Eastern Insurance (EIHI) 10-Q 2010 Q3 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

Quarterly Report pursuant to Section 13 or 15(d) of

the Securities Exchange Act of 1934

for the Quarterly Period Ended September 30, 2010,

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.

COMMON STOCK (No Par Value)	Number of Shares Outstanding as of November 3, 2010 9,210,262
(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		21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		34
Item 4.	Controls and Procedures		35
PART II -OTHER INFORMATION			35
Item 1.	Legal Proceedings		35
Item 1A.	Risk Factors		35
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		35
Item 3.	Defaults Upon Senior Securities		36
Item 4.	Submission of Matters to Vote of Security Holders		36
Item 5.	Other Information		36
Item 6.	Exhibits		36

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 2010			December 31 2009
ASSETS
Investments:
Fixed income securities, at estimated fair value (amortized cost, $172,314; $154,828)	$	179,641		$	159,101
Convertible bonds, at estimated fair value (amortized cost, $16,516; $3,641)		17,354			4,134
Equity securities, at estimated fair value (cost, $18,343; $16,438)		21,332			20,332
Other long-term investments, at estimated fair value (cost, $10,232; $7,879)		10,903			8,197
Total investments		229,230			191,764
Cash and cash equivalents		47,625			50,841
Accrued investment income		1,530			1,444
Premiums receivable (net of allowance, $631; $631)		40,032			32,404
Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses		13,000			12,354
Deferred acquisition costs		8,099			6,487
Deferred income taxes, net		333			1,343
Federal income taxes recoverable		1,395			1,549
Intangible assets		6,484			7,448
Goodwill		10,752			10,752
Other assets		10,207			8,203
Discontinued operations – group benefits insurance		—			66,935
Total assets	$	368,687		$	391,524
LIABILITIES
Reserves for unpaid losses and loss adjustment expenses	$	123,342		$	121,093
Unearned premium reserves		59,024			46,016
Advance premium		77			657
Accounts payable and accrued expenses		11,850			11,853
Ceded reinsurance balances payable		7,312			5,900
Segregated portfolio cell dividend payable		13,156			16,684
Loan payable		1,518			1,986
Discontinued operations – group benefits insurance		—			33,470
Total liabilities	$	216,279		$	237,659
Commitments and contingencies (Note 11)
SHAREHOLDERS’ EQUITY
Series A preferred stock, par value $0, auth. shares – 5,000,000; no shares issued and outstanding		—			—
Common capital stock, par value $0, auth. shares – 20,000,000; issued – 11,784,514 and 11,783,014, respectively; outstanding – 9,210,262 and 9,691,257, respectively		—			—
Unearned ESOP compensation		(4,300	)		(4,859	)
Additional paid in capital		114,103			113,049
Treasury stock, at cost (2,574,252 and 2,091,757 shares, respectively)		(37,889	)		(32,666	)
Retained earnings		73,756			73,038
Accumulated other comprehensive income, net		6,738			5,303
Total shareholders’ equity		152,408			153,865
Total liabilities and shareholders’ equity	$	368,687		$	391,524

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, 2010 and 2009

(Unaudited, in thousands, except per share data)

	For the Three  Months Ended September 30,					For the Nine Months Ended September 30,
	2010			2009		2010			2009
REVENUE
Net premiums earned	$	28,777		$	24,156	$	80,041		$	74,094
Net investment income		1,189			1,575		3,515			4,373
Change in equity interest in limited partnerships		266			462		520			681
Net realized investment gains (losses)		2,470			710		2,747			(2,321	)
Other revenue		143			206		434			569
Total revenue		32,845			27,109		87,257			77,396
EXPENSES
Losses and loss adjustment expenses incurred		19,918			14,115		57,747			45,385
Acquisition and other underwriting expenses		3,277			3,060		9,101			9,300
Other expenses		5,883			5,165		16,252			15,247
Amortization of intangibles		321			433		963			1,299
Policyholder dividend expense		333			118		732			241
Segregated portfolio dividend expense		84			1,086		(618	)		434
Total expenses		29,816			23,977		84,177			71,906
Income from continuing operations before income taxes		3,029			3,132		3,080			5,490
Income tax expense from continuing operations		732			833		1,127			2,078
Net income from continuing operations		2,297			2,299		1,953			3,412
Discontinued operations – group benefits insurance (Note 3):
Income from discontinued operations before income taxes		35			1,494		1,438			3,412
Income tax expense		154			502		760			1,111
Net (loss) income from discontinued operations		(119	)		992		678			2,301
Net income	$	2,178		$	3,291	$	2,631		$	5,713
Other comprehensive income
Unrealized holding gains arising during period, net of tax of $1,257, $2,366, $2,375 and $3,442		2,333	��		4,394		4,411			6,392
Amortization of unrecognized benefit plan amounts, net of tax of $2, $1, $5, and $4		4			3		10			8
Less: Reclassification adjustment for gains (losses) included in net income, net of tax of $376, $16, $1,608, and $(753)		697			31		2,986			(1,399	)
Other comprehensive income		1,640			4,366		1,435			7,799
Comprehensive income	$	3,818		$	7,657	$	4,066		$	13,512
	Three Months Ended September 30					Nine Months Ended September 30
Earnings per share (See Note 5):	2010			2009		2010			2009
Basic earnings per share:
Income from continuing operations	$	0.26		$	0.25	$	0.22		$	0.38
(Loss) income from discontinued operations	$	(0.01	)	$	0.11	$	0.08		$	0.25
Diluted earnings per share:
Income from continuing operations	$	0.26		$	0.25	$	0.22		$	0.37
(Loss) income from discontinued operations	$	(0.01	)	$	0.11	$	0.07		$	0.25

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, 2010

(Unaudited, in thousands, except share data)

Three Months Ended September 30, 2010

	Outstanding Shares																		Accumulated Other
	Series A Preferred Stock		Common Capital Stock			Common Capital Stock		Unearned ESOP Compensation			Additional Paid-In Capital		Treasury Stock			Retained Earnings			Comprehensive Income Net of Tax		Total
Balance, July 1, 2010		—		9,372,701			—	$	(4,488	)	$	113,771	$	(36,114	)	$	72,223		$	5,098	$	150,490
ESOP shares released		—		—			—		188			6		—			—			—		194
Stock compensation expense		—		1,500			—		—			326		—			—			—		326
Repurchase of common stock		—		(163,939	)		—		—			—		(1,775	)		—			—		(1,775	)
Shareholder dividend		—		—			—		—			—		—			(645	)		—		(645	)
Net income		—		—			—		—			—		—			2,178			—		2,178
Other comprehensive income, net of tax		—		—			—		—			—		—			—			1,640		1,640
Balance, September 30, 2010		—		9,210,262			—	$	(4,300	)	$	114,103	$	(37,889	)	$	73,756		$	6,738	$	152,408

Nine Months Ended September 30, 2010

	Outstanding Shares																		Accumulated Other
	Series A Preferred Stock		Common Capital Stock			Common Capital Stock		Unearned ESOP Compensation			Additional Paid-In Capital		Treasury Stock			Retained Earnings			Comprehensive Income Net of Tax		Total
Balance, January 1, 2010		—		9,691,257			—	$	(4,859	)	$	113,049	$	(32,666	)	$	73,038		$	5,303	$	153,865
ESOP shares released		—		—			—		559			36		—			—			—		595
Stock compensation expense		—		1,500			—		—			1,018		—			—			—		1,018
Repurchase of common stock		—		(482,495	)		—		—			—		(5,223	)		—			—		(5,223	)
Shareholder dividend		—		—			—		—			—		—			(1,913	)		—		(1,913	)
Net income		—		—			—		—			—		—			2,631			—		2,631
Other comprehensive income, net of tax		—		—			—		—			—		—			—			1,435		1,435
Balance, September 30, 2010		—		9,210,262			—	$	(4,300	)	$	114,103	$	(37,889	)	$	73,756		$	6,738	$	152,408

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, 2009

(Unaudited, in thousands, except share data)

Three Months Ended September 30, 2009

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

6

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Nine Months Ended September 30, 2010 and 2009

(Unaudited, in thousands)

	2010			2009
Cash flows from operating activities:
Net income	$	2,631		$	5,713
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		520			440
Amortization of bond premium/discount		1,058			(220	)
Net realized investment (gains) losses		(2,747	)		2,321
Change in equity interest in limited partnerships		(520	)		(681	)
Deferred tax expense		397			94
Stock compensation		1,582			1,454
Intangible asset amortization		963			1,299
Changes in assets and liabilities:
Accrued investment income		(86	)		227
Premiums receivable		(7,628	)		(9,557	)
Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses		(646	)		(188	)
Deferred acquisition costs		(1,612	)		(1,579	)
Other assets		(329	)		(1,012	)
Reserves for unpaid losses and loss adjustment expenses		2,249			(714	)
Unearned and advance premium		12,428			10,534
Accounts payable and accrued expenses		29			48
Ceded reinsurance balances payable		1,412			(1,180	)
Segregated portfolio cell dividend payable		(2,940	)		(127	)
Federal income taxes recoverable/payable		154			(90	)
Net cash provided by operating activities – continuing operations		6,915			6,782
Net cash used in operating activities – discontinued operations		(2,772	)		(2,061	)
Net cash provided by operating activities		4,143			4,721
Cash flows from investing activities:
Purchase of fixed income securities		(91,352	)		(83,609	)
Purchase of equity securities		(7,289	)		(5,642	)
Purchase of other long-term investments		(2,186	)		—
Proceeds from sale of fixed income securities		37,834			57,581
Proceeds from maturities/calls of fixed income securities		23,426			20,058
Proceeds from equity securities		6,757			5,810
Proceeds from other long-term investments		—			461
Proceeds from sale of Eastern Life and Health Insurance Company		534			—
Purchase of equipment, net		(445	)		(250	)
Net cash used in investing activities – continuing operations		(32,721	)		(5,591	)
Net cash provided by investing activities – discontinued operations		32,967			18,761
Net cash provided by investing activities		246			13,170
Cash flows from financing activities:
Repurchase of common stock		(5,223	)		(11	)
Repayment of loan principal		(500	)		(500	)
Shareholder dividend		(1,913	)		(1,901	)
Tax benefit related to ESOP		31			—
Net cash used in financing activities		(7,605	)		(2,412	)
Net (decrease) increase in cash and cash equivalents		(3,216	)		15,479
Cash and cash equivalents, beginning of period		50,841			52,090
Reclassification to discontinued operations		—			(5,875	)
Cash and cash equivalents, end of period	$	47,625		$	61,694
Non-cash investing activity:
Receipt of promissory note	$	1,750		$	—

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 insurance products and reinsurance products through its direct and indirect wholly-owned subsidiaries, Global Alliance Holdings, Ltd. (“Global Alliance”), Eastern Alliance Insurance Company (“Eastern Alliance”), Allied Eastern Indemnity Company (“Allied Eastern”), Eastern Advantage Assurance Company (“Eastern Advantage”), Employers Security Insurance Company (“Employers Security”), Eastern Re Ltd., S.P.C. (“Eastern Re”), and Eastern Services Corporation (“Eastern Services), collectively referred to as the Company.

On June 21, 2010, EIHI announced the completion of its previously announced agreement to sell Eastern Life and Health Insurance Company (“Eastern Life”) (Note 3). As a result of this agreement, Eastern Life’s operations have been reflected as discontinued operations in the accompanying consolidated financial statements. Eastern Life’s net premiums earned and revenue, prior to the sale, totaled $18,262 and $20,563, respectively, for the nine months ended September 30, 2010. Eastern Life’s net premiums earned and revenue totaled $8,952 and $10,776 and $26,770 and $30,818, respectively, for the three and nine months ended September 30, 2009.

The Company currently operates in four segments: workers’ compensation insurance, segregated portfolio cell reinsurance, specialty reinsurance, and corporate/other. The specialty reinsurance segment was placed into run-off effective July 1, 2008. See Note 10 for a description of each segment.

2. Significant Accounting Policies

Basis of Presentation

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments, being normal, recurring adjustments, necessary for a fair statement of the financial position and results of operations of the Company for the periods presented have been included. The results of operations for an interim period are not necessarily indicative of the results for an entire year. These financial statements should be read in conjunction with the Company’s audited financial statements and notes thereto as of and for the year ended December 31, 2009 included in the Company’s Annual Report on Form 10-K, which was filed with the U.S. Securities and Exchange Commission on March 5, 2010.

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

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

Use of Estimates

The preparation of the unaudited interim consolidated financial statements requires management to make estimates and assumptions that affect the amount of reported assets and liabilities and disclosures of contingent assets and liabilities as of the date of the unaudited interim consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. The most significant estimates in the unaudited interim consolidated financial statements include reserves for unpaid losses and loss adjustment expenses (“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.

Recent Accounting Pronouncements

Deferred Acquisition Costs

In October 2010, the Financial Accounting Standards Board (“FASB”) issued new accounting guidance related to the accounting for costs related to the acquisition or renewal of insurance contracts. The new guidance provides specific types of costs that should be capitalized in connection with the acquisition or renewal of insurance contracts. Those costs include incremental direct costs of contract acquisition incurred in connection with independent third parties and certain costs related to activities performed by the insurer for the contract, including underwriting, policy issuance and processing, medical and inspection, and sales force contract selling. Under the new guidance, costs incurred by an entity related to unsuccessful acquisition or renewal efforts must be charged to expense as incurred. The new guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011 and is to be applied prospectively. Retrospective application to all prior periods upon the date of adoption is permitted, but not required. Early adoption is permitted but only at the beginning of an entity’s annual reporting period. The Company currently capitalizes and defers commissions and related expenses, premium taxes and certain underwriting personnel salaries. The Company expects to adopt this new guidance effective January 1, 2011 and apply it retrospectively to prior periods for purposes of consistency across all periods presented. Upon adoption, the Company expects to reduce the amount of acquisition costs capitalized related to certain underwriting personnel salaries to give effect to unsuccessful acquisition or renewal activities. Management has not completed its’ evaluation to determine the impact of the new guidance on the Company’s consolidated financial position and results of operations.

8

Fair Value Measurements

In January 2010, the FASB issued new accounting guidance related to disclosures about fair value measurements. The new guidance requires the following new or enhanced disclosures: 1) details of significant transfers in and out of Level 1 and Level 2 measurements and the reasons for the transfers, 2) a gross presentation of activity within the Level 3 rollforward, presenting separately information about purchases, sales, issuances, and settlements, and 3) fair value disclosures must be presented by class of assets and liabilities rather than by major category. The new guidance was effective for the first interim or annual reporting period beginning after December 15, 2009, except for the gross presentation of the Level 3 rollforward information, which is required for annual reporting periods beginning after December 15, 2010 and for interim periods within those years. The Company adopted the new accounting guidance effective January 1, 2010. The adoption of the new guidance resulted in enhanced disclosures related to the Company’s fair value measurements of its investments.

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 was effective for financial statements issued for fiscal years beginning after November 15, 2009. The Company adopted the new accounting guidance effective January 1, 2010. The adoption of the new guidance had no impact on the Company’s consolidated financial statements.

3. Sale of Eastern Life

On June 21, 2010, EIHI announced the completion of its previously announced agreement to sell its wholly-owned group benefits insurance subsidiary, Eastern Life, to Security Life Insurance Company of America (“Security”). The agreement effected a statutory merger of Eastern Life into Security, with Security continuing as the surviving corporation. Total transaction consideration to EIHI was $34,102, which represented GAAP shareholders’ equity as of May 31, 2010 plus $250. The consideration consisted of cash and a $1,750 promissory note from Security’s parent. The note bears interest at 4.0%, payable quarterly, and is due in full 36 months after the close of the transaction.

The issuance of the promissory note totaling $1,750 is considered a non-cash investing activity and has been excluded from the consolidated statement of cash flows for the nine months ended September 30, 2010.

The Company’s group benefits insurance segment, which consisted of the business of Eastern Life, has been recorded in the consolidated financial statements as discontinued operations. The sale of Eastern Life resulted in the recognition of a gain totaling $564, which is included in discontinued operations. The Company also included transaction expenses of $9 and $873 ($6 and $567 net of tax, respectively) in discontinued operations for the three and nine months ended September 30, 2010, respectively. Certain corporate expenses previously reported in the group benefits insurance segment were reclassified to continuing operations. The reclassification of these corporate expenses totaled $125 and $375 for three and nine months ended September 30, 2010 and 2009, respectively.

9

The group benefits insurance segment’s assets and liabilities as December 31, 2009 were as follows:

	December 31, 2009
ASSETS
Investments:
Fixed income securities	$	30,173
Equity securities		941
Other long-term investments		2,118
Total investments		33,232
Cash and cash equivalents		16,176
Accrued investment income		220
Premiums receivable		53
Reinsurance recoverable on paid and unpaid losses and LAE		16,167
Deferred income taxes, net		6
Federal income taxes recoverable		685
Other assets		396
Total assets	$	66,935
LIABILITIES
Reserves for unpaid losses and LAE	$	30,419
Unearned premium reserves		83
Advance premium		1,063
Accounts payable and accrued expenses		1,392
Reinsurance premiums payable		202
Benefit plan liabilities		311
Total liabilities	$	33,470

4. Goodwill

Management tests goodwill for impairment annually as of September 30 and more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company’s goodwill is allocated 100% to the workers’ compensation insurance segment.

Management tested goodwill for impairment as of September 30, 2010 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, 2010, the Company’s stock price was trading below book value, primarily reflecting the impact of current market conditions; however, the stock price has increased 9.0% since September 30, 2009, the date of management’s most recent goodwill impairment analysis. The discounted cash flow analysis resulted in the workers’ compensation insurance segment’s estimated fair value exceeding its carrying value as of September 30, 2010; therefore, goodwill was considered not impaired.

In the event the operating results of the Company’s workers’ compensation insurance segment were to be adversely impacted by a significant loss of business or higher than expected losses and LAE, management’s internal forecast may need to be re-evaluated, which could result in a fair value that is less than the carrying value of the workers’ compensation insurance segment and the need to recognize a goodwill impairment.

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 and nine months ended September 30, 2010, there were 1,006,405 and 1,016,535 stock options and restricted stock awards, respectively, that were not included in the Company’s earnings per share calculation because to do so would have been anti-dilutive. For the three and nine months ended September 30, 2010, dilutive potential common shares outstanding included 67,293 and 57,163 restricted stock awards, respectively. For the three and nine months ended September 30, 2009, there were 746,878 and 681,518 stock options and restricted stock awards, respectively, that were not included in the Company’s earnings per share calculation because to do so would have been

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anti-dilutive. For the three and nine months ended September 30, 2009, dilutive potential common shares outstanding included 18,650 and 7,485 restricted stock awards, respectively. For the nine months ended September 30, 2009, dilutive potential common shares outstanding also included 76,525 stock warrants.

Consolidated net income, basic shares outstanding, diluted shares outstanding, basic earnings per share, diluted earnings per share and cash dividends per share for the three and nine months ended September 30, 2010 and 2009 were as follows (unaudited, in thousands, except share and per share data):

	Three Months Ended September 30, 2010			Three Months Ended September 30, 2009			Nine Months Ended September 30, 2010			Nine Months Ended September 30, 2009
Net income for basic and diluted earnings per share	$	2,178		$	3,291		$	2,631		$	5,713
Less: Dividends declared – common and unvested restricted share units		(645	)		(678	)		(1,913	)		(1,901	)
Undistributed earnings		1,533			2,613			718			3,812
Percent allocated to common shareholders		98.8	%		98.3	%		98.8	%		98.3	%
		1,515			2,569			709			3,747
Add: Dividends declared – common shares		637			667			1,891			1,869
	$	2,152		$	3,236		$	2,600		$	5,616
Denominator for basic earnings per share		8,690,061			9,027,706			8,797,417			8,963,740
Effect of dilutive securities		67,293			18,650			57,163			84,010
Denominator for diluted earnings per common share		8,757,353			9,046,356			8,854,580			9,047,750
Basic earnings per share:
Income from continuing operations	$	0.26		$	0.25		$	0.22		$	0.38
Income from discontinued operations	$	(0.01	)	$	0.11		$	0.08		$	0.25
Diluted earnings per share:
Income from continuing operations	$	0.26		$	0.25		$	0.22		$	0.37
Income from discontinued operations	$	(0.01	)	$	0.11		$	0.07		$	0.25
Cash dividends per share	$	0.07		$	0.07		$	0.21		$	0.21

6. 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, 2010:

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

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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, 2010 and December 31, 2009, excluding the segregated portfolio cell reinsurance segment (unaudited, in thousands):

			Fair Value Measurements at Reporting Date Using
	9/30/10		Level 1		Level 2		Level 3
Fixed income securities – available for sale:
U.S. Treasuries and government agencies	$	42,576	$	13,077	$	29,499	$	—
States, municipalities, and political subdivisions		34,820		—		34,820		—
Corporate securities		27,417		—		27,417		—
Residential mortgage-backed securities		31,868		—		31,868		—
Commercial mortgage-backed securities		6,765		—		6,765		—
Collateralized mortgage obligations		14,817		—		14,817		—
Other structured securities		838		—		838		—
Convertible bonds		17,354		—		17,354		—
Equity securities – available for sale		17,304		17,304		—		—
Total	$	193,759	$	30,381	$	163,378	$	—

			Fair Value Measurements at Reporting Date Using
	12/31/09		Level 1		Level 2		Level 3
Fixed income securities – available for sale:
U.S. Treasuries and government agencies	$	16,206	$	8,989	$	7,217	$	—
States, municipalities, and political subdivisions		39,811		—		39,811		—
Corporate securities		24,332		—		24,332		—
Residential mortgage-backed securities		26,592		—		26,592		—
Commercial mortgage-backed securities		6,725		—		6,725		—
Collateralized mortgage obligations		14,585		—		14,585		—
Other structured securities		390		—		390		—
Convertible bonds		4,134		—		4,134		—
Equity securities – available for sale		15,826		15,826		—		—
Total	$	148,601	$	24,815	$	123,786	$	—

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 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.

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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 structured finance opportunity fund, an open-ended investment fund and a real estate limited partnership. The Company records its investment in the limited partnerships using the equity method. The carrying value of the Company’s limited partnership investments are based on the Company’s allocable share of the limited partnership’s net asset value. 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, 2010 (unaudited) and December 31, 2009, the estimated fair values of the Company’s limited partnership investments, by investment strategy, were as follows (in thousands):

	9/30/10		12/31/09
Multi-strategy fund of funds	$	5,153	$	3,923
Natural resources		2,343		1,291
Structured finance opportunity fund		2,764		2,410
Open-ended investment fund		590		573
Real estate		53		—
Total	$	10,903	$	8,197

The activity in the Company’s limited partnership investments for the three and nine months ended September 30, 2010 and 2009 was as follows (unaudited, in thousands):

	Three Months  Ended September 30,				Nine Months  Ended September 30,
	2010		2009		2010		2009
Balance, beginning of period	$	10,638	$	7,350	$	8,197	$	7,592
Contributions		—		—		2,186		—
Withdrawals		—		—		—		(461	)
Unrealized change in interest		265		462		520		681
Balance, end of period	$	10,903	$	7,812	$	10,903	$	7,812

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.

7. 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, 2010 and December 31, 2009 (unaudited, in thousands):

September 30, 2010	Cost or Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair  Value
U.S. Treasuries and government agencies	$	41,418	$	1,158	$	—		$	42,576
States, municipalities, and political subdivisions		32,268		2,552		—			34,820
Corporate securities		45,955		2,003		(1	)		47,957
Residential mortgage-backed securities		30,832		1,036		—			31,868
Commercial mortgage-backed securities		6,435		330		—			6,765
Collateralized mortgage obligations		14,593		307		(83	)		14,817
Other structured securities		813		25		—			838
Total fixed income securities		172,314		7,411		(84	)		179,641
Equity securities		18,343		3,091		(102	)		21,332
Total fixed income and equity securities	$	190,657	$	10,502	$	(186	)	$	200,973

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December 31, 2009	Cost or Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
U.S. Treasuries and government agencies	$	20,547	$	358	$	(39	)	$	20,866
States, municipalities, and political subdivisions		38,002		1,865		(56	)		39,811
Corporate securities		48,285		1,910		(63	)		50,132
Residential mortgage-backed securities		25,947		654		(9	)		26,592
Commercial mortgage-backed securities		6,925		59		(259	)		6,725
Collateralized mortgage obligations		14,672		180		(267	)		14,585
Other structured securities		450		16		(76	)		390
Total fixed income securities		154,828		5,042		(769	)		159,101
Equity securities		16,438		3,907		(13	)		20,332
Total fixed income and equity securities	$	171,266	$	8,949	$	(782	)	$	179,433

Other structured securities include other asset-backed securities collateralized by home equity loans, credit card receivables and manufactured homes.

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, 2010 (unaudited, in thousands) and December 31, 2009 are as follows (in thousands):

	Less Than 12 Months					12 Months or More					Total
September 30, 2010	Estimated Fair Value		Gross Unrealized Losses			Estimated Fair Value		Gross Unrealized Losses			Estimated Fair Value		Gross Unrealized Losses
Collateralized mortgage obligations	$	—	$	—		$	913	$	(83	)	$	913	$	(83	)
Total fixed income securities		—		—			913		(83	)		913		(83	)
Equity securities		3,956		(54	)		—		—			3,956		(54	)
Total fixed income and equity securities	$	3,956	$	(54	)	$	913	$	(83	)	$	4,869	$	(137	)

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.

	Less Than 12 Months					12 Months or More					Total
December 31, 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	$	6,715	$	(39	)	$	—	$	—		$	6,715	$	(39	)
States, municipalities, and political subdivisions		2,757		(56	)		—		—			2,757		(56	)
Corporate securities		4,059		(36	)		124		(2	)		4,183		(38	)
Residential mortgage-backed securities		903		(9	)		—		—			903		(9	)
Commercial mortgage-backed securities		1,017		(2	)		3,248		(258	)		4,265		(260	)
Collateralized mortgage obligations		1,327		(44	)		1,771		(223	)		3,098		(267	)
Other structured securities		—		—			315		(76	)		315		(76	)
Total fixed income securities		16,778		(186	)		5,458		(559	)		22,236		(745	)
Equity securities		—		—			—		—			—		—
Total fixed income and equity securities	$	16,778	$	(186	)	$	5,458	$	(559	)	$	22,236	$	(745	)

As of September 30, 2010, the Company held 2 fixed income securities with gross unrealized losses totaling $83. Management has evaluated the unrealized losses related to those fixed income securities and determined that they are primarily due to the current

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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 asset-backed 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, 2010.

As of September 30, 2010, the Company held 2 equity securities with gross unrealized losses totaling $54. The unrealized losses reflect the decline in the equity markets during the third quarter of 2010. None of the equity securities have been in an unrealized loss position for more than six months and the unrealized losses are less than 20% of the securities’ book value; therefore, management does not consider the equity securities to be other-than-temporarily impaired as of September 30, 2010.

The Company recognized other-than-temporary impairments, excluding impairments in the segregated portfolio cell reinsurance segment, of $0 and $6 for the three and nine months ended September 30, 2010, respectively, compared to other-than-temporary impairments of $398 and $3,618 for the three and nine months ended September 30, 2009, respectively.

The following table provides a rollforward of the Company’s other-than-temporary impairments related to credit losses for which a portion of the other-than-temporary impairment was recognized in other comprehensive income for the nine months ended September 30, 2010.

Balance, January 1, 2010	$	29
Credit loss impairment recognized in current period on securities not previously impaired		6
Credit loss impairments previously recognized on securities which matured, paid down, or were sold during the period		—
Balance, September 30, 2010	$	35

The Company’s equity interest in limited partnerships increased $266 and $520 for the three and nine months ended September 30, 2010, compared to an increase of $462 and $681 for the same periods in 2009. The Company obtains audited financial statements of its limited partnership investments on an annual basis. The total assets, total liabilities and results of operations of the limited partnerships in which the Company invests as of and for the year ended December 31, 2009, based on the limited partnerships’ audited financial statements, were as follows (unaudited, in thousands):

	Total Assets		Total Liabilities		Results of  Operations
Multi-strategy fund of funds	$	536,626	$	36,551	$	89,292
Natural resource funds	$	208,477	$	19,411	$	38,249
Structured finance opportunity fund	$	254,611	$	8,920	$	48,520
Open-ended investment fund	$	107,901	$	961	$	20,440
Real estate partnership	$	3,843	$	2,702	$	(156	)

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8. 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 for the three and nine months ended September 30, 2010 and 2009 (unaudited, in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Balance, beginning of period	$	120,261		$	125,226		$	121,093		$	126,532
Reinsurance recoverables on unpaid losses and LAE		8,273			8,026			8,512			7,835
Net balance, beginning of period		111,988			117,200			112,581			118,697
Incurred related to:
Current year		20,579			15,656			54,388			48,092
Prior year		(610	)		(1,261	)		3,542			(2,112	)
Total incurred before purchase accounting adjustments		19,969			14,395			57,930			45,980
Purchase accounting adjustments		(51	)		(115	)		(183	)		(432	)
Total incurred		19,918			14,280			57,747			45,548
Paid related to:
Current year		7,325			5,178			18,742			11,858
Prior year		9,384			9,104			36,389			35,189
Total paid		16,709			14,282			55,131			47,047
Net balance, end of period		115,197			117,198			115,197			117,198
Reinsurance recoverables on unpaid losses and LAE		8,145			8,621			8,145			8,621
Balance, end of period	$	123,342		$	125,819		$	123,342		$	125,819

Incurred losses by segment were as follows for the three and nine months ended September 30, 2010 and 2009, respectively (unaudited, in thousands):

Three Months Ended September 30, 2010

September 30, 2010	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Run-Off Specialty Reinsurance Segment		Total
Incurred related to:
Current year, gross of discount	$	15,282		$	5,809		$	—	$	21,091
Current period discount		(337	)		(175	)		—		(512	)
Prior year, gross of discount		—			(854	)		—		(854	)
Accretion of prior period discount		190			54			—		244
Total incurred before purchase accounting adjustments		15,135			4,834			—		19,969
Purchase accounting adjustments		(49	)		(4	)		2		(51	)
Total incurred	$	15,086		$	4,830		$	2	$	19,918

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Three Months Ended September 30, 2009

September 30, 2009	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Run-Off Specialty Reinsurance Segment		Total
Incurred related to:
Current year, gross of discount	$	11,567		$	4,483		$	—	$	16,050
Current period discount		(226	)		(168	)		—		(394	)
Prior year, gross of discount		(350	)		(1,252	)		—		(1,602	)
Accretion of prior period discount		188			153			—		341
Total incurred before purchase accounting adjustments		11,179			3,216			—		14,395
Purchase accounting adjustments		(110	)		(7	)		2		(115	)
Total incurred	$	11,069		$	3,209		$	2	$	14,280

Nine Months Ended September 30, 2010

September 30, 2010	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Run-Off Specialty Reinsurance Segment		Total
Incurred related to:
Current year, gross of discount	$	41,496		$	14,835		$	—	$	56,331
Current period discount		(1,373	)		(570	)		—		(1,943	)
Prior year, gross of discount		—			(873	)		2,300		1,427
Accretion of prior period discount		1,264			851			—		2,115
Total incurred before purchase accounting adjustments		41,387			14,243			2,300		57,930
Purchase accounting adjustments		(172	)		(18	)		7		(183	)
Total incurred	$	41,215		$	14,225		$	2,307	$	57,747

Nine Months Ended September 30, 2009

September 30, 2009	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Run-Off Specialty Reinsurance Segment		Total
Incurred related to:
Current year, gross of discount	$	35,607		$	13,417		$	768	$	49,792
Current period discount		(1,181	)		(519	)		—		(1,700	)
Prior year, gross of discount		(1,649	)		(2,031	)		—		(3,680	)
Accretion of prior period discount		1,107			461			—		1,568
Total incurred before purchase accounting adjustments		33,884			11,328			768		45,980
Purchase accounting adjustments		(408	)		(34	)		10		(432	)
Total incurred	$	33,476		$	11,294		$	778	$	45,548

The Company’s results of operations, excluding the segregated portfolio cell reinsurance segment, include no reserve development for the three months ended September 30, 2010 and unfavorable development of $2,300 for the nine months ended September 30, 2010, compared to favorable development of $350 and $1,649 for the three and nine months ended September 30, 2009, respectively. The unfavorable development reported for the nine months ended September 30, 2010 reflects reserve strengthening in the run-off specialty reinsurance segment. The favorable development reported for the three and nine months ended September 30, 2009 primarily reflects the impact of claim settlements at, or less then, previously established case and IBNR reserves in the workers’ compensation insurance segment. Prior period reserve development in the segregated portfolio cell reinsurance segment results in an increase or decrease in the segment’s losses and LAE incurred and a corresponding decrease or increase in the segregated portfolio cell dividend expense.

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9. Income Taxes

Management has estimated its provision for federal income taxes using the actual effective tax rate for the three and nine months ended September 30, 2010. Management has used the actual, rather than annualized, effective tax rate due to uncertainties in the projections of the run-off specialty reinsurance segment. The effective tax rate related to continuing operations for the three and nine months ended September 30, 2010 was 24.2% and 36.6%, respectively. The effective tax rate for the three months ended September 30, 2010 primarily reflects realized gains recognized by the Company’s run-off specialty reinsurance operations. Due to cumulative losses in the run-off specialty reinsurance segment, there was no income tax expense recorded related to the segment’s operating results for the three and nine months ended September 30, 2010.

10. Segment Information

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

Workers’ Compensation Insurance

The Company offers traditional workers’ compensation insurance coverage to employers, primarily in the Mid-Atlantic, Southeast and Midwest regions of the continental United States. The Company’s workers’ compensation products include guaranteed cost policies, policyholder dividend policies, retrospectively-rated policies and large deductible policies.

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 $1,134 and $1,042 for the three months ended September 30, 2010 and 2009, respectively and $3,507 and $3,366 for the nine months ended September 30, 2010 and 2009, respectively.

Run-Off Specialty Reinsurance

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, 2010 and 2009 were as follows (unaudited, in thousands):

	Three months  ended September 30,				Nine months  ended September 30,
	2010		2009		2010			2009
EnviroGuard	$	3	$	2	$	5		$	862
EIA		—		12		(4	)		275
Total	$	3	$	14	$	1		$	1,137

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. The corporate/other segment also includes the Company’s 10.0% interest in a segregated portfolio cell with an unaffiliated primary carrier that writes insurance coverage for sprinkler contractors.

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The following table represents the segment results for the three months ended September 30, 2010 (unaudited, in thousands):

	Workers’ Compensation Insurance		Segregated Portfolio Cell Reinsurance			Run-Off Specialty Reinsurance		Corporate/ Other			Total
Revenue:
Net premiums earned	$	22,409	$	6,365		$	3	$	—		$	28,777
Net investment income		598		124			320		147			1,189
Change in equity interest in limited partnerships		214		—			52		—			266
Net realized investment gains		1,191		232			957		90			2,470
Other revenue		—		—			162		(19	)		143
Total revenue		24,412		6,721			1,494		218			32,845
Expenses:
Losses and LAE incurred		15,085		4,831			2		—			19,918
Acquisition and other underwriting expenses		1,790		1,908			1		(422	)		3,277
Other expenses		4,110		50			282		1,441			5,883
Amortization of intangibles		—		—			—		321			321
Policyholder dividend expense		333		—			—		—			333
Segregated portfolio dividend expense		—		(68	)		—		152			84
Total expenses		21,318		6,721			285		1,492			29,816
Income (loss) from continuing operations before income taxes		3,094		—			1,209		(1,274	)		3,029
Income tax expense (benefit) from continuing operations		1,094		—			—		(362	)		732
Net income (loss) from continuing operations	$	2,000	$	—		$	1,209	$	(912	)	$	2,297
Total assets	$	265,297	$	58,673		$	54,219	$	(9,502	)	$	368,687

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		Run-Off Specialty Reinsurance			Corporate/ Other			Total
Revenue:
Net premiums earned	$	17,786	$	6,356	$	14		$	—		$	24,156
Net investment income		800		154		259			362			1,575
Change in equity interest in limited partnerships		358		—		104			—			462
Net realized investment gains		339		329		11			31			710
Other revenue		—		—		143			63			206
Total revenue		19,283		6,839		531			456			27,109
Expenses:
Losses and LAE incurred		10,905		3,209		1			—			14,115
Acquisition and other underwriting expenses		1,436		1,942		4			(322	)		3,060
Other expenses		3,373		86		182			1,524			5,165
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		187			1,119			23,977
Income (loss) from continuing operations before income taxes		3,451		—		344			(663	)		3,132
Income tax expense (benefit) from continuing operations		1,001		—		(1	)		(167	)		833
Net income (loss) from continuing operations	$	2,450	$	—	$	345		$	(496	)	$	2,299
Total assets	$	245,562	$	58,886	$	58,027		$	(30,284	)	$	332,191

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The following table represents the segment results for the nine months ended September 30, 2010 (unaudited, in thousands):

	Workers’ Compensation Insurance		Segregated Portfolio Cell Reinsurance			Run-Off Specialty Reinsurance			Corporate/ Other			Total
Revenue:
Net premiums earned	$	62,025	$	18,015		$	1		$	—		$	80,041
Net investment income		1,812		433			998			272			3,515
Change in equity interest in limited partnerships		445		—			75			—			520
Net realized investment gains (losses)		1,062		774			1,155			(244	)		2,747
Other revenue		—		—			513			(79	)		434
Total revenue		65,344		19,222			2,742			(51	)		87,257
Expenses:
Losses and LAE incurred		41,214		14,226			2,307			—			57,747
Acquisition and other underwriting expenses		4,860		5,488			—			(1,247	)		9,101
Other expenses		11,087		199			557			4,409			16,252
Amortization of intangibles		—		—			—			963			963
Policyholder dividend expense		732		—			—			—			732
Segregated portfolio dividend expense		—		(691	)		—			73			(618	)
Total expenses		57,893		19,222			2,864			4,198			84,177
Income (loss) from continuing operations before income taxes		7,451		—			(122	)		(4,249	)		3,080
Income tax expense (benefit) from continuing operations		2,351		—			(2	)		(1,222	)		1,127
Net income (loss) from continuing operations	$	5,100	$	—		$	(120	)	$	(3,027	)	$	1,953
Total assets	$	265,297	$	58,673		$	54,219		$	(9,502	)	$	368,687

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			Run-Off Specialty Reinsurance			Corporate/ Other			Total
Revenue:
Net premiums earned	$	54,599		$	18,358		$	1,137		$	—		$	74,094
Net investment income		2,575			531			686			581			4,373
Change in equity interest in limited partnerships		538			—			143			—			681
Net realized investment (losses) gains		(477	)		(697	)		(1,431	)		284			(2,321	)
Other revenue		—			—			370			199			569
Total revenue		57,235			18,192			905			1,064			77,396
Expenses:
Losses and LAE incurred		33,313			11,294			778			—			45,385
Acquisition and other underwriting expenses		4,392			5,600			341			(1,033	)		9,300
Other expenses		10,277			125			396			4,449			15,247
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			1,515			3,976			71,906
Income (loss) from continuing operations before income taxes		9,012			—			(610	)		(2,912	)		5,490
Income tax expense (benefit) from continuing operations		2,696			—			(4	)		(614	)		2,078
Net income (loss) from continuing operations	$	6,316		$	—		$	(606	)	$	(2,298	)	$	3,412
Total assets	$	245,562		$	58,886		$	58,027		$	(30,284	)	$	332,191

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11. Commitments and Contingencies

Legal Proceedings

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

12. Subsequent Events

Management performed an evaluation of subsequent events and determined there were no recognized or unrecognized subsequent events that would require an adjustment and/or additional disclosure in the consolidated financial statements.

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 5, 2010.

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;

• 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;

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• 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.

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 from continuing operations of $2.3 million and $2.0 million for the three and nine months ended September 30, 2010, respectively, compared to net income of $2.3 million and $3.4 million for the same periods in 2009. The decrease in operating results for the nine months ended September 30, 2010, compared to the same period in 2009, primarily reflects an increase in the loss ratio in the workers’ compensation insurance and segregated portfolio call reinsurance segments and a reduction in net investment income, partially offset by an increase in net premiums earned and net realized investment gains. The 2010 results were also impacted by reserve strengthening in the run-off specialty reinsurance segment totaling $2.3 million in the second quarter of 2010.

The workers’ compensation insurance segment reported net income of $2.0 million and $5.1 million for the three and nine months ended September 30, 2010, respectively, compared to net income of $2.5 million and $6.3 million for the same periods in 2009. The segment reported a combined ratio of 95.1% and 93.3% for the three and nine months ended September 30, 2010, respectively, compared to a combined ratio of 89.0% and 88.3% for the same periods in 2009. The increase in the combined ratio primarily reflects an increase in the loss ratio and return premiums to insureds as a result of premium audits, partially offset by a decrease in the expense ratio. The increase in the loss ratio primarily reflects the impact of the current economic environment on the Company’s loss and LAE reserve estimates. The Company did not record any favorable development during the three and nine months ended September 30, 2010, compared to favorable development of $350,000 and $1.6 million, respectively, for same periods in 2009. Net premiums earned were reduced by $1.1 million for the nine months ended September 30, 2010, reflecting return premiums to insureds and a decrease in the earned but unbilled premium estimate as a result of decreasing payrolls. Net premiums earned increased by $632,000 for the nine months ended September 30, 2009 as a result of additional premium from insureds. The decrease in the expense ratio for the three months ended September 30, 2010, compared to the same period in 2009, primarily reflects the impact of audit premiums, which increased premiums by $81,000 in 2010 and decreased premiums by $179,000 in 2009. The decrease in the expense ratio for the nine months ended September 30, 2010, compared to the same period in 2009, primarily reflects the reversal of the 2009 Security Fund accrual as a result of receiving notice from the Security Fund that an assessment for 2009 would not be made, partially offset by the impact of return premiums to insureds.

The segregated portfolio cell reinsurance segment reported a combined ratio of 106.7% and 110.5% for the three and nine months ended September 30, 2010, compared to a combined ratio of 82.4% and 92.7% for the same periods in 2009. The increase in the combined ratio primarily reflects an increase in the accident period loss ratio, reflecting an increase in the severity and number of reported claims, specifically in economically sensitive segregated portfolio cell programs.

Principal Revenue and Expense Items

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

Direct and net premiums written. Direct premiums written is the sum of both direct premiums and assumed premiums before the effect of ceded reinsurance. Direct premiums written include all premiums billed during a specific policy period. Net premiums written is the difference between direct premiums written and premiums ceded or paid to reinsurers (ceded premiums written). In the segregated portfolio cell reinsurance segment, assumed premiums are derived from insurance contracts written by the Company and ceded to the segregated portfolio cells. In the 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, 2009,

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one-half of the premiums would be earned in 2009 and the other half would be earned in 2010. Workers’ compensation premiums are determined based upon the payroll of the insured, the applicable premium rates and, where applicable, an experience based modification factor. An audit of the policyholders’ records is conducted after policy expiration, to make a final determination of applicable premiums. Included with net premiums earned is an estimate for earned but unbilled final audit premiums. The Company can estimate earned but unbilled premiums because it keeps track, by policy, of how much additional premium is billed (or returned to insureds as a result of payroll reductions) 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.

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 insurance segment, 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 insurance segment.

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

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

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

Critical Accounting Policies and Estimates

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

Reserves for Unpaid Losses and LAE

The Company establishes reserves for unpaid losses and LAE for its workers’ compensation insurance, segregated portfolio cell reinsurance 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. Establishing reserves continues to be a complex and imprecise process, requiring the use of informed estimates and judgments. The Company’s estimates and judgments may be revised as additional experience and other data becomes available and are reviewed, as new or improved methodologies are developed, or as current laws change. Any such revisions could result in future changes in estimates of losses or reinsurance recoverable and would be reflected in the Company’s results of operations in the period in which the estimates are changed. Estimating the ultimate claims liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management’s informed estimates and judgments using data currently available. If ultimate losses, net of reinsurance, prove to be substantially higher than the amounts recorded as of September 30, 2010, 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, 2010 and December 31, 2009, the Company’s reserves for unpaid losses and LAE were reduced by $4.4 million and $4.3 million, respectively, related to the effects of discounting.

The reserves for unpaid losses and LAE in the run-off specialty reinsurance segment are based on claim information received from the ceding company on a quarterly basis. Each quarter, the Company compares its actual reported losses for the quarter, and cumulative reported losses since the most recently completed reserve study, to expected reported losses for the respective period, which may result in the Company increasing its losses and LAE, and its corresponding loss reserves in that quarter. During the second quarter of 2010, management concluded its review of the open claims inventory at the ceding company and, as a result of that review, the reserves for unpaid losses and LAE were increased by $2.3 million.

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The Company’s reserves for unpaid losses and LAE in its workers’ compensation insurance, segregated portfolio cell reinsurance and run-off specialty reinsurance segments as of September 30, 2010 (unaudited) and December 31, 2009 are summarized below (in thousands):

September 30, 2010	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Specialty Reinsurance Segment			Total
Case / tabular reserves	$	37,635		$	11,887		$	17,882		$	67,404
Case incurred development, IBNR, and unallocated LAE reserves		26,992			12,851			12,040			51,883
Amount of discount		(3,207	)		(1,237	)		—			(4,444	)
Net reserves		61,420			23,501			29,922			114,843
Reinsurance recoverables on unpaid losses and LAE		4,118			4,027			—			8,145
Purchase accounting adjustments		342			23			(11	)		354
Reserves for unpaid losses and LAE	$	65,880		$	27,551		$	29,911		$	123,342
December 31, 2009	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Specialty Reinsurance Segment			Total
Case / tabular reserves	$	33,073		$	10,978		$	15,761		$	59,812
Case incurred development, IBNR, and unallocated LAE reserves		27,451			12,196			16,841			56,488
Amount of discount		(3,097	)		(1,159	)		—			(4,256	)
Net reserves		57,427			22,015			32,602			112,044
Reinsurance recoverables on unpaid losses and LAE		4,909			3,603			—			8,512
Purchase accounting adjustments		514			41			(18	)		537
Reserves for unpaid losses and LAE	$	62,850		$	25,659		$	32,584		$	121,093

“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 net realized investment loss. 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, 2010, the Company recognized other-than-temporary impairments, excluding impairments in the segregated portfolio cell reinsurance segment, of $0 and $6,000, respectively, compared to other-than-temporary impairments of $398,000 and $3.6 million for the same periods in 2009. As of September 30, 2010, the Company held securities with gross unrealized losses of $137,000, excluding those securities in the segregated portfolio cell reinsurance segment, of which $83,000 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 impaired when one of the following conditions exist: 1) an equity security’s market value is less than 80.0% of its cost for a continuous period of six months, 2) an equity’s security’s market value is less than 50.0% of its cost, regardless of the amount of time the security’s market value has been below cost, and 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.

The Company did not recognize any other-than-temporary impairments related to its equity securities for the three and nine months ended September 30, 2010.

25

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). When the Company determines a credit loss has been incurred, but the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery of the security’s amortized cost basis, the portion of the other-than-temporary impairment that is credit related is recorded as a realized loss in the consolidated statements of operations and comprehensive income, and the portion of the other-than-temporary impairment that is not credit related is included in other comprehensive income. A fixed income security is reviewed for potential credit loss 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, 2010, the Company recognized other-than-temporary impairments of $0 and $6,000 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 limited partnerships in the consolidated statement of operations and comprehensive income. There were no other-than-temporary impairments related to the Company’s limited partnership interests for the three and nine months ended September 30, 2010 or 2009.

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, 2010 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 2010 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, 2010, the Company’s stock price was trading below book value, primarily reflecting the impact of current market conditions; however, the stock price has increased 9.0% since September 30, 2009, the date of management’s most recent goodwill impairment analysis.

The discounted cash flow analysis resulted in the workers’ compensation insurance segment’s estimated fair value exceeding its carrying value as of September 30, 2010; therefore, goodwill was considered not impaired, and the second step of impairment testing was not necessary.

In the event the operating results of the Company’s workers’ compensation insurance segment were to be adversely impacted by a significant loss of business or higher than expected losses and LAE, management’s internal forecast may need to be re-evaluated, which could result in a fair value that is less than the carrying value of the workers’ compensation insurance segment and the need to recognize a goodwill impairment.

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 September 30, 2010, the Company recorded a net deferred tax asset of $333,000.

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Management expects that the net deferred tax asset is fully recoverable. If this assumption were to change, any amount of the net deferred tax asset that the Company could not expect to recover would be provided for as an allowance and would be reflected as an increase in income tax expense in the period in which it was established.

Reinsurance Recoverables

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

Recent Accounting Pronouncements

Deferred Acquisition Costs

In October 2010, the FASB issued new accounting guidance related to the accounting for costs related to the acquisition or renewal of insurance contracts. The new guidance provides specific types of costs that should be capitalized in connection with the acquisition or renewal of insurance contracts. Those costs include incremental direct costs of contract acquisition incurred in connection with independent third parties and certain costs related to activities performed by the insurer for the contract, including underwriting, policy issuance and processing, medical and inspection, and sales force contract selling. Under the new guidance, costs incurred by an entity related to unsuccessful acquisition or renewal efforts must be charged to expense as incurred. The new guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011 and is to be applied prospectively. Retrospective application to all prior periods upon the date of adoption is permitted, but not required. Early adoption is permitted but only at the beginning of an entity’s annual reporting period. The Company currently capitalizes and defers commissions and related expenses, premium taxes and certain underwriting personnel salaries. The Company expects to adopt this new guidance effective January 1, 2011 and apply it retrospectively to prior periods for purposes of consistency across all periods presented. Upon adoption, the Company expects to reduce the amount of acquisition costs capitalized related to certain underwriting personnel salaries to give effect to unsuccessful acquisition or renewal activities. Management has not completed its’ evaluation to determine the impact of the new guidance on the Company’s consolidated financial position and results of operations.

Fair Value Measurements

In January 2010, the FASB issued new accounting guidance related to disclosures about fair value measurements. The new guidance requires the following new or enhanced disclosures: 1) details of significant transfers in and out of Level 1 and Level 2 measurements and the reasons for the transfers, 2) a gross presentation of activity within the Level 3 rollforward, presenting separately information about purchases, sales, issuances, and settlements, and 3) fair value disclosures must be presented by class of assets and liabilities rather than by major category. The new guidance was effective for the first interim or annual reporting period beginning after December 15, 2009, except for the gross presentation of the Level 3 rollforward information, which is required for annual reporting periods beginning after December 15, 2010 and for interim periods within those years. The Company adopted the new accounting guidance effective January 1, 2010. The adoption of the new guidance resulted in enhanced disclosures related to the Company’s fair value measurements of its investments.

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 was effective for financial statements issued for fiscal years beginning after November 15, 2009. The Company adopted the new accounting guidance effective January 1, 2010. The adoption of the new guidance had no impact on the Company’s consolidated financial statements.

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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, 2010 and 2009 (unaudited, in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
Net premiums written	$	32,340	$	27,470	$	93,048	$	84,881
Net premiums earned		28,777		24,156		80,041		74,094
Net investment income		1,189		1,575		3,515		4,373
Change in equity interest in limited partnerships		266		462		520		681
Net realized investment gains (losses)		2,470		710		2,747		(2,321	)
Other revenue		143		206		434		569
Consolidated revenue	$	32,845	$	27,109	$	87,257	$	77,396

The increase in consolidated revenue primarily reflects an increase in net premiums earned in the workers’ compensation insurance segment and an increase in net realized investment gains, partially offset by a decrease in net investment income. The increase in net premiums earned primarily reflects new business written. The increase in net realized investment gains for the three months ended September 30, 2010, compared to the same period in 2009, reflects an increase in the fair value of the Company’s convertible bond portfolio, the sale of previously impaired equity securities, and other-than-temporary impairments recognized in 2009. The increase in net realized investment gains for the nine months ended September 30, 2010, compared to the same period in 2009, primarily reflects other-than-temporary impairments recognized in 2009. The Company recognized other-than-temporary impairments, including impairments in the segregated portfolio cell reinsurance segment, of $1 and $82,000 for the three and nine months ended September 30, 2010, respectively, compared to impairments of $439,000 and $4.4 million for same periods in 2009. The decrease in net investment income primarily reflects the current interest rate environment. The decrease in net investment income for the nine months ended September 30, 2010, compared to the same period in 2009, also reflects the recognition of an incentive fee related to the Company’s convertible bond portfolio. There was no incentive fee recognized in 2009.

The components of consolidated net (loss) income, by segment, for the three and nine months ended September 30, 2010 and 2009 were as follows (unaudited, in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Workers’ compensation insurance	$	2,000		$	2,450		$	5,100		$	6,316
Segregated portfolio cell reinsurance		—			—			—			—
Run-off specialty reinsurance		1,209			345			(120	)		(606	)
Corporate / other		(912	)		(496	)		(3,027	)		(2,298	)
Consolidated net income from continuing operations	$	2,297		$	2,299		$	1,953		$	3,412

The decrease in consolidated net income for the three months ended September 30, 2010, compared to the same period in 2009, primarily reflects an increase in the workers’ compensation insurance segment’s loss ratio, the aforementioned reduction in net investment income, and a reduction in the Company’s interest in its segregated portfolio cell investment.

The decrease in consolidated net income for the nine months ended September 30, 2010, compared to the same period in 2009, primarily reflects the reserve strengthening in the run-off specialty reinsurance segment and the aforementioned items that resulted in a decrease in net income in the workers’ compensation insurance and corporate/other segments, partially offset by the reduction in other-than-temporary investment impairments in the run-off specialty reinsurance segment. The 2009 net income was also positively impacted by the reversal of a deferred tax valuation allowance totaling $438,000 in the corporate/other segment.

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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, 2010 and 2009 (unaudited, in thousands):

	Three Months  Ended September 30,						Nine Months  Ended September 30,
	2010			2009			2010			2009
Revenue:
Direct premiums written	$	34,541		$	29,762		$	100,014		$	90,806
Reinsurance premiums assumed		401			169			1,159			803
Ceded premiums written		(8,743	)		(8,553	)		(28,609	)		(28,197	)
Net premiums written		26,199			21,378			72,564			63,412
Change in unearned premiums		(3,790	)		(3,592	)		(10,539	)		(8,813	)
Net premiums earned		22,409			17,786			62,025			54,599
Net investment income		598			800			1,812			2,575
Change in equity interest in limited partnerships		214			358			445			538
Net realized investment gains (losses)		1,191			339			1,062			(477	)
Other revenue		—			—			—			—
Total revenue		24,412			19,283			65,344			57,235
Expenses:
Losses and LAE incurred		15,085			10,905			41,214			33,313
Acquisition and other underwriting expenses		1,790			1,436			4,860			4,392
Other expenses		4,110			3,373			11,087			10,277
Policyholder dividend expense		333			118			732			241
Total expenses		21,318			15,832			57,893			48,223
Income before income taxes		3,094			3,451			7,451			9,012
Income tax expense		1,094			1,001			2,351			2,696
Net income	$	2,000		$	2,450		$	5,100		$	6,316

The workers’ compensation insurance ratios were as follows for the three and nine months ended September 30, 2010 and 2009:

	Three Months  Ended September 30,						Nine Months  Ended September 30,
	2010			2009			2010			2009
Loss and LAE ratio		67.3	%		61.3	%		66.4	%		61.0	%
Expense ratio		26.3	%		27.0	%		25.7	%		26.9	%
Policyholders’ dividend ratio		1.5	%		0.7	%		1.2	%		0.4	%
Combined ratio		95.1	%		89.0	%		93.3	%		88.3	%

Premiums

The increase in direct premiums written primarily reflects new business sales of $25.1 million and an increase in the renewal retention rate, partially offset by renewal rate decreases of 2.4% and return premiums to insureds as a result of payroll audits. The renewal retention rate increased from 84.7% in 2009 to 86.9% in 2010. Net premiums earned were reduced by $1.1 million for the nine months ended September 30, 2010, reflecting return premiums to insureds and a decrease in the earned but unbilled premium estimate as a result of decreasing payrolls. Net premiums earned increased by $632,000 for the nine months ended September 30, 2009 as a result of additional premium from insureds. Net premiums earned increased $81,000 as a result of additional premium from insureds for the three months ended September 30, 2010, compared to return premium to insureds of $179,000 for the same period in 2009.

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Net Investment Income

The decrease in net investment income primarily reflects the decline in short-term interest rates. Net investment income for the nine months ended September 30, 2010 was also impacted by the recognition of an incentive fee related to the performance of the convertible bond portfolio. There was no incentive fee incurred for the same period in 2009. The average yield on the fixed income portfolio was 3.66% as of September 30, 2010, compared to 3.73% as of September 30, 2009.

Net Realized Investment Gains (Losses)

Net realized investment gains for the three and nine months ended September 30, 2010 primarily reflect the change in fair value of the Company’s convertible bond portfolio. Net realized investment losses for the three and nine months ended September 30, 2009 primarily reflect other-than-temporary investment impairments.

Losses and LAE

The increase in the calendar period loss and LAE ratio primarily reflects a decrease in favorable loss reserve development and an increase in the accident period loss ratio. There was no favorable development recorded for the three and nine months ended September 30, 2010. Favorable loss reserve development totaled $350,000 and $1.6 million for the three and nine months ended September 30, 2009, respectively. The accident period loss ratio was 67.5% and 66.7% for the three and nine months ended September 30, 2010, respectively, compared to an accident period loss ratio of 64.8% and 65.1% for the same periods in 2009. The increase in the accident period loss ratio from 2009 to 2010 primarily reflects the impact of the current economic environment on the Company’s workers’ compensation book of business.

Acquisition and Other Underwriting Expenses

The decrease in acquisition and other underwriting expenses as a percent of net premiums earned for the nine months ended September 30, 2010, compared to the same period in 2009, primarily reflects the reversal of the 2009 Security Fund accrual in the second quarter of 2010, partially offset by an increase in commissions paid to the administrator of the Company’s Parallel Pay program, which allows insureds to remit monthly premium based on their monthly payroll, and the impact of return premiums to insureds during the first nine months of 2010.

Other Expenses

Other expenses as a percent of net premiums earned for the three months ended September 30, 2010, compared to the same period in 2009, decreased primarily as a result of the aforementioned additional premium from insureds in 2010. The decrease in the other expense ratio for the nine months ended September 30, 2010, compared to the same period in 2009, primarily reflects the impact of premium revenue growth in the Company’s Southeast region.

Policyholder Dividends

For the nine months ended September 30, 2010 and 2009, 12.3% and 9.4%, respectively, of all policies were written on a dividend policy basis. The increase in policyholder dividend expense primarily reflects the increase in dividend paying policies from 2009 to 2010 and an improvement in the loss experience of the underlying policies.

Tax Expense

The effective tax rate for the three and nine months ended September 30, 2010 was 35.4% and 31.6%, respectively, compared to an effective tax rate of 29.0% and 29.9% for the same periods in 2009. The increase in the effective tax rate from 2009 to 2010 primarily reflects a prior year tax return adjustment that increased tax expense in the third quarter of 2010, partially offset by 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, 2010 and 2009 (unaudited, in thousands):

	Three Months  Ended September 30,						Nine Months  Ended September 30,
	2010			2009			2010			2009
Revenue:
Reinsurance premiums assumed	$	7,003		$	6,917		$	22,895		$	23,715
Ceded premiums written		(865	)		(839	)		(2,412	)		(2,406	)
Net premiums written		6,138			6,078			20,483			21,309
Change in unearned premiums		227			278			(2,468	)		(2,951	)
Net premiums earned		6,365			6,356			18,015			18,358
Net investment income		124			154			433			531
Net realized investment gains (losses)		232			329			774			(697	)
Total revenue		6,721			6,839			19,222			18,192
Expenses:
Losses and LAE incurred		4,831			3,209			14,226			11,294
Acquisition and other underwriting expenses		1,908			1,942			5,488			5,600
Other expenses		50			86			199			125
Segregated portfolio dividend expense (1)		(68	)		1,602			(691	)		1,173
Total expenses		6,721			6,839			19,222			18,192
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, 2010 and 2009:

	Three Months  Ended September 30,						Nine Months  Ended September 30,
	2010			2009			2010			2009
Loss and LAE ratio		75.9	%		50.5	%		79.0	%		61.5	%
Expense ratio		30.8	%		31.9	%		31.5	%		31.2	%
Combined ratio		106.7	%		82.4	%		110.5	%		92.7	%

Reinsurance Premiums Assumed

The decrease in reinsurance premiums assumed for the nine months ended September 30, 2010, compared to the same period in 2009, primarily reflects an increase in return premium to insureds related to premium audits and a decrease in the renewal retention rate, partially offset by new business sales of $3.7 million. Premium audits resulted in return premium of $952,000 for the nine months ended September 30, 2010, compared to return premium of $592,000 for the same period in 2009. The renewal retention rate decreased from 89.1% in 2009 to 86.7% in 2010. The increase in reinsurance premiums assumed for the three months ended September 30, 2010, compared to the same period in 2009, primarily reflects premium from a new segregated portfolio cell that commenced business in the second quarter of 2010 and a decrease in return premium to insureds, partially offset by the aforementioned decreases. Return premium to insureds totaled $86,000 for the three months ended September 30, 2010, compared to return premium of $133,000 for the same period in 2009.

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Net Investment Income

The decrease in net investment income primarily reflects a decrease in fixed income securities and the impact of the current interest rate environment.

Net Realized Investment Gains (Losses)

The improvement in net realized investment gains (losses) for the nine months ended September 30, 2010, compared to the same period in 2009, primarily reflects a reduction in other-than-temporary investment impairments. The 2009 net realized investment losses also reflect the impact of reducing the segregated portfolio cells’ exposure to investments in financial institutions. Other-than-temporary impairments totaled $1 and $76 for the three and nine months ended September 30, 2010, respectively, compared to impairments of $41,000 and $749,000 for the same periods in 2009. The decline in net realized investment gains (losses) for the three months ended September 30, 2010, compared to the same period in 2009, primarily reflects a reduction in gains recognized from investment sales.

Losses and LAE

The increase in the calendar period loss and LAE ratio primarily reflects an increase in the accident period loss ratio. The accident period loss ratio was 89.4% and 83.9% for the three and nine months ended September 30, 2010, respectively, compared to 70.3% and 72.8% for the same periods in 2009, respectively. The increase in the accident period loss ratio primarily reflects an increase in the severity and number of reported claims, specifically in economically sensitive segregated portfolio cell programs. The Company recorded favorable loss reserve development of $854,000 and $873,000 for the three and nine months ended September 30, 2010, respectively, compared to favorable loss reserve development of $1.3 million and $2.0 million for the same periods in 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, 2010 and 2009.

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.

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, 2010 and 2009 (unaudited, in thousands):

	Three Months  Ended September 30,					Nine Months  Ended September 30,
	2010		2009			2010			2009
Revenue:
Reinsurance premiums assumed	$	3	$	14		$	1		$	159
Change in unearned premiums		—		—			—			978
Net premiums earned		3		14			1			1,137
Net investment income		320		259			998			686
Change in equity interest in limited partnerships		52		104			75			143
Net realized investment gains (losses)		957		11			1,155			(1,431	)
Other revenue		162		143			513			370
Total revenue		1,494		531			2,742			905
Expenses:
Losses and LAE incurred		2		1			2,307			778
Acquisition and other underwriting expenses		1		4			—			341
Other expenses		282		182			557			396
Total expenses		285		187			2,864			1,515
Income (loss) before income taxes		1,209		344			(122	)		(610	)
Income tax benefit		—		(1	)		(2	)		(4	)
Net income (loss)	$	1,209	$	345		$	(120	)	$	(606	)

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Net Income (Loss)

The results of operations for the three months ended September 30, 2010 primarily reflect the sale of previously impaired mutual funds. The results of operations for the nine months ended September 30, 2010 are reflective of the second quarter reserve strengthening of $2.3 million. During the second quarter of 2010, management concluded its review of the open claims inventory at the ceding company and, as a result of that review, the reserves for losses and loss adjustment expenses were increased by $2.3 million.

Reinsurance Premiums Assumed

Reinsurance premiums assumed, by line of business, were as follows for the three and nine months ended September 30, 2010 and 2009 (unaudited, in thousands):

	Three Months  Ended September 30,				Nine Months  Ended September 30,
	2010		2009		2010			2009
EnviroGuard	$	3	$	2	$	5		$	197
EIA liability		—		12		(4	)		(38	)
Total assumed premiums	$	3	$	14	$	1		$	159

Net Investment Income

The increase in net investment income primarily reflects the increase in fixed income securities. The average yield on the fixed income portfolio was 3.19% as of September 30, 2010, compared to 3.00% as of September 30, 2009.

Net Realized Investment Gains (Losses)

The improvement in net realized investment gains (losses) for the nine months ended September 30, 2010, compared to the same periods in 2009, primarily reflects a reduction in other-than-temporary investment impairments. There were no other-than-temporary impairments in 2010. Other-than-temporary impairments totaled $1.8 million for the nine months ended September 30, 2009. The increase in net realized investment gains for the three months ended September 30, 2010, compared to the same period in 2009, primarily reflects the sale of previously impaired mutual funds.

Losses and LAE Incurred

The increase in losses and LAE incurred for the nine months ended September 30, 2010, compared to the same period in 2009, reflects the second quarter reserve strengthening of $2.3 million.

CORPORATE/OTHER

The corporate/other segment reported a net loss of $912,000 and $3.0 million for the three and nine months ended September 30, 2010, respectively, compared to a net loss of $496,000 and $2.3 million for the same periods in 2009. The increase in the net loss for the three and nine months ended September 30, 2009 primarily reflects a decrease in the Company’s interest in the segregated portfolio cells and the reversal of a deferred tax valuation allowance in 2009 totaling $438,000, which reduced the net loss for the nine months ended September 30, 2009.

CONSOLIDATED FINANCIAL POSITION

Consolidated assets totaled $368.7 million at September 30, 2010, compared to $391.5 million at December 31, 2009. The decrease in consolidated assets primarily reflects the sale of Eastern Life. The decrease in federal income taxes recoverable primarily reflects the receipt of a refund related to the carryback of 2008 capital losses to prior tax periods. The increase in other assets primarily reflects the promissory note from Security Life totaling $1.75 million.

Consolidated liabilities totaled $216.3 million at September 30, 2010, compared to $237.7 million at December 31, 2009. The decrease in consolidated liabilities primarily reflects the sale of Eastern Life. Excluding the sale of Eastern Life, consolidated liabilities increased, which primarily reflects an increase in unearned premiums, partially offset by a decrease in the segregated portfolio cell dividend payable. The decrease in the segregated portfolio cell dividend payable reflects a decrease in the segregated portfolio cells’ operating results for the nine months ended September 30, 2010 and dividends paid to preferred shareholders during the first nine months of 2010.

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Consolidated equity totaled $152.4 million at September 30, 2010, compared to $153.8 million at December 31, 2009. The decrease in consolidated equity primarily reflects the repurchase of common stock under the Company’s stock buyback program, partially offset by net income for the nine months ended September 30, 2010.

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 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 $45.8 million for the purpose of securing obligations to reinsurers, if necessary. As of September 30, 2010, there was approximately $5.9 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 10.0% 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, 2010 and 2009 were as follows (unaudited, in thousands):

	2010			2009
Cash flows provided by operating activities	$	4,140		$	4,721
Cash flows provided by investing activities		246			13,170
Cash flows used in financing activities		(7,602	)		(2,412	)
Net (decrease) increase in cash and cash equivalents	$	(3,216	)	$	15,479

Cash flows from operating activities for the nine months ended September 30, 2010 primarily reflect an increase in premiums related to new business, partially offset by an increase in claim payments related to the run off of the specialty reinsurance business.

Cash flows from investing activities for the nine months ended September 30, 2010 primarily reflect the liquidation of Eastern Life’s investment portfolio prior to the sale to Security Life, partially offset by the purchase of investments at EIHI.

The decrease in cash flows from financing activities primarily reflects the repurchase of the Company’s common stock. The Company reentered the market for repurchasing its common stock under its current stock buyback program in May 2010.

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, 2010, 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, 2009. 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 5, 2010.

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Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including the President, the Chief Executive Officer, the Chief Financial Officer and the Vice President of Finance, we have evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a – 15(e) and 15 d – 15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based on that evaluation, the President, the Chief Executive Officer, the Chief Financial Officer and the Vice President of Finance have concluded that, as of the end of such period, these disclosure controls and procedures are effective.

Changes in Internal Control Over Financial Reporting

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

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

None

Item 1A. Risk Factors

With the exception of the risk factor noted below, there are no material changes from the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, SEC File No. 001-32899.

A Divestiture of our Specialty Reinsurance Business Could Result in a Material Loss

We are exploring the sale of our run-off specialty reinsurance business, which principally reinsured a large primary carrier who insured first and third party claims related to underground storage tanks. This line of business was placed in run-off effective July 1, 2008. The sale of the run-off specialty reinsurance business could be accomplished through the sale of our shares of our wholly-owned subsidiary, Eastern Re, a loss portfolio transfer or a commutation with the primary insurer. Any sale or similar transaction could result in a material loss that would adversely affect our results of operation in the period in which the transaction occurs.

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 5.0% 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 $10.0 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, 2010, the Company has repurchased 2,574,252 shares, and has approximately $4.4 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, 2010. 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, 2010		—	$	—		—	$	9,570,000
February 1-28, 2010		—	$	—		—	$	9,570,000
March 1-31, 2010		—	$	—		—	$	9,570,000
April 1-30, 2010		—	$	—		—	$	9,570,000
May 1-31, 2010		167,128	$	10.79		167,128	$	7,770,000
June 1-30, 2010		218,917	$	10.75		218,917	$	5,420,000
July 1-31, 2010		96,450	$	10.79		96,450	$	4,380,000
August 1-31, 2010		—	$	—		—	$	4,380,000
September 1-30, 2010		—	$	—		—	$	4,380,000
Total		482,495	$	10.77		482,495

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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 13, 2010.

(b) The names of each director elected to serve until 2013 at the Annual Meeting of Shareholders are as follows:

Director	Votes For		Votes Withheld
Bruce M. Eckert		5,896,659		347,491
John O. Shirk		5,905,549		338,601

The following directors are serving terms of office that continue through 2011 and 2012, as noted:

Director	Year Term Expires
Robert M. McAlaine	2011
Scott C. Penwell	2011
Charles H. Vetterlein, Jr.	2011
Paul R. Burke	2012
Ronald L. King	2012
W. Lloyd Snyder III	2012

(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, 2010		7,544,682		97,346		17,468

Item 5. Other Information

None

Item 6. Exhibits

Exhibits

Exhibit No.	Title
3.1	Articles of Incorporation of Eastern Insurance Holdings, Inc. (Incorporated by reference from Exhibit 3.1 to the Eastern Insurance Holdings, Inc. Registration Statement No. 333-128913 on Form S-1)
3.2	Bylaws of Eastern Insurance Holdings, Inc. (Incorporated by reference from Exhibit 3.2 to the Eastern Insurance Holdings, Inc. Registration Statement No. 333-128913 on Form S-1)
10.12	Eastern Insurance Holdings, Inc. 2006 Stock Incentive Plan (Incorporated by reference from Exhibit 4.1 to EIHI’s Registration Statement on Form S-8 filed on April 2, 2007)
21.1	Subsidiaries of Eastern Insurance Holdings, Inc. (Incorporated by reference from Exhibit 21 to the Eastern Insurance Holdings, Inc. Registration Statement No. 333-128913 on Form S-1)

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Exhibit No.	Title
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 4, 2010	By:	/s/ Bruce M. Eckert
		Bruce M. Eckert,
		Chief Executive Officer
Dated: November 4, 2010	By:	/s/ Kevin M. Shook
		Kevin M. Shook,
		Treasurer and Chief Financial Officer

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