Eastern Insurance (EIHI) 10-Q 2009 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, 2009,

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    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.

	Number of Shares Outstanding as of November 4, 2009
COMMON STOCK (No par Value)	9,691,257
(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	27
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	46
Item 4.	Controls and Procedures	46
PART II - OTHER INFORMATION		47
Item 1.	Legal Proceedings	47
Item 1A.	Risk Factors	47
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47
Item 3.	Defaults Upon Senior Securities	47
Item 4.	Submission of Matters to Vote of Security Holders	47
Item 5.	Other Information	48
Item 6.	Exhibits	48

2

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except share data)

	September 30, 2009			December 31, 2008
ASSETS
Investments:
Fixed income securities, at estimated fair value (amortized cost, $168,734; $180,102)	$	175,349		$	183,136
Convertible bonds, at estimated fair value (amortized cost, $14,431; $13,783)		15,955			12,346
Equity securities, at estimated fair value (cost, $17,927; $22,287)		21,104			17,162
Other long-term investments, at estimated fair value (cost, $10,177; $10,586)		9,857			9,519
Total investments		222,265			222,163
Cash and cash equivalents		68,354			52,875
Accrued investment income		1,676			2,058
Premiums receivable (net of allowance, $582; $581)		39,171			29,615
Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses		28,188			29,637
Deferred acquisition costs		7,339			5,760
Deferred income taxes, net		3,438			6,281
Federal income taxes recoverable		205			16
Intangible assets		7,880			9,179
Goodwill		10,752			10,752
Other Assets		9,920			8,975
Total assets	$	399,188		$	377,311
LIABILITIES
Reserves for unpaid losses and loss adjustment expenses	$	156,500		$	159,117
Unearned premium reserves		53,442			42,365
Advance premium		1,375			1,594
Accounts payable and accrued expenses		12,791			13,136
Ceded reinsurance balances payable		5,754			6,886
Benefit plan liabilities		499			497
Segregated portfolio cell dividend payable		15,422			13,140
Loan payable		1,975			2,439
Total liabilities	$	247,758		$	239,174
Commitments and contingencies (Note 14)
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 – 11,783,014 and 11,602,723, respectively; outstanding – 9,691,257 and 9,512,366, respectively		—			—
Unearned ESOP compensation		(5,047	)		(5,606	)
Additional paid in capital		112,666			111,772
Treasury stock, at cost (2,091,757 and 2,090,357 shares, respectively)		(32,666	)		(32,655	)
Retained earnings		70,989			66,492
Accumulated other comprehensive income (loss), net		5,488			(1,866	)
Total shareholders’ equity		151,430			138,137
Total liabilities and shareholders’ equity	$	399,188		$	377,311

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, 2009 and 2008

(Unaudited, in thousands, except per share data)

	For the Three Months Ended September 30,					For the Nine Months Ended September 30,
	2009		2008			2009			2008
REVENUE
Net premiums earned	$	33,108	$	33,118		$	100,864		$	99,363
Net investment income		1,960		2,412			5,632			7,407
Change in equity interest in limited partnerships		523		(1,657	)		800			(1,965	)
Net realized investment gains (losses)		2,088		(4,518	)		349			(4,213	)
Other revenue		206		167			569			522
Total revenue		37,885		29,522			108,214			101,114
EXPENSES
Losses and loss adjustment expenses incurred		20,595		22,517			64,479			62,930
Acquisition and other underwriting expenses		4,415		4,588			13,371			14,224
Other expenses		6,612		6,584			19,488			19,113
Amortization of intangibles		433		328			1,299			984
Policyholder dividend expense		118		325			241			253
Segregated portfolio dividend expense		1,086		29			434			2,602
Total expenses		33,259		34,371			99,312			100,106
Income (loss) before incomes taxes		4,626		(4,849	)		8,902			1,008
Income tax expense (benefit)		1,335		(1,760	)		3,189			20
Net income (loss)	$	3,291	$	(3,089	)	$	5,713		$	988
Other comprehensive income (loss)
Unrealized holding gains (losses) arising during period, net of tax of $2,366, $(2,201), $3,442 and $(3,680)		4,394		(4,088	)		6,392			(6,835	)
Amortization of unrecognized benefit plan amounts, net of tax of $1, $2, $4 and $6		3		4			8			12
Less: Reclassification adjustment for gains (losses) included in net income (loss), net of tax of $16, $(893), $(753) and $(591)		31		(1,658	)		(1,399	)		(1,097	)
Other comprehensive income (loss)		4,366		(2,426	)		7,799			(5,726	)
Comprehensive income (loss)	$	7,657	$	(5,515	)	$	13,512		$	(4,738	)
	Three Months Ended September 30,					Nine Months Ended September 30,
Earnings per share (See Note 5):	2009		2008			2009			2008
Net income (loss)	$	3,291	$	(3,089	)	$	5,713		$	988
Basic earnings per share	$	0.36	$	(0.34	)	$	0.63		$	0.11
Diluted earnings per share	$	0.36	$	(0.34	)	$	0.62		$	0.10
Cash dividends per share	$	0.07	$	0.07		$	0.21		$	0.21
Weighted average basis shares outstanding		9,027,706		8,776,743			8,963,740			9,017,853
Weighted average diluted shares outstanding		9,046,356		8,776,743			9,047,750			9,371,896

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, 2009

(Unaudited, in thousands, except share data)

Three Months Ended September 30, 2009

	Outstanding Shares
	Series A Preferred Stock	Common Capital Stock	Common Capital Stock		Unearned ESOP Compensation			Additional Paid-In Capital			Treasury Stock			Retained Earnings			Accumulated Other Comprehensive Income (Loss) Net of Tax		Total
Balance, July 1, 2009	—	9,691,257	$	—	$	(5,235	)	$	112,350		$	(32,666	)	$	68,376		$	1,122	$	143,947
ESOP shares released	—	—		—		188			(10	)		—			—			—		178
Stock compensation expense	—	—		—		—			326			—			—			—		326
Shareholder dividend	—	—		—		—			—			—			(678	)		—		(678	)
Net income	—	—		—		—			—			—			3,291			—		3,291
Other comprehensive income, net of tax	—	—		—		—			—			—			—			4,366		4,366
Balance, September 30, 2009	—	9,691,257	$	—	$	(5,047	)	$	112,666		$	(32,666	)	$	70,989		$	5,488	$	151,430

Nine Months Ended September 30, 2009

	Outstanding Shares
	Series A Preferred Stock	Common Capital Stock		Common Capital Stock		Unearned ESOP Compensation			Additional Paid-In Capital			Treasury Stock			Retained Earnings			Accumulated Other Comprehensive Income (Loss) Net of Tax			Total
Balance, January 1, 2009	—	9,512,366		$	—	$	(5,606	)	$	111,772		$	(32,655	)	$	66,492		$	(1,866	)	$	138,137
Cumulative effect adjustment	—	—			—		—			—			—			685			(445	)		240
ESOP shares released	—	—			—		559			(75	)		—			—			—			484
Stock compensation expense	—	180,291			—		—			969						—			—			969
Repurchase of common stock	—	(1,400	)		—		—			—			(11	)		—			—			(11	)
Shareholder dividend	—	—			—		—			—			—			(1,901	)		—			(1,901	)
Net income	—	—			—		—			—			—			5,713			—			5,713
Other comprehensive income, net of tax	—	—			—		—			—			—			—			7,799			7,799
Balance, September 30, 2009	—	9,691,257		$	—	$	(5,047	)	$	112,666		$	(32,666	)	$	70,989		$	5,488		$	151,430

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, 2008

(Unaudited, in thousands, except share data)

Three Months Ended September 30, 2008

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

6

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Nine Months Ended September 30, 2009 and 2008

(Unaudited, in thousands)

	2009			2008
Cash flow from operating activities:
Net income	$	5,713		$	988
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		467			390
Amortization of bond premium/discount		(97	)		326
Net realized investment (gains) losses		(349	)		4,212
Change in equity interest in limited partnerships		(800	)		1,965
Deferred tax (benefit) expense		1,001			(3,437	)
Stock compensation		1,454			1,828
Intangible asset amortization		1,299			984
Changes in assets and liabilities:
Accrued investment income		382			340
Premiums receivable		(9,556	)		(6,797	)
Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses		1,449			(125	)
Deferred acquisition costs		(1,579	)		(421	)
Other assets		(1,161	)		(259	)
Reserves for unpaid losses and loss adjustment expenses		(2,617	)		7,153
Unearned and advance premium		10,858			9,356
Ceded reinsurance balances payable		(1,132	)		(459	)
Accounts payable and accrued expenses		(309	)		2,489
Segregated portfolio cell dividend payable		(127	)		189
Benefit plan liabilities		14			(36	)
Federal income taxes recoverable/payable		(189	)		(1,483	)
Net cash provided by operating activities		4,721			17,203
Cash flows from investing activities:
Purchase of fixed income securities		(87,335	)		(34,171	)
Purchase of equity securities		(5,806	)		(11,070	)
Purchase of other long-term investments		—			(3,000	)
Proceeds from sale of fixed income securities		74,024			39,907
Proceeds from maturities/calls of fixed income securities		26,054			25,701
Proceeds from equity securities		6,022			4,263
Proceeds from other long-term investments		461			820
Acquisition of ESHC, net of cash received		—			(8,025	)
Principal payments received on mortgage loans		2			7
Purchase of equipment, net		(252	)		(1,192	)
Net cash provided by investing activities		13,170			13,240
Cash flows from financing activities:
Repurchase of common stock		(11	)		(16,719	)
Repayment of loan principal		(500	)		—
Repayment of junior subordinated debentures		—			(8,007	)
Shareholder dividend		(1,901	)		(2,064	)
Excess tax benefit from vested restricted stock		—			32
Net cash used in financing activities		(2,412	)		(26,758	)
Net increase in cash and cash equivalents		15,479			3,685
Cash and cash equivalents, beginning of period		52,875			45,940
Cash and cash equivalents, end of period	$	68,354		$	49,625

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”), Global Alliance Holdings, Ltd. (“Global Alliance”), 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 Services Corporation (“Eastern Services”), Employers Alliance, Inc. (“Employers Alliance”), Employers Security Holding Company (“ESHC”), Employers Security Insurance Company (“ESIC”), Affinity Management Services, Inc., (“Affinity”) and Eastern Life and Health Insurance Company (“ELH”), collectively referred to as the Company.

On September 29, 2008, EIHI acquired all of the outstanding stock of ESHC and its wholly-owned subsidiaries, ESIC and Affinity (See Note 3). ESIC is an Indiana-domiciled workers’ compensation insurance company licensed to write business in Indiana, Illinois and Missouri. Affinity is a third party administrator offering claims administration and risk management services to self-insured property/casualty customers.

The Company currently operates in five segments: workers’ compensation insurance, segregated portfolio cell reinsurance, group benefits insurance, specialty reinsurance and corporate/other. The specialty reinsurance segment was placed into run-off effective July 1, 2008. See Note 12 for a description of each segment.

2. Significant Accounting Policies

Basis of Presentation

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments, being normal, recurring adjustments, necessary for a fair presentation of the financial position and results of operations of the Company for the periods presented have been included. The results of operations for an interim period are not necessarily indicative of the results for an entire year. These financial statements should be read in conjunction with the Company’s audited financial statements and notes thereto as of and for the year ended December 31, 2008 included in the Company’s Annual Report on Form 10-K, which was filed with the U.S. Securities and Exchange Commission on March 13, 2009.

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. The Company reclassified the change in equity interest in its limited partnership investments from net investment income to the change in equity interest in limited partnerships in the consolidated statements of operations. The reclassification did not have any impact on prior year revenues, expenses, or net income.

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 are based on prices obtained from an

8

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements—(Continued)

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

independent pricing service. Prices obtained from the independent pricing service are determined based on quoted market 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. When prices provided by the independent pricing service vary significantly from week to week, management reviews and validates such prices with other recognized market information sources or independent broker/dealers. Other criteria used by management to determine whether a market has become inactive include price quotations not based on current information, price quotations varying among brokers, significant increases in the bid-ask spread of a security and a significant decline or absence of a market for new issuances. 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. A fixed income security is considered to be other-than-temporarily impaired when the security’s fair value is less than its amortized cost basis and 1) the Company intends to sell the security, 2) it is more likely than not that the Company will be required to sell the security before recovery of the security’s amortized cost basis, or 3) the Company believes it will be unable to recover the entire amortized cost basis of the security (i.e., a credit loss has occurred). For those fixed income securities for which an other-than-temporary impairment has occurred, the Company adjusts the amortized cost basis of the security and records a realized loss in the consolidated statements of operations. Any subsequent increase in the security’s estimated fair value would be reported as an unrealized gain.

Convertible Bond Securities

The Company’s investments in convertible bond securities are considered hybrid financial instruments and are carried at estimated fair value, with changes in estimated fair value reported as a realized gain or loss in the consolidated statement of operations and comprehensive income (loss).

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. At the time a security is determined to be other-than-temporarily impaired, the Company reduces the cost of the security to the current estimated fair value as of 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 the change in equity interest in limited partnerships 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 as a result of the timing of statements being received from the limited partnership.

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, 2009 and December 31, 2008 totaled $1,701 and $1,800, respectively.

Premiums generated by the Company’s group benefits insurance segment are generally billed on a monthly basis with premiums being earned in the month in which the coverage is provided. Unearned premiums represent premiums that have been received but for which

9

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements—(Continued)

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

the coverage period has not expired. Advance premiums represent 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 run-off specialty reinsurance segment were estimated based on information provided by the ceding company. The information used in establishing these estimates was reviewed and subsequent adjustments were recorded in the period in which they were reported. These premiums were earned over the terms of the related reinsurance contracts.

Other Revenue

Other revenue primarily consists of service revenues 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 approximately 3.0%. The reserves for unpaid losses and LAE have been reduced for the effects of discounting by approximately $4,330 and $4,145 as of September 30, 2009 and December 31, 2008, 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 2009 and 2008 is 4.00% and 3.85%, 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 run-off specialty reinsurance segment based on information provided by the ceding company. Premiums and reported claims data provided by the ceding company is utilized by management to estimate the ultimate losses and LAE, including an amount for 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, 2009. 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, 2009, the related adjustments could have a material adverse effect on the Company’s financial condition, results of operations or liquidity.

Reinsurance

In the ordinary course of business, the Company assumes and cedes reinsurance with other insurance companies. These arrangements provide greater diversification of business and minimize the net loss potential arising from large claims. Ceded reinsurance contracts

10

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements—(Continued)

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

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 $1,114 and $1,380 for the three months ended September 30, 2009 and 2008, respectively, and $5,404 and $5,093 for the nine months ended September 30, 2009 and 2008, 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.

EIHI’s insurance subsidiaries 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, Eastern Services and Affinity are subject to state income tax in the states in which they operate.

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

The Company includes income tax-related interest and penalties as a component of income tax expense. The Company did not incur any income tax-related interest or penalties during the three months ended September 30, 2009 and 2008.

The Company’s federal income tax returns for tax years subsequent to December 31, 2005 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, 2009 and December 31, 2008, the Company accrued dividends payable of $1,073 and $1,311, 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 states in which it is licensed, which provide for the payment of covered claims or to meet other insurance obligations from insurance company insolvencies. The Company’s assessments consist primarily of charges from the Workers’ Compensation Security Fund of Pennsylvania (“Security Fund”). The Security Fund serves as a guaranty fund to provide claim payments for those workers entitled to workers’ compensation benefits when the insurance company originally providing the benefits was placed into liquidation by a court. Security Fund assessments are established on an actuarial basis to provide an amount sufficient to pay the outstanding and anticipated claims in a timely manner, to meet the costs of the Pennsylvania Insurance Department 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

11

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements—(Continued)

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

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, 2009 and December 31, 2008, the Company accrued $1,941 and $1,052 related to the Security Fund assessment. The Company has not yet been notified by the Security Fund of the 2008 assessment, but management believes an assessment is probable; therefore the amount accrued as of September 30, 2009 includes the estimated 2008 assessment of $1,052.

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 Accounting Standards Codification (“ASC”) 350, Intangibles – Goodwill and Other.

Goodwill is assigned to one or more reporting units at the date of acquisition. The goodwill reported by the Company has been allocated 100% to the workers’ compensation insurance segment, which is considered a reporting unit for goodwill purposes. The annual goodwill impairment test, performed as of September 30, each year, consists of a two-step process. The first step identifies whether potential impairment exists by comparing the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of a reporting unit is less than its carrying amount, the second step is required to measure the amount of any impairment loss.

Management tested goodwill for impairment as of September 30, 2009 using a discounted cash flow analysis and by evaluating the Company’s common stock price in relation to the book value of the workers’ compensation insurance segment. The discounted cash flow analysis was based on management’s internal four-year forecast for the workers’ compensation insurance segment, assuming a long-term growth rate of 5.0% and a discount rate of 13.0%. Cash flows were adjusted as necessary to maintain adequate capital requirements. As of September 30, 2009, the Company’s stock price was trading below book value, primarily reflecting the impact of market conditions over the past year; therefore, management considered an estimate of the Company’s value in a potential transaction and allocated that value to the Company’s reporting units, including the workers’ compensation insurance segment. Both the discounted cash flow analysis and the estimate of the Company’s value in a potential transaction resulted in the workers’ compensation insurance segment’s estimated fair value exceeding its carrying value as of September 30, 2009; therefore, goodwill was considered not impaired.

Treasury Stock

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

Stock-Based Compensation

The Company adopted the Eastern Insurance Holdings, Inc. 2006 Stock Incentive Plan (the “Stock Incentive Plan”) on December 18, 2006. Under the terms of the Stock Incentive Plan, stock awards may be made in the form of incentive stock options, non-qualified stock options or restricted stock. The Company 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, 2009 and 2008 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,
	2009		2008		2009		2008
Suspense shares		560,625		635,375		560,625		635,375
Allocated shares		186,875		112,125		186,875		112,125
Shares committed to be released		18,841		18,841		55,909		56,318
Average price per share	$	9.47	$	14.49	$	8.66	$	15.04
Stock compensation expense	$	178	$	273	$	484	$	847

As of September 30, 2009 and 2008, the estimated fair value of unearned ESOP shares were $4,371 and $8,709, respectively.

Recent Accounting Guidance

Fair Value Measurements – Investments in Certain Entities that Calculation Net Asset Value per Share

In September 2009, the Financial Accounting Standards Board (“FASB”) issued new accounting and disclosure guidance related to the determination of fair value of investments in entities (investees) that permit the investor to redeem its investments directly with the

12

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements—(Continued)

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

investee or receive distributions from the investee at times specified under the terms of the investee’s governing documents. Many of these investees do not have readily determinable fair values and provide their investors with a net asset value per share (or its equivalent, such as member units or an ownership interest in partners’ capital). Under the new guidance, investments in entities that calculate net asset value per share (or its equivalent) may be measured at fair value using the investee’s net asset value per share (or its equivalent) if the net asset value of the investment is calculated in a manner consistent with the measurement principles of investment companies as of the reporting entity’s measurement date, including measurement of all or substantially all of the underlying investments of the investee in accordance with the fair value measurement principles. The new guidance also requires enhanced disclosure related to the reporting entity’s investment is such investees including, but not limited to, the nature of any restrictions on the reporting entity’s ability to redeem its investments at the measurement date, any unfunded commitments, and the investment strategies of the investee. The Company’s limited partnership interests are currently reported in the consolidated balance sheets using the net asset value per share (or its equivalent) of the investee. We do not expect the new accounting guidance to have a material impact, if any, on the estimated fair value of our limited partnership interests.

FASB Accounting Standards Codification

In June 2009, the FASB established the FASB Accounting Standards Codification (“Codification”) as the single source of authoritative accounting principles in the preparation of financial statements in conformity with GAAP. The Codification explicitly recognizes rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under federal securities laws as authoritative GAAP for SEC registrants. The Codification is effective for financial statements issued for periods ending after September 15, 2009. The Company adopted the Codification effective September 30, 2009 and revised its disclosures to reflect Codification as the source of authoritative accounting principles.

Variable Interest Entities

In June 2009, the FASB issued new accounting guidance related to variable interest entities. The new guidance 1) replaces the quantitative-based risks and rewards calculation for determining whether an enterprise is the primary beneficiary in a variable interest entity with an approach that is primarily qualitative, 2) requires ongoing assessments of whether an enterprise is the primary beneficiary of a variable interest entity, and 3) requires additional disclosures about an enterprise’s involvement in variable interest entities. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2009. We do not expect the adoption of FAS 167 to have a material impact, if any, on our consolidated financial condition and results of operations.

Transfers of Financial Assets

In June 2009, the FASB issued new disclosure guidance related to the transfer of financial assets. The new guidance requires enhanced disclosures about transfers of financial assets and a company’s continuing involvement in transferred assets and is effective for financial statements issued for fiscal years beginning after November 15, 2009. We do not expect the adoption of FAS 166 to have any impact on our disclosures since we do not engage in transfers of financial assets.

Subsequent Events

In May 2009, the FASB issued new accounting and disclosure guidance related to subsequent events. The new guidance defines subsequent events as either “recognized” or “nonrecognized” and is consistent with existing guidance related to the reporting of subsequent events. Recognized subsequent events are those events that provide additional evidence about conditions that existed at the balance sheet date and must be recognized in an entity’s financial statements. Nonrecognized events are those events that provide evidence about conditions that did not exist at the balance sheet date but arose before the financial statements are issued or are available to be issued. Nonrecognized events may require disclosure in an entity’s financial statements to prevent the financial statements from being misleading. Entities are required to disclose the date through which subsequent events have been evaluated, as well as whether the date is the date the financial statements were issued or the date the financial statements were available to be issued. Publicly traded entities must evaluate subsequent events through the financial statement issuance date. The new guidance is effective for interim or annual financial periods ending after June 15, 2009. The Company adopted the new accounting and disclosure requirements effective June 30, 2009, which are included in Note 15.

Other-than-Temporary Investment Impairments

In April 2009, the FASB issued new accounting guidance related to the recognition and presentation of other-than-temporary investment impairments. The new guidance requires entities to separate an other-than-temporary impairment of a debt security into two components when there are credit related losses associated with the impaired debt security for which management asserts that it does not have the intent to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of its cost basis. The amount of the other-than-temporary impairment related to a credit loss is recorded as a net realized investment loss in the statements of operations, and the amount of the other-than-temporary impairment related to other factors is recorded as an other comprehensive loss. The new guidance is effective for periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company adopted the new guidance effective April 1, 2009, which resulted in the Company recording a cumulative effect adjustment that increased retained earnings and decreased accumulated other comprehensive income

13

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements—(Continued)

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

(loss), net, as of April 1, 2009, by $685 and $445, respectively, resulting in an increase to shareholders’ equity of $240. The increase in shareholders’ equity reflects the reversal of a prior period deferred tax valuation allowance, of which $240 was applied to the retained earnings cumulative effect adjustment.

Fair Value Measurements

In April 2009, the FASB issued new accounting guidance related to determining fair value of an asset or liability when the volume or level of activity for the asset or liability has significantly decreased and for identifying transactions that are not orderly. Under the new guidance, if an entity determines that there has been a significant decrease in the volume and level of activity for the asset or the liability in relation to the normal market activity for the asset or liability (or similar assets or liabilities), then transactions or quoted prices may not accurately reflect fair value. In addition, if there is evidence that the transaction for the asset or liability is not orderly, the entity shall place little, if any weight on that transaction price as an indicator of fair value. The new guidance is effective for periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company adopted the new guidance effective June 30, 2009. The adoption of the new guidance did not have a material effect on the Company’s consolidated financial statements.

Disclosures About Fair Value of Financial Instruments

In April 2009, the FASB issued new accounting guidance related to the interim disclosures about fair value of financial instruments. The new guidance requires disclosures about fair value of financial instruments in interim and annual financial statements and is effective for periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company adopted the interim period disclosure requirements of effective June 30, 2009, which are included in Notes 8 and 9.

3. Business Combinations

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 and goodwill totaling $2,760. Direct costs related to the acquisition totaling $107 were capitalized and included in goodwill.

4. Intangible Assets

As of September 30, 2009 and December 31, 2008, intangible assets consisted of the following (unaudited, in thousands):

	September 30, 2009				December 31, 2008
Intangible Assets with Finite Life	Gross Balance		Accumulated Amortization		Gross Balance		Accumulated Amortization
Agency relationships (15 year amortization period)	$	3,564	$	1,145	$	3,564	$	715
Renewal rights (15 year amortization period)		8,238		4,352		8,238		3,483
	$	11,802	$	5,497	$	11,802	$	4,198
Intangible Assets with Indefinite Life
State insurance licenses		1,575		—		1,575		—
Total intangible assets	$	13,377	$	5,497	$	13,377	$	4,198

Amortization expense totaled $433 and $328 for the three months ended September 30, 2009 and 2008, respectively, and $1,299 and $984 for the nine months ended September 30, 2009 and 2008, respectively.

5. Earnings Per Share

Basic earnings per share are computed by dividing net (loss) income by the weighted average number of shares outstanding for the respective period. Diluted earnings per share are computed by dividing net (loss) income 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, 2009 and 2008, there were 746,878 and 1,203,038 stock options and restricted stock awards that were not included in the Company’s earnings per share calculation because to do so would have been anti-dilutive. For the nine months ended September 30, 2009 and 2008, there were 681,518 and 848,995 stock options and restricted stock awards that were not included in the Company’s earnings per share calculation because to do so would have been anti-dilutive. For the three months ended September 30, 2009, dilutive potential common shares outstanding included 18,650 restricted stock awards. For the nine months ended September 30, 2009 and 2008, dilutive potential common shares outstanding included 76,525 and 306,099 stock warrants and 7,485 and 47,944 restricted stock awards, respectively.

In June 2008, the FASB issued new accounting guidance with respect to determining whether instruments granted in share-based payment transactions are considered participating securities. The new guidance provides that unvested share-based payment awards

14

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements—(Continued)

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

that contain non-forfeitable rights to dividends are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method described in ASC 260 – Earnings Per Share. The two-class method of computing earnings per share is an earnings allocation formula that determines earnings per share for common stock and any participating securities according to dividends declared (whether paid or unpaid) and participation rights in undistributed earnings. The Company’s unvested restricted stock are considered participating securities since the share-based awards contain a non-forfeitable right to dividends irrespective of whether the awards ultimately vest. The new guidance is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years. Upon adoption, earnings per share data must be retrospectively adjusted to conform to the new guidance. The Company adopted the new guidance effective January 1, 2009 and computed earnings per common share using the two-class method for all periods presented. The new guidance resulted in an increase of $0.01 per basic and diluted earnings per share for the three months ended September 30, 2008 and a decrease of $0.01 per diluted earnings per share for the nine months ended September 30, 2009.

Consolidated net (loss) 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, 2009 and 2008 were as follows (unaudited, in thousands, except share and per share data):

	Three Months Ended September 30, 2009			Three Months Ended September 30, 2008			Nine Months Ended September 30, 2009			Nine Months Ended September 30, 2008
Net income for basic and diluted earnings per share	$	3,291		$	(3,089	)	$	5,713		$	988
Less: Dividends declared – common and unvested restricted share units		(678	)		(668	)		(1,901	)		(2,064	)
Undistributed earnings		2,613			(3,757	)		3,812			(1,076	)
Percent allocated to common shareholders		98.3	%		97.8	%		98.3	%		97.9	%
		2,569			(3,674	)		3,747			(1,053	)
Add: Dividends declared – common stock		667			653			1,869			2,020
		3,236			(3,021	)		5,616			967
Denominator for basic earnings per share		9,027,706			8,776,743			8,963,740			9,017,853
Effect of dilutive securities		18,650			—			84,010			354,043
Denominator for diluted earnings per common share		9,046,356			8,776,743			9,047,750			9,371,896
Basic earnings per share	$	0.36		$	(0.34	)	$	0.63		$	0.11
Diluted earnings per share	$	0.36		$	(0.34	)	$	0.62		$	0.10
Cash dividends per share	$	0.07		$	0.07		$	0.21		$	0.21

15

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements—(Continued)

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

6. Exercise of Outstanding Warrants

As of January 1, 2009, contingent warrants to purchase 306,099 common shares of EIHI stock at an exercise price of $1.63 were outstanding. These warrants were awarded in 1999 as compensation to a Director of the Company who acted as the insurance broker for premium production in the Company’s run-off specialty reinsurance segment. The number of warrants ultimately earned was contingent upon achievement of predetermined direct premiums written thresholds. As of January 1, 2009, 244,879 warrants were earned. The remaining 61,220 warrants will not be earned because the specialty reinsurance segment was placed into run-off on July 1, 2008 and, therefore, there is no additional premium production. On March 10, 2009, the Director notified the Company that he was exercising the 244,879 earned warrants. Furthermore, as provided in the terms of the warrant, the Director instructed the Company to retain 64,588 shares in payment of the exercise price. Accordingly, on March 31, 2009, 180,291 shares of EIHI common stock were issued to the Director in full satisfaction of the 244,879 warrants earned. This was a non-cash transaction that had no impact on cash flows from operating or financing activities.

7. Share Repurchase

The Company recognized the repurchase of 42,377 shares, at a cost of $647, for the three months ended September 30, 2008. There were no share repurchases during the three months ended September 30, 2009. The Company recognized the repurchase of 1,400 and 1,034,289 shares, at a cost of $11 and $16,719, for the nine months ended September 30, 2009 and 2008, respectively.

8. Fair Value Measurements

The Company’s assets and liabilities that are measured at fair value on a recurring basis are 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, 2009:

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 fair 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, 2009, excluding the segregated portfolio cell segment (unaudited, in thousands):

	9/30/09		Fair Value Measurements at Reporting Date Using
			Level 1		Level 2		Level 3
Fixed income securities – available for sale	$	153,995	$	13,744	$	140,251	$	—
Convertible bonds		15,955		—		15,955		—
Equity securities – available for sale		16,934		16,934		—		—
Total	$	186,884	$	30,678	$	156,206	$	—

The estimated fair values of the Company’s investments in fixed income securities, convertible bonds, and equity securities are based on prices provided by an independent, nationally recognized pricing service. Approximately 99.0% of the Company’s fixed income and equity security prices are obtained from the independent pricing service. The prices provided by the independent pricing service

16

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements—(Continued)

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

are based on quoted market prices, when available, non-binding broker quotes, or matrix pricing. The independent pricing service provides a single price or quote per security and the Company does not adjust security prices. The Company obtains an understanding of the methods, models and inputs, used by the independent pricing service, 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 the methodologies used by the independent pricing service as well as 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.

The Company’s fixed income securities and convertible bonds consist primarily of publicly traded securities for which there are observable inputs and/or broker quotes. Most fixed income security prices provided by the independent pricing service are based on observable inputs and, therefore, are classified as Level 2 securities. The Company does not hold any fixed income securities, for which pricing was based on significant unobservable inputs; therefore, the Company has not classified any of its fixed income securities as Level 3 securities.

The Company’s equity securities consist primarily of mutual fund instruments for which there is an active market and quoted market prices; therefore, the Company has classified its equity securities as Level 1 securities.

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, 2009 (unaudited) and December 31, 2008, the Company’s limited partnership investments, by investment strategy, were as follows (in thousands):

	9/30/09		12/31/08
Multi-strategy fund of funds	$	4,767	$	4,421
Natural resources		2,251		2,130
Structured finance opportunity fund		2,242		1,958
Municipal bond arbitrage		—		466
Open-ended investment fund		529		470
Real estate		61		66
Total	$	9,850	$	9,511

The activity in the Company’s limited partnership investments for the three and nine months ended September 30, 2009 and 2008 was as follows (unaudited, in thousands):

	Three Months Ended September 30,					��	Nine Months Ended September 30,
	2009		2008				2009			2008
Balance, beginning of period	$	9,327	$	11,992			$	9,511		$	11,300
Contributions		—		2,000				—			3,000
Withdrawals		—		(820	)			(461	)		(820	)
Unrealized change in interest		523		(1,657	)			800			(1,965	)
Balance, end of period	$	9,850	$	11,515			$	9,850		$	11,515

The change in interest in the Company’s limited partnership investments is included in the change in equity interest in limited partnerships in the consolidated statements of operations and comprehensive income.

17

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements—(Continued)

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

9. Investments

The following tables provide the amortized cost and estimated fair value of the Company’s fixed income and equity securities as of September 30, 2009 and December 31, 2008 (unaudited, in thousands):

September 30, 2009	Cost or Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
U.S. Treasuries and government agencies	$	20,136	$	1,043	$	—		$	21,179
States, municipalities, and political subdivisions		42,408		2,890		(14	)		45,284
Corporate securities		44,889		2,484		(22	)		47,351
Residential mortgage-backed securities		28,350		1,015		—			29,365
Collateralized mortgage obligations		26,064		436		(761	)		25,739
Other structured securities		6,887		41		(497	)		6,431
Total fixed income securities		168,734		7,909		(1,294	)		175,349
Equity securities		17,927		3,491		(314	)		21,104
Total fixed income and equity securities	$	186,661	$	11,400	$	(1,608	)	$	196,453
December 31, 2008	Cost or Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
U.S. Treasuries and government agencies	$	26,463	$	2,170	$	(3	)	$	28,630
States, municipalities, and political subdivisions		45,109		1,611		(183	)		46,537
Corporate securities		60,480		991		(854	)		60,617
Residential mortgage-backed securities		16,349		1,265		—			17,614
Collateralized mortgage obligations		20,195		336		(1,503	)		19,028
Other structured securities		11,506		7		(803	)		10,710
Total fixed income securities		180,102		6,380		(3,346	)		183,136
Equity securities		22,287		50		(5,175	)		17,162
Total fixed income and equity securities	$	202,389	$	6,430	$	(8,521	)	$	200,298

Other structured securities primarily include commercial mortgage-backed securities and other asset-backed securities.

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 a available-for-sale by category and length of time an individual security has been in a continuous unrealized position as of September 30, 2009 (unaudited, in thousands) and December 31, 2008 are as follows (in thousands):

	Less Than 12 Months					12 Months or More					Total
September 30, 2009	Estimated Fair Value		Gross Unrealized Losses			Estimated Fair Value		Gross Unrealized Losses			Estimated Fair Value		Gross Unrealized Losses
U.S. Treasuries and government agencies	$	—	$	—		$	—	$	—		$	—	$	—
States, municipalities, and political subdivisions		686		(12	)		—		—			686		(12	)
Corporate securities		571		(14	)		—		—			571		(14	)
Collateralized mortgage obligations		3,103		(195	)		4,769		(567	)		7,872		(762	)
Other structured securities		1,954		(205	)		3,614		(292	)		5,568		(497	)
Total fixed income securities		6,314		(426	)		8,383		(859	)		14,697		(1,285	)
Equity securities		253		(287	)		—		—			253		(287	)
Total fixed income and equity securities	$	6,567	$	(713	)	$	8,383	$	(859	)	$	14,950	$	(1,572	)

Note: The Company has excluded the segregated portfolio cell reinsurance segment’s gross unrealized losses from the above table because changes in the estimated fair value of the segregated portfolio cell reinsurance segment’s fixed income and equity securities inures to the segregated portfolio cell dividend participant and, accordingly, is included in the segregated portfolio cell dividend payable and the related segregated portfolio dividend expense in the Company’s consolidated balance sheet and consolidated statement of operations, respectively. Management believes the exclusion of the segregated portfolio cell reinsurance segment from this disclosure provides a more transparent understanding of gross unrealized losses in the Company’s fixed income and equity security portfolios that could impact its consolidated financial position or results of operations.

18

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements—(Continued)

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

	Less Than 12 Months					12 Months or More					Total
December 31, 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	$	200	$	(3	)	$	—	$	—		$	200	$	(3	)
States, municipalities, and political subdivisions		6,631		(169	)		246		(14	)		6,877		(183	)
Corporate securities		15,506		(552	)		1,398		(67	)		16,904		(619	)
Collateralized mortgage obligations		6,853		(756	)		2,279		(747	)		9,132		(1,503	)
Other structured securities		6,817		(232	)		2,747		(571	)		9,564		(803	)
Total fixed income securities		36,007		(1,712	)		6,670		(1,399	)		42,677		(3,111	)
Equity securities		9,047		(4,184	)		—		—			9,047		(4,184	)
Total fixed income and equity securities	$	45,054	$	(5,896	)	$	6,670	$	(1,399	)	$	51,724	$	(7,295	)

Note: The Company has excluded the segregated portfolio cell reinsurance segment’s gross unrealized losses from the above table because changes in the estimated fair value of the segregated portfolio cell reinsurance segment’s fixed income and equity securities inures to the segregated portfolio cell dividend participant and, accordingly, is included in the segregated portfolio cell dividend payable and the related segregated portfolio dividend expense in the Company’s consolidated balance sheet and consolidated statement of operations, respectively. Management believes the exclusion of the segregated portfolio cell reinsurance segment from this disclosure provides a more transparent understanding of gross unrealized losses in the Company’s fixed income and equity security portfolios that could impact its consolidated financial position or results of operations.

As of September 30, 2009, the Company held 32 fixed income securities with gross unrealized losses totaling $1,285. Management has evaluated the unrealized losses related to those fixed income securities and determined that they are primarily due to the current liquidity issues in the fixed income markets or to a fluctuation in interest rates and not to credit issues of the issuer or the underlying assets in the case of collateralized mortgage obligations and other structured securities. The Company does not intend to sell the fixed income securities and it is not more likely than not that the Company will be required to sell the fixed income securities before recovery of their amortized cost bases, which may be maturity; therefore, management does not consider the fixed income securities to be other-than-temporarily impaired as of September 30, 2009.

As of September 30, 2009, the Company held 1 equity security with a gross unrealized loss totaling $287. All of the equity securities have been in an unrealized loss position for less than twelve months and management has determined, based on an evaluation of these securities, that the decline in value is temporary as of September 30, 2009.

The Company recognized other-than-temporary impairments of $439 and $4,367 for the three and nine months ended September 30, 2009, respectively, compared to impairments of $2,768 for the same periods in 2008. The impairments primarily relate to equity securities that had been in an unrealized loss position for 12 months or more.

19

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements—(Continued)

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

10. 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, 2009 and 2008 (unaudited, in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2009			2008			2009			2008
Balance, beginning of period	$	151,619		$	129,599		$	155,314		$	125,249
Reinsurance recoverables on unpaid losses and LAE		24,343			24,260			25,636			23,429
Net balance, beginning of period		127,276			105,339			129,678			101,820
Net reserves acquired as a result of ESHC acquisition		—			9,591			—			9,591
Incurred related to:
Current year		21,910			20,405			67,882			62,868
Prior year		(1,141	)		2,362			(2,799	)		867
Total incurred before purchase accounting adjustments		20,769			22,767			65,083			63,735
Purchase accounting adjustments		(115	)		(81	)		(432	)		(391	)
Total incurred		20,654			22,686			64,651			63,344
Paid related to:
Current year		10,983			9,911			27,608			24,851
Prior year		9,001			9,229			38,775			31,428
Total paid		19,984			19,140			66,383			56,279
Net balance, end of period		127,946			118,476			127,946			118,476
Reinsurance recoverables on unpaid losses and LAE		24,755			24,032			24,755			24,032
Balance, end of period	$	152,701		$	142,508		$	152,701		$	142,508
Total reserves for unpaid for losses and loss adjustment expenses	$	156,500		$	146,530		$	156,500		$	146,530
Less: Term life premium waiver reserves		3,774			3,980			3,774			3,980
Less: Other		25			42			25			42
Balance, end of period	$	152,701		$	142,508		$	152,701		$	142,508

Incurred losses by segment were as follows for the three and nine months ended September 30, 2009 and 2008, respectively (unaudited, in thousands):

Three Months Ended September 30, 2009

	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	$	11,567		$	4,483		$	6,254	$	—	$	22,304
Current period discount		(226	)		(168	)		—		—		(394	)
Prior year, gross of discount		(350	)		(1,252	)		120		—		(1,482	)
Accretion of prior period discount		188			153			—		—		341
Total incurred before purchase accounting adjustments		11,179			3,216			6,374		—		20,769
Purchase accounting adjustments		(110	)		(7	)		—		2		(115	)
Total incurred	$	11,069		$	3,209		$	6,374	$	2	$	20,654

20

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements—(Continued)

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

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

Nine Months Ended September 30, 2009

	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	$	35,607		$	13,417		$	19,790		$	768	$	69,582
Current period discount		(1,181	)		(519	)		—			—		(1,700	)
Prior year, gross of discount		(1,649	)		(2,031	)		(687	)		—		(4,367	)
Accretion of prior period discount		1,107			461			—			—		1,568
Total incurred before purchase accounting adjustments		33,884			11,328			19,103			768		65,083
Purchase accounting adjustments		(408	)		(34	)		—			10		(432	)
Total incurred	$	33,476		$	11,294		$	19,103		$	778	$	64,651

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

The Company’s results of operations include favorable development on prior year reserves of $1,482 and $4,367 for the three and nine months ended September 30, 2009, respectively, compared to (unfavorable) favorable development of $(2,140) and $474 for the three and nine months ended September 30, 2008. The favorable development in the workers’ compensation insurance and segregated portfolio cell reinsurance segments for the three and nine months ended September 30, 2009 primarily reflects the impact of claim settlements for amounts at, or less than, previously established case and IBNR reserves. The unfavorable development in the group benefits insurance segment for the three months ended September 30, 2009 primarily reflects a prior year long-term disability claim settlement. The favorable development for the nine months ended September 30, 2009 primarily reflects more favorable claims experience than anticipated at the time the reserves were established in the dental and short-term disability lines of business and the

21

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements—(Continued)

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

termination of prior year long-term disability claims, partially offset by the impact of the term life claims and long-term disability claim settlement noted above. The unfavorable development in the run-off specialty reinsurance segment for the three and nine months ended September 30, 2008 primarily reflects an increase in reported claims from the ceding company.

11. Income Taxes

As a result of the continued decline in the fixed income and equity security markets during the first quarter of 2009, management performed an assessment and concluded that the Company may be unable to generate sufficient future capital gains to offset capital losses in the foreseeable future, which is generally considered to be twelve months from the balance sheet date. Accordingly, management recorded a valuation allowance as of March 31, 2009 against its net deferred tax asset related to realized and unrealized capital losses of $904, of which $678 was reported as an increase to income tax expense and $226 was reported as a reduction to the accumulated other comprehensive loss, net of tax. During the second quarter of 2009, valuations in the fixed income and equity markets improved, resulting in an increase in the fair value of the Company’s investment portfolio. As a result, management determined that the deferred tax valuation allowance was not necessary as of June 30, 2009. Based on the continued improvement in the fixed income and equity markets during the third quarter of 2009, management continues to believe a deferred tax valuation allowance is not necessary as of September 30, 2009. The reversal of the valuation allowance was first applied to the April 1, 2009 cumulative effect adjustment, which increased retained earnings by $240. The remainder of the reversal decreased income tax expense by $438 and increased accumulated other comprehensive income (loss), net, by $226.

12. 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, Delaware, North Carolina, Maryland and Indiana. 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, run-off specialty reinsurance, and corporate/other segments totaling $1,042 and $910 for the three months ended September 30, 2009 and 2008, respectively, and $3,366 and $3,437 for the nine months ended September 30, 2009 and 2008, respectively.

Group Benefits Insurance

The Company’s group benefits insurance products include dental, short and long-term disability, term life and vision 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, 2009 and 2008 were as follows (unaudited, in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2009		2008		2009		2008
Dental	$	5,651	$	5,669	$	16,758	$	17,002
Short-term disability		1,516		1,625		4,608		4,932
Long-term disability		425		385		1,251		1,205
Term life		1,335		1,452		4,109		4,366
Vision		25		—		44		—
Total	$	8,952	$	9,131	$	26,770	$	27,505

22

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements—(Continued)

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

Run-Off Specialty Reinsurance

The specialty reinsurance segment was placed into run-off effective July 1, 2008. Prior to July 1, 2008, the Company assumed business through its participation in reinsurance treaties with an unaffiliated insurance company related to an underground storage tank insurance program, referred to as “EnviroGuard,” and a non-hazardous waste transportation product, referred to as “EIA liability” (“EIA”). The EnviroGuard program provided 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 provided commercial automobile liability coverage for non-hazardous waste haulers. Net premiums earned, by program, for the three and nine months ended September 30, 2009 and 2008 were as follows (unaudited, in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2009		2008		2009		2008
EnviroGuard	$	2	$	1,723	$	862	$	6,588
EIA		12		391		275		2,156
Other		—		—		—		6
Total	$	14	$	2,114	$	1,137	$	8,750

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 interest in jointly owned segregated portfolio cells and a 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, 2009 (unaudited, in thousands):

	Workers’ Compensation Insurance		Segregated Portfolio Cell Reinsurance		Group Benefits Insurance		Run-Off Specialty Reinsurance			Corporate/ Other			Total
Revenue:
Net premiums earned	$	17,786	$	6,356	$	8,952	$	14		$	—		$	33,108
Net investment income		800		154		385		259			362			1,960
Change in equity interest in limited partnerships		358		—		61		104			—			523
Net realized investment gains		339		329		1,378		11			31			2,088
Other revenue		—		—		—		143			63			206
Total revenue		19,283		6,839		10,776		531			456			37,885
Expenses:
Losses and LAE incurred		10,905		3,209		6,480		1			—			20,595
Acquisition and other underwriting expenses		1,436		1,942		1,355		4			(322	)		4,415
Other expenses		3,373		86		1,572		182			1,399			6,612
Amortization of intangibles		—		—		—		—			433			433
Policyholder dividend expense		118		—		—		—			—			118
Segregated portfolio dividend expense		—		1,602		—		—			(516	)		1,086
Total expenses		15,832		6,839		9,407		187			994			33,259
Income (loss) before income taxes		3,451		—		1,369		344			(538	)		4,626
Income tax expense (benefit)		1,001		—		458		(1	)		(123	)		1,335
Net income (loss)	$	2,450	$	—	$	911	$	345		$	(415	)	$	3,291
Total assets	$	245,699	$	58,886	$	67,199	$	58,027		$	(30,623	)	$	399,188

23

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements—(Continued)

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

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		1,094			291			656			338			33			2,412
Change in equity interest in limited partnerships		(1,393	)		—			(121	)		(143	)		—			(1,657	)
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

24

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements—(Continued)

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

The following table represents the segment results for the nine months ended September 30, 2009 (unaudited, in thousands):

	Workers’ Compensation Insurance			Segregated Portfolio Cell Reinsurance			Group Benefits Insurance		Run-Off Specialty Reinsurance			Corporate/ Other			Total
Revenue:
Net premiums earned	$	54,599		$	18,358		$	26,770	$	1,137		$	—		$	100,864
Net investment income		2,575			531			1,259		686			581			5,632
Change in equity interest in limited partnerships		538			—			119		143			—			800
Net realized investment (losses) gains		(477	)		(697	)		2,670		(1,431	)		284			349
Other revenue		—			—			—		370			199			569
Total revenue		57,235			18,192			30,818		905			1,064			108,214
Expenses:
Losses and LAE incurred		33,313			11,294			19,094		778			—			64,479
Acquisition and other underwriting expenses		4,392			5,600			4,071		341			(1,033	)		13,371
Other expenses		10,277			125			4,616		396			4,074			19,488
Amortization of intangibles		—			—			—		—			1,299			1,299
Policyholder dividend expense		241			—			—		—			—			241
Segregated portfolio dividend expense		—			1,173			—		—			(739	)		434
Total expenses		48,223			18,192			27,781		1,515			3,601			99,312
Income (loss) before income taxes		9,012			—			3,037		(610	)		(2,537	)		8,902
Income tax expense (benefit)		2,696			—			980		(4	)		(483	)		3,189
Net income (loss)	$	6,316		$	—		$	2,057	$	(606	)	$	(2,054	)	$	5,713
Total assets	$	245,699		$	58,886		$	67,199	$	58,027		$	(30,623	)	$	399,188

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Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements—(Continued)

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

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		3,025			855			2,024			1,035			468			7,407
Change in equity interest in limited partnerships		(1,948	)		—			137			(154	)		—			(1,965	)
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

13. Eastern Re Capital Contribution

As a result of Eastern Re’s net loss for the year ended December 31, 2008, EIHI made a capital contribution of $23.0 million to Eastern Re on March 6, 2009 to improve Eastern Re’s capital position and to maintain Eastern Re’s current A.M. Best financial strength rating of “A-” (Excellent). The capital contribution was funded by dividends paid to EIHI from Eastern Alliance, Allied Eastern and ELH in the amount of $10.0 million, $2.0 million and $13.0 million, respectively, on March 6, 2009, of which $2.0 million was retained by EIHI. The dividends were approved by the Pennsylvania Insurance Department.

14. 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.

15. Subsequent Events

Management performed an evaluation of subsequent events through November 5, 2009, the date the Company’s consolidated financial statements were issued, and determined there were no recognized or unrecognized subsequent events that would require an adjustment and/or additional disclosure in the consolidated financial statements as of September 30, 2009.

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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 13, 2009.

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 our business plans;

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

• 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 including, without limitation, the run-off specialty reinsurance segment, in which the establishment of reserves is heavily dependent on claims information from the ceding company;

• 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 reported net income of $3.3 million for the three months ended September 30, 2009, compared to a net loss of $3.1 million for the same period in 2008. The Company’s 2009 results of operations primarily reflect the improvement in the investment markets. Net realized investment gains were positively impact by an increase in the Company’s convertible bond portfolio of $1.7 million in the third quarter of 2009, compared to a decline in fair value of $1.3 million for the same period in 2008. The Company’s equity interest in limited partnerships also increased from 2008 to 2009 reflecting the improving investment markets. The 2008 equity interest in limited partnerships includes an impairment of $1.4 million related to a limited partnership interest that was placed in liquidation during the third quarter of 2008. For the three months ended September 30, 2009, the Company recognized other-than-temporary investment impairments related to its fixed income and equity security portfolio totaling $439,000, compared to impairments of $2.8 million for the same period in 2008.

The Company reported a combined ratio of 97.2% for the three months ended September 30, 2009, compared to a combined ratio of 103.7% for the same period in 2008. The 2008 combined ratio was significantly impacted by the run-off specialty reinsurance operations, which was placed in run-off effective July 1, 2008 but continued to experience unfavorable prior year reserve development.

The workers’ compensation insurance segment reported net income of $2.5 million for the three months ended September 30, 2009, compared to net income of $527,000 for the same period in 2008. The segment’s 2009 operating results were positively impacted by the investment markets, specifically as it relates to its convertible bond portfolio. The segment’s combined ratio was 89.0% for the three months ended September 30, 2009, compared to a combined ratio of 88.7% for the same period in 2008. The slight increase in the combined ratio reflects the impact of the current economic environment and the competitive rate environment in the workers’ compensation book of business. The segment has experienced premium renewal rate decreases throughout 2009 and the competitive environment has resulted in a decline in the renewal retention rate.

The segregated portfolio cell reinsurance segment reported a combined ratio of 82.4% for the three months ended September 30, 2009, compared to a combined ratio of 94.9% for the same period in 2008, primarily reflecting favorable prior year reserve development.

The group benefits insurance segment reported net income of $911,000 for the three months ended September 30, 2009, compared to a net loss of $1.1 million for the same period in 2008. The segment’s 2009 operating results were positively impacted by the investment markets, specifically as it relates to its convertible bond portfolio. The segment’s combined ratio was 105.1% for the three months ended September 30, 2009, compared to a combined ratio of 95.7% for the same period in 2008. The increase in the combined ratio reflects the continued impact of the rising dental loss ratio on the segment’s operating results. The segment continues to experience a competitive rate environment, which has continued to negatively impact the dental loss ratio. The current rate environment, as well as the current economic environment, has also negatively impacted the segment’s renewal retention rate, which has resulted in a decline in net premiums earned from 2008 to 2009.

The run-off specialty reinsurance operations for the three months ended September 30, 2009 continue to reflect the run-off of the quota-share reinsurance treaties.

Principal Revenue and Expense Items

The Company derives its revenue primarily from net 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 run-off 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, 2008, one-half of the premiums would be earned in 2008 and the other half would be earned in 2009. Workers’ compensation premiums are determined based upon the payroll of the insured, the applicable premium rates and, where applicable, an experience based

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modification factor. An audit of the policyholders’ records is conducted after policy expiration, to make a final determination of applicable premiums. Included with net premiums earned is an estimate for earned but unbilled final audit premiums. The Company can estimate earned but unbilled premiums because it keeps track, by policy, of how much additional premium is billed in final audit invoices as a percentage to estimate the probable additional amount that it has earned but not yet billed as of the balance sheet date. The majority of the Company’s group benefits insurance policies are billed on a monthly basis with premiums being earned in the month in which coverage is provided. As a result, there is minimal unearned premium related to the group benefits insurance policies as of the balance sheet date.

Net investment income and realized gains and losses on investments. The Company invests its surplus and the funds supporting its insurance liabilities (including unearned premiums and unpaid losses and loss adjustment expenses) in cash, cash equivalents, fixed income securities, convertible bonds, equity securities, and other long-term investments. Investment income includes interest earned on invested assets, including the impact of premium amortization and discount accretion. 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 LAE.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 from 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. In the segregated portfolio cell reinsurance and run-off 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 loan payable.

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 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.

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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.

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, expense ratio and policyholder dividend 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, segregated portfolio cell reinsurance, group benefits insurance, and run-off 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. The Company’s estimates and judgments may be revised as additional experience and other data becomes available and are reviewed, as new or improved methodologies are developed, or as current laws change. Any such revisions could result in future changes in estimates of losses or reinsurance recoverable and would be reflected in the Company’s results of operations in the period in which the estimates are changed. Estimating the ultimate claims liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management’s informed estimates and judgments using data currently available. If ultimate losses, net of reinsurance, prove to be substantially higher than the amounts recorded as of September 30, 2009, 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 approximately 3.0%. As of September 30, 2009 and December 31, 2008, the Company’s reserves for unpaid losses and LAE were reduced by $4,330 and $4,145, 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 run-off specialty reinsurance segments as of September 30, 2009 (unaudited) and December 31, 2008 are summarized below (in thousands):

September 30, 2009	Workers’ Compensation Insurance			Segregated Portfolio Cell Reinsurance			Group Benefits Insurance		Specialty Reinsurance			Total
Case/tabular reserves	$	36,496		$	10,464		$	10,200	$	15,923		$	73,083
Case incurred development, IBNR, and unallocated LAE reserves		26,756			12,921			4,167		18,363			62,207
Amount of discount		(3,161	)		(1,169	)		—		—			(4,330	)
Net reserves		60,091			22,216			14,367		34,286			130,960
Reinsurance recoverables on unpaid losses and LAE		5,065			3,556			16,314		—			24,935
Purchase accounting adjustments		578			48			—		(21	)		605
Reserves for unpaid losses and LAE	$	65,734		$	25,820		$	30,681	$	34,265		$	156,500

December 31, 2008	Workers’ Compensation Insurance			Segregated Portfolio Cell Reinsurance			Group Benefits Insurance		Specialty Reinsurance			Total
Case/tabular reserves	$	34,897		$	11,808		$	10,690	$	15,632		$	73,027
Case incurred development, IBNR, and unallocated LAE reserves		23,320			11,210			3,956		24,938			63,424
Amount of discount		(2,994	)		(1,151	)		—		—			(4,145	)
Net reserves		55,223			21,867			14,646		40,570			132,306
Reinsurance recoverables on unpaid losses and LAE		4,932			2,903			17,939		—			25,774
Purchase accounting adjustments		986			82			—		(31	)		1,037
Reserves for unpaid losses and LAE	$	61,141		$	24,852		$	32,585	$	40,539		$	159,117

“Other Than Temporary” Investment Impairments

Unrealized investment gains or losses on investments carried at fair value, net of applicable income taxes, are reflected directly in shareholders’ equity as a component of comprehensive income (loss) and, accordingly, have no effect on net income. When, in the opinion of management, a decline in the fair value of an investment below its cost or amortized cost is considered to be “other-than-temporary,” such investment is written down to its fair value. The amount written down is recorded in earnings as a realized loss on investments. Generally, the determination of other-than-temporary impairment includes, in addition to other relevant factors, a presumption that if the market value is below cost by a significant amount for a period of time, a write down is necessary. Notwithstanding this presumption, the determination of other-than-temporary impairment requires judgment about future prospects for an investment and is therefore a matter of inherent uncertainty. For the three and nine months ended September 30, 2009, the Company recognized other-than-temporary impairments of $439,000 and $4.4 million, respectively, compared to impairments of $4.2 million for the same periods in 2008. As of September 30, 2009, the Company held securities with gross unrealized losses of $1.6 million, excluding those securities in the segregated portfolio cell reinsurance segment, of which $860,000 were in an unrealized loss position for more than 12 months. Adverse investment market conditions, poor operating results of underlying investments, or the passage of time with respect to equity securities in an unrealized loss position, 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:

Equity securities. An equity security is considered to be other-than-temporarily impaired when one of the following conditions exist: 1) an equity security’s market value is less than 80% of its cost for a continuous period of six months, 2) an equity’s security’s market value is less than 50% of its cost, regardless of the amount of time the security’s market value has been below cost, or 3) an equity security’s market value has been less than cost for a continuous period of 12 months, regardless of the magnitude of the decline in market value. Equity securities that are in an unrealized loss position, but do not meet the above quantitative thresholds, are evaluated to determine if the decline in market value is other than temporary.

For the three and nine months ended September 30, 2009, the Company recognized other-than-temporary impairments of $409,000 and $4.2 million related to its equity security portfolio, respectively.

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Fixed income securities. A fixed income security is considered to be other-than-temporarily impaired when the security’s fair value is less than its amortized cost basis and 1) the Company intends to sell the security, 2) it is more likely than not that the Company will be required to sell the security before recovery of the security’s amortized cost basis, or 3) the Company believes it will be unable to recover the entire amortized cost basis of the security (i.e., a credit loss has occurred). A fixed income security is reviewed for collectibility 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.

For the three and nine months ended September 30, 2009, the Company recognized other-than-temporary impairments of $29,000 and $188,000, respectively, related to its fixed income security portfolio.

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 if management has received information that suggests the Company will be unable to recover its original investment in the limited partnership. The amount written down is recorded in the change in equity interest in other long-term investments in the consolidated statement of operations. There were no other-than-temporary impairments related to the Company’s limited partnership interests for the three and nine months ended September 30, 2009. The Company recognized an other-than-temporary impairment of $1.4 million related to its limited partnership interests for the three and nine months ended September 30, 2008.

Goodwill

In accordance with the requirements of ASC 350, Intangibles – Goodwill and Other, goodwill is not amortized but is tested for impairment at the reporting unit level, which is at the operating segment level or one level below an operating segment. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. Goodwill is required to be tested for impairment annually and between annual tests if events or circumstances change, such as adverse changes in the business climate, that would more likely than not reduce the fair value of the reporting unit below its carrying value.

Goodwill is assigned to one or more reporting units at the date of acquisition. The Company has allocated 100% of the goodwill recorded on its consolidated balance sheet as of September 30, 2009 to its workers’ compensation insurance segment. The goodwill impairment test, performed as of September 30 of each year, is a two-step test. The first step identifies whether there is potential impairment by comparing the fair value of a reporting unit to the carrying amount, including goodwill. If the fair value of a reporting unit is less than its carrying amount, the second step of the impairment test is required to measure the amount of any impairment loss.

For the 2009 annual impairment test, the fair value of the workers’ compensation insurance segment was estimated using a discounted cash flow analysis, a form of the income approach, using management’s internal four-year forecast for the workers’ compensation insurance segment and a terminal value estimated using a long-term growth rate of 5.0%, which is reflective of the segment’s historical growth rate, and a discount rate of 13.0%, which is reflective of the risks inherent in the segment. Cash flows were adjusted as necessary to maintain adequate capital requirements.

In addition to the discounted cash flow analysis, management assessed the Company’s stock price relative to the book value of the workers’ compensation insurance segment. As of September 30, 2009, the Company’s stock price was trading below book value, primarily reflecting the impact of market conditions over the past year; therefore, management considered an estimate of the Company’s value in a potential transaction and allocated that value to the Company’s reporting units, including the workers’ compensation insurance segment.

Both the discounted cash flow analysis and the estimate of the Company’s value in a potential transaction resulted in the workers’ compensation insurance segment’s estimated fair value exceeding its carrying value as of September 30, 2009; therefore, goodwill was considered not impaired, and the second step of impairment testing was not necessary.

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Deferred Acquisition Costs

Certain direct policy acquisition costs consisting of commissions, premium taxes, fronting fees and certain other direct underwriting costs are deferred and amortized as the underlying policy premiums are earned. As of September 30, 2009 (unaudited) and December 31, 2008, deferred policy acquisition costs and the related unearned premium reserves were as follows (in thousands):

	September 30, 2009		December 31, 2008
Workers’ compensation insurance segment:
Deferred policy acquisition costs	$	3,737	$	2,617
Unearned premium reserves	$	40,043	$	30,941
Segregated portfolio cell reinsurance segment:
Deferred policy acquisition costs	$	3,602	$	2,849
Unearned premium reserves	$	13,318	$	10,367
Group benefits insurance segment:
Deferred policy acquisition costs	$	—	$	—
Unearned premium reserves	$	81	$	79
Run-off specialty reinsurance segment:
Deferred policy acquisition costs	$	—	$	294
Unearned premium reserves	$	—	$	978

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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. As of March 31, 2009, management recorded a valuation allowance of $904,000 as a result of the Company’s recognition of additional realized and unrealized capital losses related to its investment portfolio. Management performed an assessment of the recoverability of its net deferred tax asset related to capital losses as of March 31, 2009 and concluded that the Company may be unable to generate sufficient future capital gains to offset capital losses in the foreseeable future, which is generally considered to be twelve months from the balance sheet date. Under United States federal income tax rules and regulations, capital losses can only be utilized to offset taxable income generated by capital gains. Capital losses can be carried back to offset capital gains reported in the three prior tax periods and can be carried forward for five tax periods. During the second quarter of 2009, valuations in the fixed income and equity markets improved, resulting in an increase in the fair value of the Company’s investment portfolio. As a result, management determined that the deferred tax valuation allowance was not necessary as of June 30, 2009. Based on the continued improvement in the fixed income and equity markets during the third quarter of 2009, management continues to believe a deferred tax valuation allowance is not necessary as of September 30, 2009. The reversal of the valuation allowance was first applied to the April 1, 2009 cumulative effect adjustment, which increased retained earnings by $240,000. The remainder of the reversal decreased income tax expense by $438,000 and increased accumulated other comprehensive income (loss), net, by $226,000.

Reinsurance Recoverables

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

Recent Accounting Guidance

Fair Value Measurements – Investments in Certain Entities that Calculation Net Asset Value per Share

In September 2009, the Financial Accounting Standards Board (“FASB”) issued new accounting and disclosure guidance related to the determination of fair value of investments in entities (investees) that permit the investor to redeem its investments directly with the investee or receive distributions from the investee at times specified under the terms of the investee’s governing documents. Many of these investees do not have readily determinable fair values and provide their investors with a net asset value per share (or its equivalent, such as member units or an ownership interest in partners’ capital). Under the new guidance, investments in entities that calculate net asset value per share (or its equivalent) may be measured at fair value using the investee’s net asset value per share (or its equivalent) if the net asset value of the investment is calculated in a manner consistent with the measurement principles of investment companies as of the reporting entity’s measurement date, including measurement of all or substantially all of the underlying investments of the investee in accordance with the fair value measurement principles. The new guidance also requires enhanced disclosure related to the reporting entity’s investment is such investees including, but not limited to, the nature of any restrictions on the reporting entity’s ability to redeem its investments at the measurement date, any unfunded commitments, and the investment strategies of the investee. The Company’s limited partnership interests are currently reported in the consolidated balance sheets using the net asset value per share (or its equivalent) of the investee. We do not expect the new accounting guidance to have a material impact, if any, on the estimated fair value of our limited partnership interests.

FASB Accounting Standards Codification

In June 2009, the FASB established the FASB Accounting Standards Codification (“Codification”) as the single source of authoritative accounting principles in the preparation of financial statements in conformity with GAAP. The Codification explicitly recognizes rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under federal securities laws as authoritative GAAP for SEC registrants. The Codification is effective for financial statements issued for periods ending after September 15, 2009. The Company adopted the Codification effective September 30, 2009 and revised its disclosures to reflect Codification as the source of authoritative accounting principles.

Variable Interest Entities

In June 2009, the FASB issued new accounting guidance related to variable interest entities. The new guidance 1) replaces the quantitative-based risks and rewards calculation for determining whether an enterprise is the primary beneficiary in a variable interest entity with an approach that is primarily qualitative, 2) requires ongoing assessments of whether an enterprise is the primary beneficiary of a variable interest entity, and 3) requires additional disclosures about an enterprise’s involvement in variable interest entities. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2009. We do not expect the adoption of the new guidance to have a material impact, if any, on our consolidated financial condition and results of operations.

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Transfers of Financial Assets

In June 2009, the FASB issued new disclosure guidance related to the transfer of financial assets. The new guidance requires enhanced disclosures about transfers of financial assets and a company’s continuing involvement in transferred assets and is effective for financial statements issued for fiscal years beginning after November 15, 2009. We do not expect the adoption of the new guidance to have any impact on our disclosures since we do not engage in transfers of financial assets.

Subsequent Events

In May 2009, the FASB issued new accounting and disclosure guidance related to subsequent events. The new guidance defines subsequent events as either “recognized” or “nonrecognized” and is consistent with existing guidance related to the reporting of subsequent events. Recognized subsequent events are those events that provide additional evidence about conditions that existed at the balance sheet date and must be recognized in an entity’s financial statements. Nonrecognized events are those events that provide evidence about conditions that did not exist at the balance sheet date but arose before the financial statements are issued or are available to be issued. Nonrecognized events may require disclosure in an entity’s financial statements to prevent the financial statements from being misleading. Entities are required to disclose the date through which subsequent events have been evaluated, as well as whether the date is the date the financial statements were issued or the date the financial statements were available to be issued. Publicly traded entities must evaluate subsequent events through the financial statement issuance date. The new guidance is effective for interim or annual financial periods ending after June 15, 2009. The Company adopted the new accounting and disclosure requirements effective June 30, 2009, which are included in Note 15.

Other-than-Temporary Investment Impairments

In April 2009, the FASB issued new accounting guidance related to the recognition and presentation of other-than-temporary investment impairments. The new guidance requires entities to separate an other-than-temporary impairment of a debt security into two components when there are credit related losses associated with the impaired debt security for which management asserts that it does not have the intent to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of its cost basis. The amount of the other-than-temporary impairment related to a credit loss is recorded as a net realized investment loss in the statements of operations, and the amount of the other-than-temporary impairment related to other factors is recorded as an other comprehensive loss. The new guidance is effective for periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company adopted the new guidance effective April 1, 2009, which resulted in the Company recording a cumulative effect adjustment that increased retained earnings and decreased accumulated other comprehensive income (loss), net, as of April 1, 2009, by $685,000 and $445,000, respectively, resulting in an increase to shareholders’ equity of $240,000. The increase in shareholders’ equity reflects the reversal of a prior period deferred tax valuation allowance, of which $240,000 was applied to the retained earnings cumulative effect adjustment.

Fair Value Measurements

In April 2009, the FASB issued new accounting guidance related to determining fair value of an asset or liability when the volume or level of activity for the asset or liability has significantly decreased and for identifying transactions that are not orderly. Under the new guidance, if an entity determines that there has been a significant decrease in the volume and level of activity for the asset or the liability in relation to the normal market activity for the asset or liability (or similar assets or liabilities), then transactions or quoted prices may not accurately reflect fair value. In addition, if there is evidence that the transaction for the asset or liability is not orderly, the entity shall place little, if any weight on that transaction price as an indicator of fair value. The new guidance is effective for periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company adopted the new guidance effective June 30, 2009. The adoption of the new guidance did not have a material effect on the Company’s consolidated financial statements.

Disclosures About Fair Value of Financial Instruments

In April 2009, the FASB issued new accounting guidance related to the interim disclosures about fair value of financial instruments. The new guidance requires disclosures about fair value of financial instruments in interim and annual financial statements and is effective for periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company adopted the interim period disclosure requirements effective June 30, 2009, which are included in Notes 8 and 9.

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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, 2009 and 2008 (unaudited, in thousands):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2009		2008			2009		2008
Net premiums written	$	36,420	$	33,314		$	111,654	$	108,752
Net premiums earned	$	33,108	$	33,118		$	100,864	$	99,363
Net investment income		1,960		2,412			5,632		7,407
Change in equity interest in limited partnerships		523		(1,657	)		800		(1,965	)
Net realized investment gains (losses)		2,088		(4,518	)		349		(4,213	)
Other revenue		206		167			569		522
Consolidated revenue	$	37,885	$	29,522		$	108,214	$	101,114

The increase in consolidated revenue for the three months ended September 30, 2009, compared to the same period in 2008, primarily reflects the improvement in the fixed income and equity security markets and the acquisition of ESIC. ESIC’s net premiums earned for the three and nine months ended September 30, 2009 totaled $1.8 million and $5.7 million, respectively. The Company’s investments in convertible bond securities experienced a significant increase in fair value during the third quarter of 2009. In addition, the Company recognized other-than-temporary investment impairments related to its fixed income and equity securities totaling $2.8 million during the third quarter of 2008, compared to impairments of $439,000 for the same period in 2009. The Company’s equity interest in limited partnerships also experienced an increase in value during the third quarter of 2009, compared to a significant decrease for the same period in 2008.

The components of consolidated net income (loss), by segment, for the three and nine months ended September 30, 2009 and 2008 were as follows (unaudited, in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2009			2008			2009			2008
Workers’ compensation insurance	$	2,450		$	527		$	6,316		$	6,473
Segregated portfolio cell reinsurance		—			—			—			—
Group benefits insurance		911			(1,138	)		2,057			(150	)
Specialty reinsurance		345			(1,293	)		(606	)		(2,121	)
Corporate/other		(415	)		(1,185	)		(2,054	)		(3,214	)
Consolidated net income (loss)	$	3,291		$	(3,089	)	$	5,713		$	988

The increase in consolidated net income for the three months ended September 30, 2009, compared to the same period in 2008, primarily reflects the impact of significant other-than-temporary investment impairments recognized in the third quarter of 2008. The workers’ compensation insurance segment was also negatively impacted in the third quarter of 2008 by losses related to its equity interest in limited partnerships of $1.4 million.

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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, 2009 and 2008 (unaudited, in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2009			2008			2009			2008
Revenue:
Direct premiums written	$	29,762		$	26,416		$	90,806		$	83,067
Reinsurance premiums assumed		169			128			803			535
Ceded premiums written		(8,553	)		(7,287	)		(28,197	)		(27,908	)
Net premiums written		21,378			19,257			63,412			55,694
Change in unearned premiums		(3,592	)		(3,435	)		(8,813	)		(9,733	)
Net premiums earned		17,786			15,822			54,599			45,961
Net investment income		800			1,094			2,575			3,025
Change in equity interest in limited partnerships		358			(1,393	)		538			(1,948	)
Net realized investment gains (losses)		339			(731	)		(477	)		(836	)
Other income		—			—			—			—
Total revenue	$	19,283		$	14,792		$	57,235		$	46,202
Expenses:
Losses and LAE incurred	$	10,905		$	9,435		$	33,313		$	24,733
Acquisition and other underwriting expenses		1,436			1,322			4,392			3,546
Other expenses		3,373			2,952			10,277			8,137
Policyholder dividend expense		118			325			241			253
Total expenses	$	15,832		$	14,034		$	48,223		$	36,669
Income before income taxes		3,451			758			9,012			9,533
Income tax expense		1,001			231			2,696			3,060
Net income	$	2,450		$	527		$	6,316		$	6,473

Net Income

The increase in net income for the three months ended September 30, 2009, compared to the same period in 2008, primarily reflects an improvement in the segment’s investment results.

The workers’ compensation insurance ratios were as follows for the three and nine months ended September 30, 2009 and 2008:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2009		2008		2009		2008
Loss and LAE ratio	61.3	%	59.6	%	61.0	%	53.8	%
Expense ratio	27.0	%	27.0	%	26.9	%	25.4	%
Policyholders’ dividend ratio	0.7	%	2.1	%	0.4	%	0.6	%
Combined ratio	89.0	%	88.7	%	88.3	%	79.8	%

Premiums

The increase in direct premiums written primarily reflects the acquisition of ESHC and new business production of $20.7 million, partially offset by a decline in the renewal retention rate, renewal rate decreases of 3.6% and a $588,000 reduction related to favorable

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loss experience under retrospectively rated policies during the third quarter of 2009. Direct premiums written for traditional business and alternative markets were $22.9 million and $6.9 million, respectively, for the three months ended September 30, 2009 and $67.1 million and $23.7 million, respectively, for the nine months ended September 30, 2009. The renewal retention rate declined from 87.9% in 2008 to 84.7% in 2009, primarily reflecting the competitive market and the loss of a large account in the Midwest region.

Net Investment Income

The decrease in net investment income primarily reflects a lower invested asset base and a decline in short-term interest rates, partially offset by net investment income related to the acquisition of ESHC. The average yield on the fixed income portfolio was 3.73% as of September 30, 2009, compared to 4.34% as of September 30, 2008.

Net Realized Investment Gains (Losses)

Net realized investment gains (losses) for the three and nine months ended September 30, 2009 include other-than temporary impairments of $278,000 and $1.7 million, respectively, compared to impairments of $504,000 for the same periods in 2008. Net realized investment gains (losses) for the three and nine months ended September 30, 2009 include an increase in the fair value of the segment’s convertible bond portfolio totaling $504,000 and $817,000, respectively, compared to a decrease in fair value of $206,000 and $474,000, respectively, for the same periods in 2008.

Losses and LAE

The increase in the calendar period loss and LAE ratio for the nine months ended September 30, 2009, compared to the same period in 2008, primarily reflects an increase the accident period loss ratio and a decrease in favorable loss reserve development on prior accident periods. The accident period loss ratio was 64.8% and 65.1% for the three and nine months ended September 30, 2009 compared to 60.0% for the three and nine months ended September 30, 2008, respectively. The increase in the accident period loss ratio primarily reflects management’s estimate of the impact of the current economic environment on the Company’s workers’ compensation book of business, including the impact of rising unemployment on management’s return to work controls. Favorable loss reserve development totaled $350,000 and $1.6 million for the three and nine months ended September 30, 2009. Favorable loss reserve development totaled $2.5 million for the nine months ended September 30, 2008. There was no loss reserve development for the three months ended September 30, 2008. The favorable loss 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 primarily reflects prior year claim settlements during 2009 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, 2009. For the nine months ended September 30, 2009, the Company closed 286, or 45.1%, of the 634 open lost time claims as of December 31, 2008. 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 enabled it to record losses and LAE that were lower than the amount reserved for claim settlements.

Acquisition and Other Underwriting Expenses

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

Other Expenses

The increase in other expenses as a percent of net premiums earned from 2008 to 2009 for the nine months ended September 30, 2009, compared to the same period in 2008, primarily reflects the impact of the lower renewal retention rate and renewal rate decreases on net premiums earned.

Policyholder Dividends

The decrease in the policyholder dividend ratio for the three months ended September 30, 2009, compared to the same period in 2008, reflects the loss experience on the underlying policies. For the nine months ended September 30, 2009 and 2008, 9.4% and 10.9% of policies were written on a dividend policy basis, respectively.

Tax Expense

The effective tax rate for the three and nine months ended September 30, 2009 was 29.0% and 29.9%, respectively, compared to 30.5% and 32.1%, respectively for the same periods in 2008. The primary difference between the statutory rate of 35.0% and the effective tax rate reflects tax-exempt income on municipal bond securities.

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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, 2009 and 2008 (unaudited, in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2009			2008			2009			2008
Revenue:
Reinsurance premiums assumed	$	6,917		$	6,008		$	23,715		$	23,873
Ceded premiums written		(839	)		(792	)		(2,406	)		(2,209	)
Net premiums written		6,078			5,216			21,309			21,664
Change in unearned premiums		278			835			(2,951	)		(4,517	)
Net premiums earned		6,356			6,051			18,358			17,147
Net investment income		154			291			531			855
Net realized investment gains (losses)		329			(706	)		(697	)		(445	)
Total revenue	$	6,839		$	5,636		$	18,192		$	17,557
Expenses:
Losses and LAE incurred	$	3,209		$	3,686		$	11,294		$	9,057
Acquisition and other underwriting expenses		1,942			1,872			5,600			5,306
Other expenses		86			183			125			234
Segregated portfolio dividend expenses (1)		1,602			(105	)		1,173			2,960
Total expenses	$	6,839		$	5,636		$	18,192		$	17,557
Net income (1)	$	—		$	—		$	—		$	—

(1) The workers’ compensation insurance, run-off 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, 2009 and 2008:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2009		2008		2009		2008
Loss and LAE ratio	50.5	%	60.9	%	61.5	%	52.8	%
Expense ratio	31.9	%	34.0	%	31.2	%	32.3	%
Combined ratio	82.4	%	94.9	%	92.7	%	85.1	%

Reinsurance Premiums Assumed

The increase in reinsurance premiums assumed primarily reflects new business production of $3.0 million and an increase in the renewal retention rate from 87.7% in 2008 to 89.1% in 2009.

Net Investment Income

The decrease in net investment income primarily reflects a decline in short-term interest rates.

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Net Realized Investment Gains (Losses)

Net realized investment gains (losses) for the three and nine months ended September 30, 2009 reflect other-than-temporary impairments of $41,000 and $749,000, respectively, compared to $478,000 for the same periods in 2008.

Losses and LAE

The decrease in the calendar period loss and LAE ratio primarily reflects an increase in favorable loss reserve development on prior accident periods. The accident period loss ratio was 70.3% and 72.8% for the three and nine months ended September 30, 2009 compared to 62.4% and 68.9% for the same period in 2008. The increase in the accident period loss ratio for the nine months ended September 30, 2009 primarily reflects management’s estimate of the impact of the current economic environment on the Company’s workers’ compensation book of business, including the impact of rising unemployment on management’s return to work controls. Favorable loss reserve development totaled $1.3 million and $2.0 million for the three and nine months ended September 30, 2009, compared to $77,000 and $2.7 million for the same periods in 2008. The favorable loss 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 primarily reflects prior year claim settlements during 2009 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, 2009.

Acquisition and Other Underwriting Expenses

The expense ratios are consistent with the contractual ceding commissions for the three and nine months ended September 30, 2009 and 2008.

Segregated Portfolio Dividend Expense

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

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GROUP BENEFITS INSURANCE

The following table represents the operations of the group benefits insurance segment for the three and nine months ended September 30, 2009 and 2008 (unaudited, in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2009			2008			2009			2008
Revenue:
Direct premiums written	$	9,723		$	9,774		$	28,893		$	29,339
Ceded premiums written		(773	)		(643	)		(2,119	)		(1,838	)
Net premiums written		8,950			9,131			26,774			27,501
Change in unearned premiums		2			—			(4	)		4
Net premiums earned		8,952			9,131			26,770			27,505
Net investment income		385			656			1,259			2,024
Change in equity interest in limited partnerships		61			(121	)		119			137
Net realized investment gains (losses)		1,378			(2,883	)		2,670			(3,212	)
Total revenue	$	10,776		$	6,783		$	30,818		$	26,454
Expenses:
Losses and LAE incurred	$	6,480		$	5,932		$	19,094		$	18,684
Acquisition and other underwriting expenses		1,355			1,383			4,071			4,242
Other expenses		1,572			1,420			4,616			4,179
Total expenses	$	9,407		$	8,735		$	27,781		$	27,105
Income before income taxes		1,369			(1,952	)		3,037			(651	)
Income tax expense		458			(814	)		980			(501	)
Net income (loss)	$	911		$	(1,138	)	$	2,057		$	(150	)

Net Income (Loss)

The increase in net income from 2008 to 2009 primarily reflects net realized investment gains related to the change in fair value of the segment’s convertible bond portfolio, partially offset by an increase in the combined ratio and a decrease in net investment income. The increase in the combined ratio primarily reflects an increase in the dental loss ratio and the decrease in net premiums earned. The decrease in net investment income primarily reflects the lower average invested asset base.

The group benefits insurance ratios were as follows for the three and nine months ended September 30, 2009 and 2008:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2009		2008		2009		2008
Loss and LAE ratio	72.4	%	65.0	%	71.3	%	67.9	%
Expense ratio	32.7	%	30.7	%	32.5	%	30.6	%
Combined ratio	105.1	%	95.7	%	103.8	%	98.5	%

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Premiums

Direct premiums written, by line of business, for the three and nine months ended September 30, 2009 and 2008 were as follows (unaudited, in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2009		2008		2009		2008
Dental	$	5,654	$	5,674	$	16,765	$	17,007
Short-term disability		1,516		1,625		4,609		4,928
Long-term disability		977		959		2,874		2,858
Term life		1,551		1,516		4,601		4,546
Vision		25		—		44		—
Total	$	9,723	$	9,774	$	28,893	$	29,339

The decrease in direct premiums written primarily reflects a decline in the renewal retention rate, partially offset by new business sales.

Net Investment Income

The decrease in net investment income primarily reflects a lower average invested asset base and a decrease in short-term interest rates. The average yield on the fixed income portfolio as of September 30, 2009 was 5.59%, compared to an average yield of 5.40% as of September 30, 2008.

Net Realized Investment Gains (Losses)

Net realized investment gains for the three and nine months ended September 30, 2009 primarily reflect the change in fair value of convertible bond securities, which increased net realized investment gains $1.2 million and $2.1 million, respectively, compared to a decrease of $1.1 million and $1.9 million for the same periods in 2008, respectively.

Losses and LAE

The calendar period loss ratios, by line of business, for the three and nine months ended September 30, 2009 and 2008 were as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2009		2008		2009		2008
Dental	79.6	%	73.5	%	80.1	%	75.3	%
Short-term disability	53.4	%	62.7	%	61.0	%	63.9	%
Long-term disability	40.3	%	(4.4	)%	18.9	%	39.7	%
Term life	68.2	%	51.2	%	61.0	%	49.2	%
Total group benefits	72.4	%	65.0	%	71.3	%	67.9	%

Dental

The increase in the dental loss ratio for the nine months ended September 30, 2009, compared to the same period in 2008, primarily reflects an increase in the accident period loss ratio from 77.2% in 2008 to 81.1% in 2009. Favorable development on prior accident year reserves reduced the loss ratio by 1.0 percentage points, or $162,000, for the nine months ended September 30, 2009, compared to 1.9 percentage points, or $325,000, for the same period in 2008. The increase in the accident period loss ratio primarily reflects the impact of the competitive rate environment.

Short-term Disability

The decrease in the short-term disability loss ratio for the nine months ended September 30, 2009, compared to the same period in 2008, primarily reflects a decrease in the accident period loss ratio from 66.3% in 2008 to 63.8% in 2009. Favorable development on prior accident year reserves reduced the loss ratio by 2.8 percentage points, or $130,000, for the nine months ended September 30, 2009, compared to 2.5 percentage points, or $120,000, for the same period in 2008. The decrease in the accident period loss ratio primarily reflects lower claim frequency and severity.

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Long-term Disability

The increase in the long-term disability loss ratio for the three months ended September 30, 2009, compared to the same period in 2008, primarily reflects an increase in new claims and lower prior year claim terminations.

Term Life

The increase in the term life loss ratio for the three months ended September 30, 2009, compared to the same period in 2008, primarily reflects an increase in reported death claims.

Acquisition and Other Underwriting Expenses

Acquisition and other underwriting expenses as a percent of direct premiums written totaled 13.9% and 14.1% for the three and nine months ended September 30, 2009, respectively, compared to 14.1% and 14.5% for the same periods in 2008, respectively. The decrease for the nine months ended September 30, 2009, compared to the same period in 2008, primarily reflects lower commissions paid to general agents, primarily IBSi, the Company’s former general agent in the Southeast.

Other Expenses

Other expenses as a percent of direct premiums written totaled 16.2% and 14.5% for the three months ended September 30, 2009 and 2008, respectively, and 16.0% and 14.2% for the nine months ended September 30, 2009 and 2008. The increase primarily reflects higher salary costs and consulting expenses related to an upgrade of the segment’s policy administration system, as well as the impact of corporate expense allocations, which increased from 2008 to 2009.

Tax Expense

The effective tax rate was 33.5% and 41.7% for the three months ended September 30, 2009 and 2008, respectively, and 32.2% and 77.0% for the nine months ended September 30, 2009 and 2008, respectively. The primary difference between the statutory rate of 35.0% and the effective tax rate relates to tax-exempt income on municipal bond securities. The decrease in the effective tax rate from 2008 to 2009 primarily reflects the impact of the 2007 tax return adjustment recorded in the third quarter of 2008, which increased the income tax benefit.

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RUN-OFF SPECIALTY REINSURANCE

The following table represents the operations of the run-off specialty reinsurance segment for the three and nine months ended September 30, 2009 and 2008 (unaudited, in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2009			2008			2009			2008
Revenue:
Reinsurance premiums assumed	$	14		$	(290	)	$	159		$	3,893
Change in unearned premiums		—			2,404			978			4,857
Net premiums earned		14			2,114			1,137			8,750
Net investment income		259			338			686			1,035
Change in equity interest in limited partnerships		104			(143	)		143			(154	)
Net realized investment gains (losses)		11			(263	)		(1,431	)		33
Other revenue		143			361			370			776
Total revenue	$	531		$	2,407		$	905		$	10,440
Expenses:
Losses and LAE incurred	$	1		$	3,464		$	778		$	10,456
Acquisition and other underwriting expenses		4			635			341			2,624
Other expenses		182			297			396			623
Total expenses	$	187		$	4,396		$	1,515		$	13,703
Income (loss) before income taxes		344			(1,989	)		(610	)		(3,263	)
Income tax benefit		(1	)		(696	)		(4	)		(1,142	)
Net income (loss)	$	345		$	(1,293	)	$	(606	)	$	(2,121	)

Net Income (Loss)

The results of operations for the three and nine months ended September 30, 2009 primarily reflects the run-off of the specialty reinsurance segment and the impact of other-than-temporary investment impairments. Other-than-temporary impairments totaled $1.8 million for the nine months ended September 30, 2009. There were no impairment recognized for the three months ended September 30, 2009.

Reinsurance Premiums Assumed

The decrease in reinsurance premiums assumed reflects the termination of the quota-share reinsurance treaty effective July 1, 2008. Reinsurance premiums assumed, by line of business, were as follows for the three and nine months ended September 30, 2009 and 2008 (unaudited, in thousands):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2009		2008			2009			2008
EnviroGuard	$	2	$	(33	)	$	197		$	2,887
EIA liability		12		(257	)		(38	)		1,000
Other		—		—			—			6
Total assumed premiums	$	14	$	(290	)	$	159		$	3,893

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Net Investment Income

The decrease in net investment income primarily reflects a decline in short-term interest rates. The average yield on the fixed income portfolio was 3.00% as of September 30, 2009, compared to 4.10% as of September 30, 2008. The decrease in the average yield reflects a higher concentration of assets in cash and cash equivalents as a result of the run-off of the segment.

Net Realized Investment Gains (Losses)

Net realized investment losses for the nine months ended September 30, 2009 primarily reflect other-than-temporary impairments of $1.8 million. There were no impairment recognized for the three months ended September 30, 2009. Net realized investment losses for the three and nine months ended September 30, 2008 include other-than-temporary impairments of $260,000.

Losses and LAE

The decrease in losses and LAE reflects the run-off of the segment.

Acquisition and Other Underwriting Expenses

The decrease in acquisition and other underwriting expenses reflects the termination of the quota-share reinsurance treaty. The expenses for the nine months ended September 30, 2009 primarily reflect the amortization of deferred acquisition costs as of December 31, 2008.

Tax Expense

The income tax benefit for the three and nine months ended September 30, 2009 reflects the tax impact of purchase accounting adjustments related to the run-off specialty reinsurance segment. The Company has not recognized any tax expense related to the operating results of the run-off specialty reinsurance segment for the three and nine months ended September 30, 2009 as a result of the net operating losses incurred by the segment in the fourth quarter of 2008.

CORPORATE/OTHER

The net loss in the corporate/other segment totaled $415,000 and $2.1 million for the three and nine months ended September 30, 2009, compared to a net loss of $1.2 million and $3.2 million for the same period in 2008. The decrease in the net loss for the nine months ended September 30, 2009, compared to the same period in the prior year, primarily reflects a decline in legal and compliance costs and the reversal of a deferred tax valuation allowance of $438,000.

CONSOLIDATED FINANCIAL POSITION

Consolidated assets totaled $399.2 million at September 30, 2009, compared to $377.3 million at December 31, 2008. The increase in consolidated assets primarily reflects an increase in cash and invested assets, premiums receivable and deferred acquisition costs, partially offset by a decrease in deferred income taxes. The increase in cash and invested assets primarily reflects the increase in fair value of the Company’s investments. The increase in premiums receivable and deferred acquisition costs primarily reflects the January 1 and July 1 policy anniversary dates of a significant portion of the Company’s workers’ compensation book of business. The decrease in deferred income taxes primarily reflects the increase in the fair value of the Company’s investments.

Consolidated liabilities totaled $247.8 million at September 30, 2009, compared to $239.2 million at December 31, 2008. The increase in consolidated liabilities primarily reflects an increase in unearned premiums and the segregated portfolio cell dividend payable, partially offset by a decrease in loss and LAE reserves. The increase in unearned premiums primarily reflects the policy anniversary dates of the Company’s workers’ compensation business. The increase in the segregated portfolio cell dividend payable primarily reflects an increase in the fair value of the segregated portfolio cells’ investments. The decrease in loss and LAE reserves primarily reflects the run-off of the specialty reinsurance operations.

Consolidated equity totaled $151.4 million at September 30, 2009, compared to $138.1 million at December 31, 2008. The increase in consolidated equity primarily reflects net income for the nine months ended September 30, 2009 and an increase in the fair value of the Company’s fixed income and equity security portfolios, partially offset by the payment of shareholder dividends.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s principal sources of funds are premiums, investment income, and proceeds from sales and maturities 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

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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. In addition to the line of credit, the Company has obtained letters of credit totaling $44.9 million for the purpose of securing obligations to reinsurers, if necessary. As of September 30, 2009, there was approximately $6.6 million still available under the Company’s letter of credit facilities.

Our domestic insurance subsidiaries’ ability to pay dividends to EIHI is limited by the insurance laws and regulations of Pennsylvania and Indiana. The maximum annual dividends that the domestic insurance entities may pay without prior approval from the Pennsylvania Insurance Department and the Indiana 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.

Eastern Re must receive approval from the Cayman Islands Monetary Authority before it can pay any dividend to the Company.

CASH FLOWS

Cash flows for the nine months ended September 30, 2009 and 2008 were as follows (unaudited, in thousands):

	2009			2008
Cash flows provided by operating activities	$	4,721		$	17,203
Cash flows provided by investing activities		13,170			13,240
Cash flows used in financing activities		(2,412	)		(26,758	)
Net increase in cash and cash equivalents	$	15,479		$	3,685

The increase in cash and cash equivalents from 2008 to 2009 primarily reflects the Company’s decision to suspend its common stock repurchases in 2009, partially offset by a decrease in operating cash flows. The decrease in operating cash flows primarily reflects an increase in paid claims and a reduction in interest income. The increase in paid claims primarily reflects activity in the run-off specialty reinsurance segment. The reduction in interest income primarily reflects the current interest rate environment.

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, 2009, future effect on the Company’s financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company is subject to market risk with respect to its fixed income investment portfolio. 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.

There have been no material changes in the Company’s market risk since December 31, 2008. 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 13, 2009.

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.

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings

None

Item 1A. Risk Factors

There are no material changes from the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, SEC File No. 001-32899.

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

Issuer Purchases of Equity Securities

On February 15, 2007, the Company’s Board of Directors authorized the repurchase of up to 5 percent of the Company’s issued and outstanding shares of common stock for the purpose of funding the issuance of stock under the Eastern Insurance Holdings, Inc. 2006 Stock Incentive Plan. On August 2, 2007, the Company’s Board of Directors authorized the repurchase of additional shares of the Company’s outstanding common stock up to an aggregate of 1,046,500 shares, which represented the total number of shares of common stock for which awards may be granted under the Company’s Stock Incentive Plan at that time. On September 27, 2007, the Company’s Board of Directors increased the share repurchase authorization to 2,046,500 shares. On March 24, 2008, the Company received approval from the Pennsylvania Insurance Department to repurchase up to $10 million of the Company’s issued and outstanding common stock, which is in addition to the 2,046,500 shares authorized in 2007. As of September 30, 2009, the Company has repurchased 2,091,757 shares, and has approximately $9.6 million authorized for future repurchases.

The following table presents information with respect to those purchases of our common stock made during the nine months ended September 30, 2008. There were no purchases of our common stock during the nine months ended September 30, 2009.

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
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

Item 3. Defaults Upon Senior Securities

None

Item 4. Submission of Matters to a Vote of Security Holders

(a) The Company held its Annual Meeting of Shareholders on May 14, 2009.

(b) The names of each director elected to serve until 2012 at the Annual Meeting of Shareholders are as follows:

Director	Votes For	Votes Withheld
Paul R. Burke	7,098,939	944,597
Ronald L. King	7,098,439	945,097
W. Lloyd Snyder III	7,202,135	841,401

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The following directors are serving terms of office that continue through 2010 and 2011, as noted:

Director	Year Term Expires
Lawrence W. Bitner	2010
Bruce M. Eckert	2010
John O. Shirk	2010
Robert M. McAlaine	2011
Scott C. Penwell	2011
Charles H. Vetterlein, Jr.	2011

(c) One additional proposal was submitted for a vote, with the following results:

	Votes For	Votes Against	Abstentions
To ratify the appointment of PricewaterhouseCoopers LLP as the company’s independent auditor for the fiscal year ending December 31, 2009	7,967,473	60,628	15,435

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)
10.15	Standard Agency Terms and Conditions (filed herewith as Exhibit 10.15)
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 5, 2009	By:	/S/    BRUCE M. ECKERT
		Bruce M. Eckert,
		Chief Executive Officer
Dated: November 5, 2009	By:	/S/    KEVIN M. SHOOK
		Kevin M. Shook,
		Treasurer and Chief Financial Officer

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