inappropriate. Where independent pricing services provide fair values, the Company has obtained an understanding of the methods, models and inputs used in pricing, and has controls in place to validate that amounts provided represent current exit values. The Company’s controls include, but are not limited to, initial and ongoing evaluation of methodologies used by outside parties as well as other techniques and assumptions to calculate fair value and comparing the fair value estimates to the Company’s knowledge of the current market. Fixed income securities include U.S. Treasuries, agencies backed by the U.S. Government, municipal bonds, mortgage-backed securities, collateralized mortgage obligations, asset-backed securities, and corporate bonds.

Other long-term investments include the Company’s interest in various limited partnerships, including a low volatility multi-strategy fund of funds, two natural resource limited partnerships, a municipal bond based limited partnership, an open-ended investment fund and a real estate limited partnership. The Company records its investment in the limited partnerships using the equity method. Changes in the Company’s investments are based on statements received directly from the limited partnership and/or the limited partnership’s administrator. The estimated fair values of the underlying investments in the limited partnerships may be based on Level 1, Level 2, or Level 3 inputs, or a combination thereof.

As of September 30, 2008 and December 31, 2007, the estimated fair values of the Company’s limited partnership investments, by investment strategy, were as follows (unaudited, in thousands):

	9/30/08		12/31/07
Multi-strategy fund of funds	$	5,617	$	5,809
Natural resources		2,855		3,312
Structured finance opportunity fund		1,991		—
Municipal bond arbitrage		466		1,484
Open-ended investment fund		520		622
Real estate		67		73
Total	$	11,516	$	11,300

The activity in the Company’s limited partnership investments for the three and nine months ended September 30, 2008 and 2007 was as follows (unaudited, in thousands):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2008			2007		2008			2007
Balance, beginning of period	$	11,999		$	10,394	$	11,300		$	11,572
Contributions		2,000			500		3,000			500
Withdrawals		(820	)		—		(820	)		(1,876	)
Unrealized change in interest		(1,663	)		60		(1,964	)		758
Balance, end of period	$	11,516		$	10,954	$	11,516		$	10,954

The change in interest in the Company’s limited partnership investments is included in net investment income in the consolidated statements of operations and comprehensive income (loss). As a result of the current credit market conditions, the municipal bond arbitrage fund experienced a permanent decline in value during the third quarter of 2008 and will be dissolved. The estimated fair value of the Company’s interest in the limited partnership as of September 30, 2008 reflects management’s best estimate of the proceeds the Company is expected to receive upon dissolution of the fund. As a result of these events, the Company recorded an impairment write-down of $1,397 as of and for the three and nine months ended September 30, 2008.

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8. Investments

The gross unrealized losses and estimated fair value of fixed income and equity securities, excluding those securities in the segregated portfolio cell reinsurance segment, classified as available-for-sale by category and length of time an individual security has been in a continuous unrealized position as of September 30, 2008 and December 31, 2007 are as follows (unaudited, in thousands):

	Less Than 12 Months					12 Months or More					Total
September 30, 2008	Estimated Fair Value		Gross Unrealized Losses			Estimated Fair Value		Gross Unrealized Losses			Estimated Fair Value		Gross Unrealized Losses
U.S. Treasuries and government agencies	$	8,195	$	(77	)	$	501	$	(7	)	$	8,696	$	(84	)
States, municipalities, and political subdivisions		20,476		(545	)		235		(26	)		20,711		(571	)
Corporate securities		9,585		(1,021	)		1,908		(136	)		11,493		(1,157	)
Mortgage-backed securities		383		(1	)		—		—			383		(1	)
Other structured securities		17,633		(726	)		4,400		(603	)		22,033		(1,329	)
Total fixed income securities		56,272		(2,370	)		7,044		(772	)		63,316		(3,142	)
Equity securities		17,276		(4,428	)		18		(5	)		17,294		(4,443	)
Total fixed income and equity securities	$	73,548	$	(6,798	)	$	7,062	$	(777	)	$	80,610	$	(7,575	)
	Less Than 12 Months					12 Months or More					Total
December 31, 2007	Estimated Fair Value		Gross Unrealized Losses			Estimated Fair Value		Gross Unrealized Losses			Estimated Fair Value		Gross Unrealized Losses
U.S. Treasuries and government agencies	$	—	$	—		$	1,045	$	(7	)	$	1,045	$	(7	)
Corporate securities		4,658		(85	)		2,958		(31	)		7,616		(116	)
Mortgage-backed securities		437		(2	)		—		—			437		(2	)
Other structured securities		14,409		(354	)		1,758		(20	)		16,167		(374	)
Total fixed income securities		19,504		(441	)		5,761		(58	)		25,265		(499	)
Equity securities		5,972		(132	)		—		—			5,972		(132	)
Total fixed income and equity securities	$	25,476	$	(573	)	$	5,761	$	(58	)	$	31,237	$	(631	)

As of September 30, 2008, the Company held 148 fixed income securities with gross unrealized losses of $3,142. Management has evaluated the gross unrealized losses related to the fixed income securities and determined that the decline in the market value primarily reflects the current credit and liquidity issues in the fixed income markets and not the underlying credit quality of the issuer of the securities. Management has concluded that the carrying value of its fixed income securities in a gross unrealized loss position will be realized and that the Company has the ability and intent to hold them until that time.

As of September 30, 2008, the Company held 41 equity securities with gross unrealized losses of $4,443. The equity securities consist primarily of mutual fund instruments. Management has determined that the decline in market value is due to the broad decline in the equity securities markets.

As a result of the current adverse conditions in the credit markets, as well as the bankruptcy of Lehman Brothers Holdings, Inc. (“Lehman Brothers”), the Company recorded other-than-temporary investment impairments totaling $2,768 related to 8 fixed income securities as of and for the three and nine months ended September 30, 2008. The Company held 4 Lehman Brothers fixed income securities, which comprises $1,126 of the total impairment write-downs. The other impairment write-downs related primarily to collateralized mortgage obligations that had experienced a significant and prolonged decline in value as a result of the illiquidity in the credit markets. These securities continue to remain current on principal and interest payments; however, due to the significant and prolonged decline in value and the continued uncertainty surrounding the credit markets, management has determined that an impairment write-down is appropriate.

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9. 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, 2008 and 2007 (unaudited, in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2007			2008			2007
Balance, beginning of period	$	129,599		$	125,650		$	125,249		$	121,397
Reinsurance recoverables on unpaid losses and LAE		24,260			24,663			23,429			24,236
Net balance, beginning of period		105,339			100,987			101,820			97,161
Net reserves acquired as a result of ESHC acquisition		9,591			—			—			—
Incurred related to:
Current year		20,405			20,791			62,868			60,834
Prior year		2,362			862			867			(2,167	)
Total incurred before purchase accounting adjustments		22,767			21,653			63,735			58,667
Purchase accounting adjustments		(81	)		(155	)		(391	)		(692	)
Total incurred		22,686			21,498			63,344			57,975
Paid related to:
Current year		9,911			10,180			24,851			24,519
Prior year		9,229			7,540			31,428			25,852
Total paid		19,140			17,720			56,279			50,371
Net balance, end of period		118,476			104,765			118,476			104,765
Reinsurance recoverables on unpaid losses and LAE		24,032			24,261			24,032			24,261
Balance, end of period	$	142,508		$	129,026		$	142,508		$	129,026
Total reserves for unpaid for losses and loss adjustment expenses	$	146,530		$	133,910		$	146,530		$	133,910
Less: Term life premium waiver reserves		3,980			4,807			3,980			4,807
Less: Other		42			77			42			77
Balance, end of period	$	142,508		$	129,026		$	142,508		$	129,026

Incurred losses by segment were as follows for the three and nine months ended September 30, 2008 and 2007 (unaudited, in thousands):

Three Months Ended September 30, 2008

	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	$	9,642		$	3,803		$	6,159		$	1,189	$	20,793
Current period discount		(285	)		(103	)		—			—		(388	)
Prior year, gross of discount		—			(77	)		(54	)		2,271		2,140
Accretion of prior period discount		148			74			—			—		222
Total incurred before purchase accounting adjustments		9,505			3,697			6,105			3,460		22,767
Purchase accounting adjustments		(71	)		(14	)		—			4		(81	)
Total incurred	$	9,434		$	3,683		$	6,105		$	3,464	$	22,686

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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, 2008

	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	$	27,651		$	11,842		$	19,769		$	5,042	$	64,304
Current period discount		(981	)		(455	)		—			—		(1,436	)
Prior year, gross of discount		(2,500	)		(2,698	)		(670	)		5,394		(474	)
Accretion of prior period discount		907			434			—			—		1,341
Total incurred before purchase accounting adjustments		25,077			9,123			19,099			10,436		63,735
Purchase accounting adjustments		(345	)		(66	)		—			20		(391	)
Total incurred	$	24,732		$	9,057		$	19,099		$	10,456	$	63,344

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 $(2,140) and $474 for the three and nine months ended September 30, 2008, respectively, compared to (unfavorable) favorable development of $(877) and $3,331 for the same periods in 2007, respectively. The unfavorable development for the three months ended September 30, 2008 and 2007 primarily reflects an increase in reported claims from the ceding company related to prior accident years in the specialty reinsurance segment.

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10. Segment Information

The Company’s current operations are organized into the five following business segments.

Workers’ Compensation Insurance

The Company offers workers’ compensation insurance coverage to employers, primarily in Pennsylvania, Indiana, Maryland, Delaware and North Carolina. The Company offers a complete line of workers’ compensation products, including guaranteed cost and loss sensitive products.

Segregated Portfolio Cell Reinsurance

The Company offers alternative market workers’ compensation solutions to individual companies, groups and associations (referred to as “segregated portfolio cell dividend participants”) through the creation of segregated portfolio cells. The segregated portfolio cells are segregated pools of assets that function as insurance companies within an insurance company. The pool of assets and associated liabilities of each segregated portfolio cell are solely for the benefit of the segregated portfolio cell dividend participants, and the pool of assets of one segregated portfolio cell are statutorily protected from the creditors of the others. This permits the Company to provide customers with a turn-key alternative markets solution that includes program design, fronting, claims administration, risk management, segregated portfolio cell rental, investment and segregated portfolio management services. The segregated portfolio cell structure provides dividend participants the opportunity to share in both underwriting profit and investment income derived from their respective segregated portfolio cell’s financial results. The segregated portfolio cell reinsurance segment generated fee revenue to the Company’s workers’ compensation, specialty reinsurance, and corporate/other segments totaling approximately $910 and $864 for the three months ended September 30, 2008 and 2007, respectively, and $3,437 for the nine months ended September 30, 2008 and 2007.

Group Benefits Insurance

The Company’s group benefits insurance products include dental, short and long-term disability, and term life insurance. The group benefits insurance products are marketed to employers, primarily in the Mid-Atlantic, Southeast, and Midwest regions of the United States. Net premiums earned, by product, for the three and nine months ended September 30, 2008 and 2007 were as follows (unaudited in thousands):

	Three months ended September 30,				Nine months ended September 30,
	2008		2007		2008		2007
Dental	$	5,669	$	5,564	$	17,002	$	16,097
Short-term disability		1,625		1,657		4,932		4,962
Long-term disability		385		413		1,205		1,263
Term life		1,452		1,430		4,366		4,256
Total	$	9,131	$	9,064	$	27,505	$	26,578

Specialty Reinsurance

Prior to July 1, 2008, the Company assumed business through 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. Effective July 1, 2008, the reinsurance treaties that comprise the specialty reinsurance segment were terminated on a run-off basis. Net premiums earned, by program, for the three and nine months ended September 30, 2008 and 2007 were as follows (unaudited in thousands):

	Three months ended September 30,				Nine months ended September 30,
	2008		2007		2008		2007
EnviroGuard	$	1,723	$	3,582	$	6,588	$	8,772
EIA		391		148		2,156		2,456
Other		—		175		6		383
Purchase accounting		—		—		—		(849	)
Total	$	2,114	$	3,905	$	8,750	$	10,762

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Corporate/Other

The corporate/other segment includes the holding company and third party administration activities of the Company, as well as certain eliminations necessary to reconcile the segment information to the consolidated statements of operations and comprehensive income (loss). The corporate/other segment also includes the Company’s 10% interest in a segregated portfolio cell with an unaffiliated primary carrier that writes insurance coverage for sprinkler contractors.

The following table represents the segment results for the three months ended September 30, 2008 (unaudited, in thousands):

	Workers’ Compensation Insurance			Segregated Portfolio Cell Reinsurance			Group Benefits Insurance			Specialty Reinsurance			Corporate/ Other			Total
Revenue:
Net premiums earned	$	15,822		$	6,051		$	9,131		$	2,114		$	—		$	33,118
Net investment income		(299	)		291			535			195			33			755
Net realized investment (losses) gains		(731	)		(706	)		(2,883	)		(263	)		65			(4,518	)
Other revenue		—			—			—			361			(194	)		167
Total revenue		14,792			5,636			6,783			2,407			(96	)		29,522
Expenses:
Losses and LAE incurred		9,435			3,686			5,932			3,464			—			22,517
Acquisition and other underwriting expenses		1,322			1,872			1,383			635			(624	)		4,588
Other expenses		2,952			183			1,420			297			1,732			6,584
Amortization of intangibles		—			—			—			—			328			328
Policyholder dividend expense		325			—			—			—			—			325
Segregated portfolio dividend expense		—			(105	)		—			—			134			29
Total expenses		14,034			5,636			8,735			4,396			1,570			34,371
Income (loss) before income taxes		758			—			(1,952	)		(1,989	)		(1,666	)		(4,849	)
Income tax expense (benefit)		231			—			(814	)		(696	)		(481	)		(1,760	)
Net income (loss)	$	527		$	—		$	(1,138	)	$	(1,293	)	$	(1,185	)	$	(3,089	)
Total assets	$	233,551		$	54,171		$	82,484		$	46,428		$	(26,037	)	$	390,597

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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			500			3,108
Net realized investment gains		133		22		422		—			13			590
Other revenue		—		—		—		121			58			179
Total revenue		16,450		6,434		10,281		4,405			571			38,141
Expenses:
Losses and LAE 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		—		—			(207	)		780
Total expenses		9,633		6,434		8,760		7,102			1,388			33,317
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

The following table represents the segment results for the nine months ended September 30, 2008 (unaudited, in thousands):

	Workers’ Compensation Insurance			Segregated Portfolio Cell Reinsurance			Group Benefits Insurance			Specialty Reinsurance			Corporate/ Other			Total
Revenue:
Net premiums earned	$	45,961		$	17,147		$	27,505		$	8,750		$	—		$	99,363
Net investment income		1,077			855			2,161			881			468			5,442
Net realized investment (losses) gains		(836	)		(445	)		(3,212	)		33			247			(4,213	)
Other revenue		—			—			—			776			(254	)		522
Total revenue		46,202			17,557			26,454			10,440			461			101,114
Expenses:
Losses and LAE incurred		24,733			9,057			18,684			10,456			—			62,930
Acquisition and other underwriting expenses		3,546			5,306			4,242			2,624			(1,494	)		14,224
Other expenses		8,137			234			4,179			623			5,940			19,113
Amortization of intangibles		—			—			—			—			984			984
Policyholder dividend expense		253			—			—			—			—			253
Segregated portfolio dividend expense		—			2,960			—			—			(358	)		2,602
Total expenses		36,669			17,557			27,105			13,703			5,072			100,106
Income (loss) before income taxes		9,533			—			(651	)		(3,263	)		(4,611	)		1,008
Income tax expense (benefit)		3,060			—			(501	)		(1,142	)		(1,397	)		20
Net income (loss)	$	6,473		$	—		$	(150	)	$	(2,121	)	$	(3,214	)	$	988
Total assets	$	233,551		$	54,171		$	82,484		$	46,428		$	(26,037	)	$	390,597

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The following table represents the segment results for the nine months ended September, 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			1,365			9,326
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			1,411			107,390
Expenses:
Losses and LAE 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		—		—			(648	)		2,172
Total expenses		29,024		18,158		25,824		13,697			4,332			91,035
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

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.

12. Junior Subordinated Debentures

On May 15, 2008, the Company called its junior subordinated debentures at par. The Company paid $8,400 to satisfy its outstanding obligation related to the debentures, including accrued interest of $253.

13. Agency Stock Purchase Plan

On June 17, 2008, the Company announced its 2008 Agency Stock Purchase Plan (the “Stock Purchase Plan”). The purpose of the Stock Purchase Plan is to provide eligible insurance agencies of the Company with the opportunity to purchase the Company’s common stock at a discount from fair market value and is designed to foster the common interests of the Company and agencies in achieving long-term profitable growth for the Company. The Company has reserved 125,000 shares of its common stock for purchase under the Stock Purchase Plan for the five-year period ending June 30, 2013. Common stock issued under the Stock Purchase Plan will be issued from treasury stock.

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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 March 14, 2008.

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 we compete that are less favorable than expected, specifically in Pennsylvania, North Carolina, and Indiana;

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

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

• financial market conditions, including, but not limited to, changes in interest rates and the credit and equity 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 our investment portfolio or a reduction in the demand for our 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 collectibility of reinsurance;

• estimates and adequacy of loss reserves and trends in losses and LAE;

• 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 we use resulting from competitive pressures;

• our inability to obtain regulatory approval of, or to implement, premium rate increases;

• the potential impact on our reported earnings that could result from the adoption of future accounting standards issued by the FASB or other standard setting bodies;

• our 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.

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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’s results of operations for the three and nine months ended September 30, 2008, compared to the same periods in 2007 include the following:

• A decrease in net premiums earned for the three months ended September 30, 2008, compared to the same period in 2007, primarily reflecting the impact of the termination of the quota share reinsurance treaty in the specialty reinsurance segment effective July 1, 2008;

• Other-than-temporary impairments totaling $4.2 million for the three and nine months ended September 30, 2008, compared to no impairments for the same periods in 2007. The impairments include the write-down of an interest in a limited partnership totaling $1.4 million, which was reported as a reduction to net investment income in the workers’ compensation insurance segment;

• Net realized investment losses related to the change in fair value of the Company’s convertible bond portfolio totaling $1.3 million and $2.4 million for the three and nine months ended September 30, 2008, compared to an increase of $208,000 and $28,000 for the same periods in 2007;

• An increase in the loss ratio from 2007 to 2008, primarily reflecting unfavorable loss reserve development in the specialty reinsurance segment and a reduction in favorable loss reserve development from 2007 to 2008 in the workers’ compensation insurance segment;

• An increase in the expense ratio from 2007 to 2008, primarily reflecting costs associated with the opening of a regional office in North Carolina, state licensing initiatives in the workers’ compensation segment, and integration activities related to the acquisition of ESHC. In addition, the specialty reinsurance segment’s expense ratio increased as a result of the reduction in and subsequent termination of the quota share reinsurance treaty; and

• Purchase accounting adjustments that increased net income by $163,000 and $732,000 for three and nine months ended September 30, 2008, respectively, compared to adjustments that increased net income by $208,000 and $146,000 for the same periods in 2007, respectively.

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.

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 specific policy period. Net premiums written is the difference between direct premiums written and premiums ceded or paid to reinsurers (ceded premiums written). In the segregated portfolio cell reinsurance segment, assumed premiums are derived from insurance contracts written by the Company and ceded to the segregated portfolio cells. In the specialty reinsurance segment, assumed premiums are premiums that are received from a third party under a reinsurance agreement, which are reported to the Company directly from the broker one quarter in arrears.

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, 2007, one-half of the premiums would be earned in 2007 and the other half would be earned in 2008. 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 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 of payroll exposure 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 LAE) in cash, cash equivalents, fixed income securities,

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convertible bonds, equity securities, and other long-term investments. Investment income includes interest earned on invested assets and the change in equity interest of limited partnerships included in other long-term investments. 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. Realized gains and losses also include the change in fair value of convertible bonds.

Other revenue. Other revenue includes claim administration, risk management, and cell rental fees earned. 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 claims administration, risk management, and cell rental fees. Fronting fees are included in acquisition and other underwriting expenses as an offset to the direct costs incurred. 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 LAE, acquisition and other underwriting expenses, policyholder dividends, other expenses, and income taxes:

Losses and loss adjustment expenses.Losses and LAE 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 of commissions, 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 Security Fund. In the segregated portfolio cell reinsurance and specialty reinsurance segments, acquisition and other underwriting expenses consist of ceding commissions earned under the respective reinsurance agreements. Ceding commissions received are netted against acquisition and 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.

Policyholder dividend expense.Policyholder dividends represent the amount of dividends incurred during the period that are expected to be returned to policyholders. The dividend expense is based on the loss experience of the underlying workers’ compensation insurance policy.

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 consolidated federal income 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.

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 LAE 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 LAE 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 LAE 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.

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Policyholder dividend expense ratio.The policyholder dividend expense ratio is the ratio (expressed as a percentage) of policyholder dividend expense to net premiums earned and measures the impact of the Company’s policyholder dividend policies on its workers’ compensation segment.

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.

Reserves for Unpaid Losses and LAE

The Company establishes reserves for unpaid losses and LAE for its workers’ compensation insurance, 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 recoverables 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, 2008, the related adjustments could have a material adverse effect on the Company’s financial condition, results of operations or liquidity.

The Company discounts its workers’ compensation reserves, using a discount rate of 3%, which is based on regulatory guidelines. As of September 30, 2008 and December 31, 2007, the Company’s reserves for unpaid losses and LAE were reduced by $4.0 million and $3.5 million, respectively, related to the effects of discounting.

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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, 2008 (unaudited) and December 31, 2007 are summarized below (in thousands):

September 30, 2008	Workers’ Compensation Insurance			Segregated Portfolio Cell Reinsurance			Group Benefits Insurance		Specialty Reinsurance			Total
Case/tabular reserves	$	35,522		$	11,208		$	10,848	$	15,002		$	72,580
Case incurred development, IBNR, and unallocated LAE reserves		21,270			11,191			4,582		13,568			50,611
Amount of discount		(2,924	)		(1,120	)		—		—			(4,044	)
Net reserves		53,868			21,279			15,430		28,570			119,147
Reinsurance recoverables on unpaid losses and LAE		5,362			2,832			17,995		—			26,189
Purchase accounting adjustments		1,134			95			—		(35	)		1,194
Reserves for unpaid losses and LAE	$	60,364		$	24,206		$	33,425	$	28,535		$	146,530

December 31, 2007	Workers’ Compensation Insurance			Segregated Portfolio Cell Reinsurance			Group Benefits Insurance		Specialty Reinsurance			Total
Case/tabular reserves	$	19,915		$	8,906		$	12,131	$	10,873		$	51,825
Case incurred development, IBNR, and unallocated LAE reserves		25,295			13,083			4,251		14,117			56,746
Amount of discount		(2,375	)		(1,099	)		—		—			(3,474	)
Net reserves		42,835			20,890			16,382		24,990			105,097
Reinsurance recoverables on unpaid losses and LAE		2,709			2,033			18,900		—			23,642
Purchase accounting adjustments		941			161			—		(53	)		1,049
Reserves for unpaid losses and LAE	$	46,485		$	23,084		$	35,282	$	24,937		$	129,788

As a result of the economic uncertainty in the Company’s primary geographic markets and the potential impact on its insureds, management increased the absolute value of its workers’ compensation base case reserves during the third quarter of 2008. The increase in case reserves resulted in a reduction to the workers’ compensation IBNR reserves. The workers’ compensation case and IBNR reserves also reflect the acquisition of ESHC, which reported case and IBNR reserves of $5,991 and $1,524, respectively, as of September 30, 2008.

“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. For fixed income and equity securities, the amount written down is recorded in earnings as a realized loss on investments. For limited partnership investments, the amount written down is included as a reduction to net investment income. 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 three and nine months ended September 30, 2008, the Company recorded other-than-temporary investment impairments totaling $4.2 million. For the three and 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, 2008, the Company held securities with gross unrealized losses of $7.6 million, of which $777,000 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 company is performed to determine if the decline in market value is other-than-temporary. A specific determination is made for any such security. 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

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cost basis of the security is written down to realizable value. Equity securities whose market value has been below 80% of cost for more than six months are deemed other-than-temporarily impaired and are written down to net realizable value. 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 income security review for collectibility 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.

Limited partnerships.A limited partnership investment is generally written down if the Company is unable to hold or otherwise intends to sell its interest in the limited partnership at a loss, or it management has received information that suggests the Company will be unable to recover its original investment in the limited partnership.

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, 2008 (unaudited) and December 31, 2007, deferred policy acquisition costs and the related unearned premium reserves were as follows (in thousands):

	September 30, 2008		December 31, 2007
Workers’ compensation insurance segment:
Deferred policy acquisition costs	$	2,607	$	1,924
Unearned premium reserves	$	37,583	$	24,707
Segregated portfolio cell reinsurance segment:
Deferred policy acquisition costs	$	3,333	$	2,137
Unearned premium reserves	$	12,233	$	7,716
Group benefits insurance segment:
Deferred policy acquisition costs	$	—	$	—
Unearned premium reserves	$	78	$	83
Specialty reinsurance segment:
Deferred policy acquisition costs	$	739	$	2,196
Unearned premium reserves	$	2,462	$	7,320

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. The profits and losses of the Company’s specialty reinsurance segment and investment income related to the Company’s ownership interests in certain segregated portfolio cells are subject to U.S. federal income tax under Subpart F of the Internal Revenue Code. However, a Subpart F taxable loss cannot be used to offset taxable income related to the Company’s domestic operations. As of September 30, 2008, the Company’s federal income tax estimate includes a net taxable loss related to Subpart F. As of September 30, 2008, management expects the net deferred tax asset, including the net operating loss related to Subpart F, to be 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 losses and LAE 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 LAE affect the estimates for the ceded portion of these liabilities. The Company continually monitors the financial condition of its reinsurers.

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Recent Accounting Pronouncements

SFAS 159

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 159 (“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 adopted SFAS 159 effective January 1, 2008; however, no election was made to measure the Company’s financial instruments at fair value. The adoption of SFAS 159 had no effect on the Company’s consolidated financial condition and results of operations.

SFAS 141R

In December 2007, the FASB issued Statement No. 141R, “Business Combinations” (“SFAS 141R”), which revises the accounting for business combination transactions previously accounted for under SFAS No. 141, “Business Combinations” (“SFAS 141”), and broadens the scope of transactions which should be accounted for under this standard. SFAS 141R retains the fundamental requirements of SFAS 141 in that the acquisition method of accounting is still used, and an acquirer must be identified in all business combinations. SFAS 141R applies prospectively to business combinations which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity is prohibited from applying SFAS 141R prior to that date. The Company is currently in the process of evaluating the impact of SFAS 141R.

SFAS 160

In December 2007, the FASB issued Statement No. 160, “Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51” (“SFAS 160”), which establishes accounting and reporting standards for the non-controlling interests in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 requires that the ownership interests and the net income of the non-controlling interest be equally identified from that of the parent on the face of the financial statements. SFAS 160 also provides consistent accounting principles for changes in a parent controlling ownership interest in a subsidiary, and that any retained non-controlling financial interests in a deconsolidated subsidiary be measured initially at fair value. SFAS 160 applies to fiscal years beginning on or after December 15, 2008, and is applied prospectively, except for presentation and disclosure requirements, which are applied retrospectively for all periods presented. The Company is currently in the process of evaluating the impact of SFAS 160.

SFAS 161

In March 2008, the FASB issued Statement No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS 161”). SFAS 161 amends and expands the disclosure requirements of SFAS 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in derivative agreements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2008. The adoption of SFAS 161 will not affect the Company’s consolidated financial condition or results of operations, but may require additional disclosures if the Company enters into derivative and hedging activities.

SFAS 163

In May 2008, the FASB issued Statement No. 163, “Accounting for Financial Guarantee Insurance Contracts, an interpretation of FASB Statement No. 60” (“SFAS 163”). SFAS 163 clarifies how FASB Statement No. 60 applies to the recognition and measurement of premium revenue and claim liabilities under financial guarantee insurance contracts and requires expanded disclosures about financial guarantee insurance contracts. SFAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods within those fiscal years, except for certain disclosures about an entity’s risk management activities. The Company does not currently write financial guarantee insurance contracts; therefore, the adoption of SFAS 163 will not affect the Company’s consolidated financial condition or results of operations.

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RESULTS OF OPERATIONS

The major components of consolidated revenue were as follows for the three and nine months ended September 30, 2008 and 2007 (unaudited, in thousands):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2008			2007		2008			2007
Net premiums written	$	33,314		$	35,655	$	108,752		$	107,836
Net premiums earned	$	33,118		$	34,264	$	99,363		$	95,226
Net investment income		755			3,108		5,442			9,326
Net realized investment (losses) gains		(4,518	)		590		(4,213	)		2,321
Other revenue		167			179		522			517
Consolidated revenue	$	29,522		$	38,141	$	101,114		$	107,390

The decrease in consolidated revenue primarily reflects the aforementioned other-than-temporary investment impairments and the termination of the quota share reinsurance treaty.

The components of consolidated net (loss) income, by segment, for the three and nine months ended September 30, 2008 and 2007 were as follows (unaudited, in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2007			2008			2007
Workers’ compensation insurance	$	527		$	4,879		$	6,473		$	11,235
Segregated portfolio cell reinsurance		—			—			—			—
Group benefits insurance		(1,138	)		1,230			(150	)		3,157
Specialty reinsurance		(1,293	)		(1,490	)		(2,121	)		(557	)
Corporate/other		(1,185	)		(1,058	)		(3,214	)		(2,809	)
Consolidated net (loss) income	$	(3,089	)	$	3,561		$	988		$	11,026

The decrease in consolidated net income primarily reflects the impact of the aforementioned other-than-temporary investment impairments and the increase in the loss and expense ratios as described earlier. The other-than-temporary impairments reduced net income in the workers’ compensation insurance, group benefits insurance, and specialty reinsurance segments by $1.9 million, $2.0 million, and $260,000, respectively, for the three and nine months ended September 30, 2008.

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WORKERS’ COMPENSATION INSURANCE

The following table represents the operations of the workers’ compensation insurance segment for the three and nine months ended September 30, 2008 and 2007 (unaudited, in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2007			2008			2007
Revenue:
Direct premiums written	$	26,416		$	25,510		$	83,067		$	78,391
Reinsurance premiums assumed		128			293			535			1,078
Ceded premiums written		(7,287	)		(7,410	)		(27,908	)		(29,393	)
Net premiums written		19,257			18,393			55,694			50,076
Change in unearned premiums		(3,435	)		(3,176	)		(9,733	)		(9,199	)
Net premiums earned		15,822			15,271			45,961			40,876
Net investment income		(299	)		1,100			1,077			3,475
Net realized investment (losses) gains		(731	)		133			(836	)		744
Total revenue	$	14,792		$	16,450		$	46,202		$	45,095
Expenses:
Losses and LAE incurred	$	9,435		$	6,160		$	24,733		$	20,125
Acquisition and other underwriting expenses		1,322			1,107			3,546			2,683
Other expenses		2,952			2,271			8,137			5,867
Policyholder dividend expense		325			95			253			349
Total expenses	$	14,034		$	9,633		$	36,669		$	29,024
Income before income taxes		758			6,817			9,533			16,071
Income tax expense		231			1,938			3,060			4,836
Net income	$	527		$	4,879		$	6,473		$	11,235

Net Income

The decrease in net income primarily reflects an increase in the loss and expense ratios and the impact of other-than-temporary investment impairments. The decrease in net income for the nine months ended September 30, 2008 was partially offset by the impact of purchase accounting adjustments, which increased net income by $224,000 in 2008, compared to a decrease in net income of $228,000 for the same period in 2007.

The workers’ compensation insurance ratios were as follows for the three and nine months ended September 30, 2008 and 2007:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2007		2008		2007
Loss and LAE ratio	59.6	%	40.5	%	53.8	%	49.2	%
Expense ratio	27.0	%	22.2	%	25.4	%	20.9	%
Policyholders’ dividend ratio	2.1	%	0.6	%	0.6	%	0.9	%
Combined ratio	88.7	%	63.3	%	79.8	%	71.0	%

Premiums

The increase in direct premiums written primarily reflects an increase in new business production and a decrease in the impact of purchase accounting adjustments from 2007 to 2008, partially offset by a decrease in the premium renewal retention rate and continued renewal rate decreases. Direct premiums written for traditional business and alternative markets were $20.4 million and $6.0 million, respectively, for the three months ended September 30, 2008 and $59.2 million and $23.9 million for the nine months ended September 30, 2008, respectively. Direct premiums written in 2008 and 2007 include the impact of renewal rate decreases of 7.6%. Premium renewal retention rates were 87.9% and 90.0%, respectively, in 2008 and 2007. New business production was $5.8 million and $17.5 million for the three and nine months ended September 30, 2008, respectively, compared to $3.7 million and $13.3 million for the same periods in 2007, respectively. Direct premiums written for the nine months ended September 30, 2007 includes a reduction of $1.2 million related to the amortization of purchase accounting adjustments. There were no purchase accounting adjustments in 2008 or for the three months ended September 30, 2007.

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Net Investment Income

The decrease in net investment income primarily reflects a decline in value of a limited partnership interest and a slight decrease in the portfolio yield. The decline in value of the limited partnership interest totaled $1.4 million and $1.9 million for the three and nine months ended September 30, 2008, including an impairment write-down of $1.4 million. The average yield on the fixed income portfolio was 4.34% as of September 30, 2008, compared to 4.49% as of September 30, 2007.

Net Realized Gains

Net realized investment losses for the three and nine months ended September 30, 2008 primarily reflect the decline in fair value of the convertible bond portfolio from 2007 to 2008 and other-than-temporary investment impairments totaling $504,000 recognized in the third quarter of 2008. The fair value of the convertible bond portfolio declined $206,000 and $474,000 for the three and nine months ended September 30, 2008, respectively, compared to an increase of $16,000 and $101,000 for the same periods in 2007, respectively. Net realized gains for the nine months ended September 30, 2007 also include gains recognized on the sale of an equity portfolio. There were no impairments recognized in 2007.

Losses and Loss Adjustment Expenses

The increase in the calendar period loss and LAE ratios primarily reflects a decrease in favorable loss reserve development on prior accident periods. The accident period loss and LAE ratio was 60.0% for the three months ended September 30, 2008 and the nine months ended September 30, 2008 and 2007. The accident period loss ratio was decreased from 62.0% to 60.0% during the third quarter of 2007, which further decreased the calendar period loss ratio for the three months ended September 30, 2007. Favorable loss reserve development on prior accident periods of $2.5 million was recorded for the nine months ended September 30, 2008, compared to $2.3 million and $4.5 million for the three and nine months ended September 30, 2007, respectively, which lowered loss ratios by 14.8 points for the three months ended September 30, 2007 and lowered loss ratios for the nine months ended September 30, 2008 and 2007 by 5.4 points and 10.7 points, respectively. There was no loss reserve development on prior accident periods recorded for the three months ended September 30, 2008. The favorable reserve development relates primarily to a decrease in the prior accident period loss development factors used to estimate losses and LAE. The decrease in prior accident period loss development factors relates primarily to significant prior year claim settlements during 2008 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, 2008. For the nine months ended September 30, 2008, the Company closed 315, or 44.7% of the 570 open lost time claims as of December 31, 2007. 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 2006, 2007, and the first half of 2008 enabled it to record losses and LAE that were lower than the amount reserved for claim settlements. For the three and nine months ended September 30, 2008, there was one claim that exceeded the Company’s $500,000 reinsurance retention, compared to no reinsured claims for the same period in 2007.

Acquisition and Other Underwriting Expenses

The increase in acquisition and other underwriting expenses primarily reflects growth in net premiums earned and a decrease in fee based revenue from the segregated portfolio reinsurance segment during 2008, which is netted against acquisition and other underwriting expenses.

Other Expenses

The increase in other expenses primarily reflects start-up costs incurred in conjunction with the Company’s expansion into the Southeast, due diligence and integration expenses associated with the acquisition of ESHC and other state licensing initiatives.

Policyholder Dividends

The increase in the policyholders’ dividend expense ratio is due to a decrease in the loss ratio of participating policies. Policyholder dividends represent payments to customers who purchased participating policies that produced favorable loss ratios. In 2008 and 2007, 10.9% and 10.1%, respectively, of all policies were written on a dividend policy basis.

Tax Expense

The effective tax rate for the three and nine months ended September 30, 2008 was 30.5% and 32.1%, respectively, and 28.4% and 30.1% for the three and nine months ended September 30 2007, respectively. The increase in the effective tax rate from 2007 to 2008 primarily reflects rehabilitation tax credits recognized in 2007.

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SEGREGATED PORTFOLIO CELL REINSURANCE

The following table represents the operations of the segregated portfolio cell reinsurance segment for the three and nine months ended September 30, 2008 and 2007 (unaudited, in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2007			2008			2007
Revenue:
Reinsurance premiums assumed	$	6,008		$	5,718		$	23,873		$	22,958
Ceded premiums written		(792	)		(786	)		(2,209	)		(1,912	)
Net premiums written		5,216			4,933			21,664			21,047
Change in unearned premiums		835			1,145			(4,517	)		(4,037	)
Net premiums earned		6,051			6,078			17,147			17,010
Net investment income		291			334			855			967
Net realized investment (losses) gains		(706	)		22			(445	)		181
Total revenue	$	5,636		$	6,434		$	17,557		$	18,158
Expenses:
Losses and LAE incurred	$	3,686		$	3,336		$	9,057		$	9,850
Acquisition and other underwriting expenses		1,872			1,924			5,306			5,093
Other expenses		183			187			234			395
Segregated portfolio dividend expense (1)		(105	)		987			2,960			2,820
Total expenses	$	5,636		$	6,434		$	17,557		$	18,158
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 three and nine months ended September 30, 2008 and 2007:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2007		2008		2007
Loss and LAE ratio	60.9	%	54.9	%	52.8	%	57.9	%
Expense ratio	34.0	%	34.7	%	32.3	%	32.3	%
Combined ratio	94.9	%	89.6	%	85.1	%	90.2	%

Reinsurance Premiums Assumed

The increase in reinsurance premiums assumed primarily reflects an increase in new business production and a decrease in the impact of purchase accounting adjustments, partially offset by a decrease in audit premiums, a decrease in premium renewal retention rates and continued renewal rate decreases. New business sales totaled $690,000 and $2.7 million for the three and nine months ended September 30, 2008, respectively, compared to $625,000 and $1.7 million for the same periods in 2007, respectively. Reinsurance premiums assumed in 2008 and 2007 include the impact of renewal rate decreases of 4.0%. Premium renewal retention rates were 87.7% and 89.9%, respectively, in 2008 and 2007. The decrease in audit premiums reflects additional premium to the Company of $122,000 for the three months ended September 30, 2008 and return premium to customers of $344,000 for the nine months ended September 30, 2008, compared to additional premium to the Company of $413,000 and $572,000 for the three and nine months ended September 30, 2007, respectively. Reinsurance premiums assumed for the nine months ended September 30, 2007 includes a reduction of $849,000 related to the amortization of purchase accounting adjustments. There were no purchase accounting adjustments in 2008 or for the three months ended September 30, 2007.

34

Net Investment Income

The decrease in net investment income primarily reflects a reduction in short-term interest rates from 2007 to 2008.

Net Realized Investment (Losses) Gains

Net realized investment losses for the three and nine months ended September 30, 2008 include other-than-temporary impairments of $478,000. There were no impairments recorded in 2007.

Losses and Loss Adjustment Expenses

The increase in the calendar period loss and LAE ratios from 2007 to 2008 reflects a decrease in favorable loss reserve development recorded on prior accident periods of $77,000 and $2.7 million for the three and nine months ended September 30, 2008, respectively, compared to $1.1 million and $2.2 million for the same periods in 2007, respectively, which lowered loss ratios for the three months ended September 30, 2008 and 2007 by 1.3 points and 18.6 points, respectively, and lowered loss ratios for the nine months ended September 30, 2008 and 2007 by 15.7 points and 12.4 points, respectively. The favorable loss reserve development on prior accident periods relates primarily to a decrease in the prior year 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 2008 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, 2008. The accident period loss ratios were 62.4% and 68.9% for the three and nine months ended September 30, 2008, respectively, compared to 73.9% and 71.2% for the same periods in 2007, respectively.

Acquisition and Other Underwriting Expenses

The expense ratios are consistent with the contractual ceding commissions for the three and nine months ended September 30, 2008 and 2007.

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 three and nine months ended September 30, 2008 and 2007 (unaudited, in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2007			2008			2007
Revenue:
Direct premiums written	$	9,774		$	9,737		$	29,339		$	28,607
Ceded premiums written		(643	)		(672	)		(1,838	)		(2,027	)
Net premiums written		9,131			9,065			27,501			26,580
Change in unearned premiums		—			(1	)		4			(2	)
Net premiums earned		9,131			9,064			27,505			26,578
Net investment income		535			795			2,161			2,365
Net realized investment (losses) gains		(2,883	)		422			(3,212	)		1,347
Total revenue	$	6,783		$	10,281		$	26,454		$	30,290
Expenses:
Losses and LAE incurred	$	5,932		$	6,174		$	18,684		$	17,696
Acquisition and other underwriting expenses		1,383			1,389			4,242			4,159
Other expenses		1,420			1,197			4,179			3,969
Total expenses	$	8,735		$	8,760		$	27,105		$	25,824
(Loss) income before income taxes		(1,952	)		1,521			(651	)		4,466
Income tax (benefit) expense		(814	)		291			(501	)		1,309
Net (loss) income	$	(1,138	)	$	1,230		$	(150	)	$	3,157

35

Net (Loss) Income

The net loss in the group benefits insurance segment for the three months ended September 30, 2008 primarily reflects the impact of other-than-temporary investment impairments and the change in the fair value of the convertible bond portfolio. Other-than-temporary investment impairments totaled $2.0 million and the fair value of the convertible bond portfolio decreased $1.1 million for the three months ended September 30, 2008. The combined ratio in the group benefits insurance segment decreased 0.9 percentage points from 2007 to 2008, primarily reflecting a reduction in the disability and life loss ratios.

The group benefits insurance ratios were as follows for the three and nine months ended September 30, 2008 and 2007:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2007		2008		2007
Loss and LAE ratio	65.0	%	68.1	%	67.9	%	66.6	%
Expense ratio	30.7	%	28.5	%	30.6	%	30.6	%
Combined ratio	95.7	%	96.6	%	98.5	%	97.2	%

Premiums

Direct premiums written, by line of business, for the three and nine months ended September 30, 2008 and 2007 were as follows (unaudited, in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2007		2008		2007
Dental	$	5,674	$	5,565	$	17,007	$	16,101
Short-term disability		1,625		1,657		4,928		4,963
Long-term disability		959		1,010		2,858		3,054
Term life		1,516		1,505		4,546		4,489
Total	$	9,774	$	9,737	$	29,339	$	28,607

Direct premiums written were relatively consistent for the three months ended September 30, 2008 and 2007. Year-to-date new business sales have decreased $2.6 million from 2007 to 2008 and the year-to-date renewal retention rate has decreased 3.3 percentage points.

Net Investment Income

The decrease in net investment income primarily reflects the decrease in invested assets. The decrease in invested assets reflects the sale of investments to fund dividend payments to EIHI for the acquisition of ESHC and share repurchases. The average tax equivalent yield on the fixed income portfolio was 5.40% as of September 30, 2008, compared to 5.24% as of September 30, 2007.

Net Realized Investment (Losses) Gains

The net realized investment losses for the three and nine months ended September 30, 2008 primarily reflect the aforementioned other-than temporary impairments and decrease in the fair value of the convertible bond portfolio from 2007 to 2008. These realized losses were partially offset by gains recognized on the sale of investments to fund dividends paid to EIHI.

Losses and Loss Adjustment Expenses

The decrease in losses and LAE from 2007 to 2008 for the three months ended September 30, 2008 primarily reflects favorable claim activity in the long-term disability line of business. Reported claim reserves decreased $305,000 for the three months ended September 30, 2008, compared to $97,000 for the same period in 2007. The increase in losses and LAE from 2007 to 2008 for the nine months ended September 30, 2008 primarily reflects an increase in the dental accident year loss ratio and unfavorable claim activity in the long-term disability line of business. The calendar period loss ratios, by line of business, for the three and nine months ended September 30, 2008 and 2007 were as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2007		2008		2007
Dental	73.5	%	68.7	%	75.3	%	69.7	%
Short-term disability	62.7	%	64.7	%	63.9	%	70.2	%
Long-term disability	(4.4	)%	61.4	%	39.7	%	14.1	%
Term life	51.2	%	70.2	%	49.2	%	61.7	%
Total group benefits	65.0	%	68.1	%	67.9	%	66.6	%

36

Dental

The increase in the dental calendar period loss ratio reflects an accident period loss ratio of 77.2% for the nine months ended September 30, 2008, compared to an accident period loss ratio of 71.8% for the same period in 2007. The increase in the accident period loss ratio primarily reflects increased utilization and claim cost inflation. The calendar period loss ratio reflects favorable development on prior accident period reserves, which reduced the loss ratio by 1.9 and 2.1 percentage points in 2008 and 2007, respectively.

Short-term Disability

The decrease in the short-term disability calendar period loss ratio reflects an accident period loss ratio of 66.3% for the nine months ended September 30, 2008, compared to an accident period loss ratio of 73.4% for the same period in 2007. The decrease in the accident period loss ratio primarily reflects a decrease in claim frequency and severity. The calendar period loss ratio reflects favorable development on prior accident period reserves, which reduced the loss ratio by 2.5 and 3.2 percentage points in 2008 and 2007, respectively.

Long-term Disability

The long-term disability loss ratio for the three months ended September 30, 2008 reflects the impact of prior period claim reserve terminations. Claim reserve terminations totaled $251,000, compared to new reported claim reserves totaling $57,000. Claim terminations and other reserve adjustments reduced long-term disability claim reserves by $305,000 and $488,000 for the three and nine months ended September 30, 2008, compared to a reduction in claim reserves of $97,000 and $805,000 for the same period in 2007. The were several claim terminations in excess of $100,000 in the first six months of 2007

Term Life

The decrease in the term life loss ratio reflects a reduction in death claims from 2007 to 2008, as well as a decrease in premium waiver reserves.

Acquisition and Other Underwriting Expenses

Acquisition and other underwriting expenses as a percent of direct premiums written have remained consistent from 2007 to 2008.

Other Expenses

The increase in other expenses from 2007 to 2008 primarily reflects an increase in consulting costs related to outsourced actuarial services and costs associated with the acquisition of software.

Tax (Benefit) Expense

The effective tax rate was 41.7% and 77.0% for the three and nine months ended September 30, 2008, compared to 19.1% and 29.3% for the same periods in 2007. The effective tax rate in 2008 primarily reflects the impact of tax-exempt interest income in relation to the loss before income taxes. The effective tax rate for in 2007 primarily reflects the impact of a prior year tax return adjustment and tax-exempt interest income.

37

SPECIALTY REINSURANCE

The following table represents the operations of the specialty reinsurance segment for the three and nine months ended September 30, 2008 and 2007 (unaudited, in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2007			2008			2007
Revenue:
Reinsurance premiums assumed	$	(290	)	$	3,263		$	3,893		$	10,133
Change in unearned premiums		2,404			641			4,857			628
Net premiums earned	$	2,114		$	3,905		$	8,750		$	10,762
Net investment income		195			379			881			1,154
Net realized investment (losses) gains		(263	)		—			33			(5	)
Other revenue		361			121			776			525
Total revenue	$	2,407		$	4,405		$	10,440		$	12,436
Expenses:
Losses and LAE incurred	$	3,464		$	5,789		$	10,456		$	10,297
Acquisition and other underwriting expenses		635			1,132			2,624			2,861
Other expenses		297			181			623			539
Total expenses	$	4,396		$	7,102		$	13,703		$	13,697
Loss before income taxes		(1,989	)		(2,697	)		(3,263	)		(1,261	)
Income tax benefit		(696	)		(1,207	)		(1,142	)		(704	)
Net loss	$	(1,293	)	$	(1,490	)	$	(2,121	)	$	(557	)

Net Loss

The decrease in the net loss for the three months ended September 30, 2008, compared to the same period in 2007, primarily reflects a decrease in loss and LAE expenses incurred, partially offset by a reduction in investment income, and an increase in net realized investment losses. The increase in the net loss for the nine months ended September 30, 2008, compared to the same period in 2007, primarily reflects an increase in unfavorable loss reserve development on prior accident years and the impact of purchase accounting adjustments. The net loss for the nine months ended September 30, 2007 was increased by $225,000 related to the amortization of purchase accounting adjustments. There were negligible purchase accounting adjustments in 2008 and for the three months ended September 30, 2007.

The specialty reinsurance ratios were as follows for the three and nine months ended September 30, 2008 and 2007:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2007		2008		2007
Loss and LAE ratio	163.9	%	148.2	%	119.5	%	95.7	%
Expense ratio	44.1	%	33.6	%	37.1	%	31.6	%
Combined ratio	207.9	%	181.8	%	156.6	%	127.3	%

Reinsurance Premiums Assumed

Reinsurance premiums assumed, by line of business, were as follows for the three and nine months ended September 30, 2008 and 2007 (unaudited, in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2007			2008		2007
EnviroGuard	$	(33	)	$	3,287		$	2,887	$	8,516
EIA liability		(257	)		(199	)		1,000		2,083
Other		—			175			6		383
Purchase accounting adjustments		—			—			—		(849	)
Total assumed premiums	$	(290	)	$	3,263		$	3,893	$	10,133

38

The decrease in reinsurance premiums assumed is due to the termination of the quota share reinsurance treaty in the specialty reinsurance segment effective July 1, 2008, partially offset by a decrease in the impact of purchase accounting adjustments from 2007 to 2008. Reinsurance premiums assumed for the nine months ended September 30, 2007 includes a reduction of $849,000 related to the amortization of purchase accounting adjustments. There were no purchase accounting adjustments in 2008 or for the three months ended September 30, 2007.

Net Investment Income

The decrease in net investment income primarily reflects a decline in the value of limited partnership interests from 2007 to 2008 and a decrease in the portfolio yield. The average yield on the fixed income portfolio was 4.10% as of September 30, 2008, compared to 4.71% as of September 30, 2007.

Net Realized Investment (Losses) Gains

Net realized investment losses for the three and nine months ended September 30, 2008 include other-than-temporary impairments of $260,000. There were no impairments recorded in 2007

Losses and Loss Adjustment Expenses

The increase in the calendar period loss and LAE ratios reflects a decrease in net earned premium due to the termination of the quota share reinsurance treaty and unfavorable loss reserve development on prior accident years of $2.3 million and $5.4 million for the three and nine months ended September 30, 2008, respectively, and $4.1 million and $4.4 million for the same periods in 2007, respectively, which increased the loss ratios for the three months ended September 30, 2008 and 2007 by 107.4 points and 103.9 points, respectively, and increased the loss ratios for the nine months ended September 30, 2008 and 2007 by 61.7 points and 38.1 points, respectively. The unfavorable loss reserve development in 2008 relates to an increase in reported claims from the ceding company. The accident period loss ratios were 56.2% and 57.6% for the three and nine months ended September 30, 2008, respectively, compared to 44.2% and 54.3% for the same periods in 2007, respectively.

Acquisition and Other Underwriting Expenses

The increase in the expense ratio is related to a decrease in net earned premium due to the termination of the quota share reinsurance treaty. As part of its previously in-force quota share reinsurance agreement with the primary insurer, the Company paid the primary insurer a ceding commission of 30.0% based on assumed premiums

Tax Expense

The effective tax rate for the three and nine months ended September 30, 2008 was 35.0%, compared to 44.8% and 55.8% for the same periods in 2007. The 2007 effective tax rates reflect the impact of prior year tax return adjustments that increased the income tax benefit.

CORPORATE/OTHER

The increase in the net loss in the corporate/other segment primarily reflects a decline in net investment income. The decrease in net investment income reflects the decline in short-term interest rates as well as the decrease in cash related to the stock buyback program and the repayment of the junior subordinated debentures.

CONSOLIDATED FINANCIAL POSITION

Consolidated assets totaled $390.6 million as of September 30, 2008, compared to $385.5 million as of December 31, 2007. The acquisition of ESHC resulted in an increase to consolidated assets of $25.9 million, including the recognition of goodwill and intangible assets of $2.9 million and $4.2 million, respectively. The increase in consolidated assets related to the acquisition of ESHC was partially offset by a decrease in investments, which reflects the sale of investments to fund the acquisition of ESHC, share repurchases, and the repayment of the junior subordinated debentures, as well as the decrease in the fair value of the Company’s investment portfolio.

Consolidated liabilities totaled $234.5 million as of September 30, 2008, compared to $207.7 million as of December 31, 2007. The acquisition of ESHC resulted in an increase to consolidated liabilities of $19.2 million. In addition to the acquired ESHC liabilities, loss and LAE reserves and unearned premiums increased. The increase in loss and LAE reserves primarily reflects unfavorable reserve development in the specialty reinsurance segment and new business growth in the workers’ compensation insurance segment.

39

The increase in unearned premiums primarily reflects the workers’ compensation premium cycle. Unearned premiums in the workers’ compensation insurance segment totaled $46.7 million as of September 30, 2008, compared to $42.9 million as of September 30, 2007.

Consolidated equity totaled $156.1 million as of September 30, 2008, compared to $177.8 million as of December 31, 2007. The decrease primarily reflects the stock buyback program, shareholder dividends, and a decline in the market value of the Company’s investments, partially offset by net income for the nine months ended September 30, 2008.

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, 2008 and 2007 were as follows (unaudited, in thousands):

	2008			2007
Cash flows provided by operating activities	$	17,203		$	19,737
Cash flows provided by (used in) investing activities		13,240			(14,758	)
Cash flows used in financing activities		(26,758	)		(14,386	)
Net increase (decrease) in cash and cash equivalents	$	3,685		$	(9,407	)

The increase in cash flows from 2007 to 2008 primarily reflects proceeds from the sale of investments, offset by the Company’s stock buyback program and the repayment of the junior subordinated debentures. The decrease in cash flows from operations primarily reflects the reduction in net investment income and a reduction in assumed premiums in the specialty reinsurance segment. The increase in proceeds from investments reflects the sale of investments to fund the acquisition of ESHC and the stock buyback program and the repayment of the junior subordinated debentures.

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, 2008, 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 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 9.9% as of September 30, 2008), 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, 2007. 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 March 14, 2008.

40

Item 4. Controls and Procedures

Evaluation of Disclosure 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 such term is defined in Rules 13a – 15(e) and 15 d – 15(e) under the Securities Exchange Act of 1934, as amended) 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, as of the end of such period, these disclosure controls and procedures are effective.

Changes in Internal Control Over Financial Reporting

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a – 15(f) and 15d – 15(f) under the Exchange Act) during the fiscal quarter to which this report relates 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

With exception of the risk factor below, there are no material changes from the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007, SEC File No. 001-32899.

Our premium revenue in the group benefits insurance segment may be adversely affected as a result of the termination of our relationship with IBSi.

On September 2, 2008, we terminated our relationship with IBSi, a key general agent for our group benefits insurance segment in our Southeast market, primarily North Carolina, South Carolina, and Georgia. Direct premiums written in North Carolina, South Carolina, and Georgia totaled approximately $11.6 million for the nine months ended September 30, 2008. The termination is effective for all new and renewal business written on or after January 1, 2009; however, IBSiis still entitled to override payments related to renewals on existing business as of December 31, 2008 for a period of 24 months. As a result of the termination, we will no longer rely on IBSi to manage producer relationships in the Southeast market. Those relationships will be handled directly by our internal sales personnel. The termination of our relationship with IBSirequires our sales personnel to develop direct relationships with IBSi’s key producers. In the event we are unable to develop and maintain these relationships, we could experience a decrease in retention of this business upon renewal and/or our ability to generate new sales in the Southeast territory could be adversely impacted, which could result in a decrease in premium revenue in the group benefits insurance segment.

41

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, 2008 and 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, 2008	113,757	$	16.23	113,757	915,878
February 1-28, 2008	540,271	$	16.50	540,271	375,607
March 1-31, 2008	156,193	$	15.38	156,193	219,414
April 1-30, 2008	74,610	$	15.76	74,610	144,804
May 1-31, 2008	81,800	$	15.99	81,800	63,004
June 1-30, 2008	31,797	$	15.82	31,797	31,207	(a)
July 1-31 2008	21,563	$	15.05	21,563	9,644	(a)
August 1-31, 2008	10,826	$	15.18	10,826	—	(a)
September 1-30, 2008	3,472	$	15.16	3,472	—	(a)
Total	1,034,289	$	16.14	1,034,289

(a) The maximum number of remaining shares represents the difference between 2,046,500 authorized shares and the number of shares repurchased as of September 30, 2008. The approval to repurchase an additional $10 million of the Company’s common stock is not included in this amount.

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
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

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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)
10.12	Eastern Insurance Holdings, Inc. 2006 Stock Incentive Plan (Incorporated by reference from Exhibit 4.1 to EIHI’s Registration Statement on Form S-8 filed on April 2, 2007)
21.1	Subsidiaries of Eastern Insurance Holdings, Inc. (Incorporated by reference from Exhibit 21 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 6, 2008	By:	/s/ Bruce M. Eckert
		Bruce M. Eckert,
		Chief Executive Officer
Dated: November 6, 2008	By:	/s/ Kevin M. Shook
		Kevin M. Shook,
		Treasurer and Chief Financial Officer

44