Eastern Insurance (EIHI) 10-Q 2013 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, 2013,

or

Transition report pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

for the Transition Period from                    to                    

Commission File Number No. 001-32899

EASTERN INSURANCE HOLDINGS, INC.

Incorporated in Pennsylvania	I.R.S. Employer Identification No. 20-2653793
25 Race Avenue, Lancaster, Pennsylvania 17603-3179 (717) 396-7095

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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 Exchange 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.

Title of Each Class	Number of Shares Outstanding as of October 30, 2013
Common Stock, No Par Value	7,919,527 (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		23
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		35
Item 4.	Controls and Procedures		35
PART II—OTHER INFORMATION			36
Item 1.	Legal Proceedings		36
Item 1A.	Risk Factors		36
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		36
Item 3.	Defaults Upon Senior Securities		37
Item 4.	Mine Safety Disclosures		37
Item 5.	Other Information		37
Item 6.	Exhibits		37

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, 2013			December 31, 2012
ASSETS
Investments:
Fixed income securities, at estimated fair value (amortized cost, $153,036; $145,486)	$	153,259		$	148,976
Convertible bonds, at estimated fair value (amortized cost, $26,413; $18,207)		29,616			19,747
Equity securities, at estimated fair value (cost, $17,684; $20,462)		23,103			23,200
Other long-term investments, at estimated fair value (cost, $8,000; $7,000)		11,722			9,974
Total investments		217,700			201,897
Cash and cash equivalents		51,345			48,075
Accrued investment income		915			858
Premiums receivable (net of allowance, $225; $225)		80,902			67,525
Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses		19,222			19,676
Deferred acquisition costs		11,571			9,497
Deferred income taxes, net		3,574			3,239
Federal income taxes recoverable		627			—
Intangible assets		3,850			4,331
Goodwill		10,752			10,752
Other assets		16,861			14,902
Total assets	$	417,319		$	380,752
LIABILITIES
Reserves for unpaid losses and loss adjustment expenses	$	126,466		$	117,728
Unearned premium reserves		90,191			73,775
Advance premium		255			672
Accounts payable and accrued expenses		23,811			23,540
Ceded reinsurance balances payable		9,113			9,273
Segregated portfolio cell dividend payable		20,805			17,354
Policyholder dividends payable		2,536			2,312
Federal income taxes payable		—			243
Total liabilities		273,177			244,897
Commitments and contingencies (Note 10)
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—11,930,714 and 11,927,714, respectively; outstanding—7,919,527 and 7,910,609, respectively		—			—
Unearned ESOP compensation		(2,057	)		(2,616	)
Additional paid in capital		118,627			117,443
Treasury stock, at cost (4,011,187 and 4,017,105 shares, respectively)		(56,446	)		(56,532	)
Retained earnings		82,749			75,169
Accumulated other comprehensive income, net		1,269			2,391
Total shareholders’ equity		144,142			135,855
Total liabilities and shareholders’ equity	$	417,319		$	380,752

See accompanying notes to unaudited consolidated financial statements.

3

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

For the Three and Nine Months Ended September 30, 2013 and 2012

(Unaudited, in thousands, except per share data)

	Three Months Ended September 30,					Nine Months Ended September 30,
	2013			2012		2013			2012
REVENUE
Net premiums earned	$	45,129		$	41,397	$	132,982		$	116,618
Net investment income		955			892		2,778			2,906
Change in equity interest in limited partnerships		(10	)		290		748			738
Net realized investment gains		2,255			1,023		3,162			1,511
Other revenue		29			84		163			239
Total revenue		48,358			43,686		139,833			122,012
EXPENSES
Losses and loss adjustment expenses incurred		28,948			27,849		84,672			76,335
Acquisition and other underwriting expenses		5,426			5,486		16,147			15,391
Other expenses		7,868			6,224		21,591			18,119
Amortization of intangibles		160			202		480			605
Policyholder dividend expense		309			493		807			715
Segregated portfolio dividend expense		441			29		2,154			1,414
Total expenses		43,152			40,283		125,851			112,579
Income before income taxes		5,206			3,403		13,982			9,433
Income tax expense		1,514			617		4,054			2,377
Net income	$	3,692		$	2,786	$	9,928		$	7,056
Other comprehensive (loss) income:
Unrealized holding gains arising during period, net of tax of $472, $682, $396 and $1,180		877			1,272		736			2,196
Amortization of unrecognized benefit plan amounts, net of tax of $4, $2, $12 and $7		8			4		22			13
Less: Reclassification adjustment for gains included in net income, net of tax of $301, $152, $692 and $307		1,154			243		1,880			536
Other comprehensive (loss) income		(269	)		1,033		(1,122	)		1,673
Comprehensive income	$	3,423		$	3,819	$	8,806		$	8,729
EARNINGS PER SHARE (SEE NOTE 4):
Net income	$	3,692		$	2,786	$	9,928		$	7,056
Basic earnings per share	$	0.48		$	0.37	$	1.29		$	0.92
Diluted earnings per share	$	0.48		$	0.36	$	1.29		$	0.90

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, 2013 and 2012

(Unaudited, in thousands, except share data)

Three Months Ended September 30, 2013

	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 Taxes			Total
Balance, July 1, 2013		—		7,910,827	$	—	$	(2,246	)	$	118,197	$	(56,529	)	$	79,841		$	1,538		$	140,801
ESOP shares released		—		—		—		189			218		—			—			—			407
Equity awards		—		3,000		—		—			205		—			—			—			205
Issuance of shares under stock compensation plan		—		5,700		—		—			—		83			(1	)		—			82
Tax benefit related to stock compensation		—		—		—		—			7		—			11			—			18
Shareholder dividend		—		—		—		—			—		—			(794	)		—			(794	)
Net income		—		—		—		—			—		—			3,692			—			3,692
Other comprehensive loss, net of tax		—		—		—		—			—		—			—			(269	)		(269	)
Balance, September 30, 2013		—		7,919,527	$	—	$	(2,057	)	$	118,627	$	(56,446	)	$	82,749		$	1,269		$	144,142

Nine Months Ended September 30, 2013

	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 Taxes			Total
Balance, January 1, 2013		—		7,910,609	$	—	$	(2,616	)	$	117,443	$	(56,532	)	$	75,169		$	2,391		$	135,855
ESOP shares released		—		—		—		559			527		—			—			—			1,086
Equity awards		—		3,000		—		—			602		—			—			—			602
Issuance of shares under stock compensation plan		—		5,918		—		—			—		86			(1	)		—			85
Tax benefit related to stock compensation		—		—		—		—			55		—			29			—			84
Shareholder dividend		—		—		—		—			—		—			(2,376	)		—			(2,376	)
Net income		—		—		—		—			—		—			9,928			—			9,928
Other comprehensive loss, net of tax		—		—		—		—			—		—			—			(1,122	)		(1,122	)
Balance, September 30, 2013		—		7,919,527	$	—	$	(2,057	)	$	118,627	$	(56,446	)	$	82,749		$	1,269		$	144,142

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, 2013 and 2012

(Unaudited, in thousands, except share data)

Three Months Ended September 30, 2012

	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 Taxes		Total
Balance, July 1, 2012		—		7,910,609	$	—	$	(2,991	)	$	116,772	$	(56,532	)	$	70,112		$	3,190	$	130,551
ESOP shares released		—		—		—		188			130		—			—			—		318
Equity awards		—		—		—		—			201		—			—			—		201
Tax benefit related to stock compensation		—		—		—		—			8		—			—			—		8
Shareholder dividend		—		—		—		—			—		—			(552	)		—		(552	)
Net income		—		—		—		—			—		—			2,786			—		2,786
Other comprehensive income, net of tax		—		—		—		—			—		—			—			1,033		1,033
Balance, September 30, 2012		—		7,910,609	$	—	$	(2,803	)	$	117,111	$	(56,532	)	$	72,346		$	4,223	$	134,345

Nine Months Ended September 30, 2012

	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 Taxes		Total
Balance, January 1, 2012		—		7,935,446		$	—	$	(3,364	)	$	116,272	$	(54,109	)	$	66,910		$	2,550	$	128,259
ESOP shares released		—		—			—		561			318		—			—			—		879
Equity awards		—		141,700			—		—			510		—			—			—		510
Tax benefit related to stock compensation		—		—			—		—			11		—			—			—		11
Repurchase of common stock		—		(166,537	)		—		—			—		(2,423	)		—			—		(2,423	)
Shareholder dividend		—		—			—		—			—		—			(1,620	)		—		(1,620	)
Net income		—		—			—		—			—		—			7,056			—		7,056
Other comprehensive income, net of tax		—		—			—		—			—		—			—			1,673		1,673
Balance, September 30, 2012		—		7,910,609		$	—	$	(2,803	)	$	117,111	$	(56,532	)	$	72,346		$	4,223	$	134,345

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, 2013 and 2012

(Unaudited, in thousands)

	2013			2012
Cash flows from operating activities:
Net income	$	9,928		$	7,056
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		583			599
Net amortization of bond premium/discount		700			900
Net realized investment gains		(3,162	)		(1,511	)
Change in equity interest in limited partnerships		(748	)		(738	)
Deferred tax benefit		140			(1,519	)
Stock compensation expense		1,688			1,389
Intangible asset amortization		480			605
Changes in assets and liabilities:
Accrued investment income		(57	)		(87	)
Premiums receivable		(13,377	)		(15,809	)
Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses		454			(2,750	)
Deferred acquisition costs		(2,074	)		(797	)
Other assets		(1,985	)		(1,896	)
Reserves for unpaid losses and loss adjustment expenses		8,738			9,608
Unearned and advance premium		15,999			16,196
Ceded reinsurance balances payable		(160	)		(636	)
Accounts payable and accrued expenses		93			278
Federal income taxes recoverable/payable		(870	)		(165	)
Policyholder dividends payable		224			263
Segregated portfolio cell dividend payable		2,411			1,243
Net cash provided by operating activities		19,005			12,229
Cash flows from investing activities:
Purchase of fixed income securities		(53,904	)		(37,383	)
Purchase of equity securities		(3,258	)		(7,246	)
Purchase of other long-term investments		(1,000	)		—
Proceeds from sale of fixed income securities		15,672			17,274
Proceeds from maturities/calls of fixed income securities		21,949			9,865
Proceeds from the sale of equity securities		7,570			5,582
Proceeds from sale of other long-term investments		—			1,248
Purchase of equipment		(557	)		(617	)
Net cash used in investing activities		(13,528	)		(11,277	)
Cash flows from financing activities:
Repurchase of common stock		—			(2,423	)
Shareholder dividend		(2,376	)		(1,620	)
Issuance of shares under stock compensation plan		85			—
Tax benefit related to stock compensation		84			11
Net cash used in financing activities		(2,207	)		(4,032	)
Net decrease in cash and cash equivalents		3,270			(3,080	)
Cash and cash equivalents, beginning of period		48,075			52,448
Cash and cash equivalents, end of period	$	51,345		$	49,368

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 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”) Employers Alliance, Inc. (“Employers Alliance”), Eastern Re Ltd., SPC (“Eastern Re”), and Eastern Services Corporation (“Eastern Services”), collectively referred to as the “Company.”

In September 2013, Employers Security Insurance Company was merged into and with Eastern Alliance Insurance Company.

The Company currently operates in three segments: workers’ compensation insurance, segregated portfolio cell reinsurance, and corporate/other.

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 toForm 10-Q and Article 10 of Regulation S-X of the U.S. Securities and Exchange Commission. 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, 2012 included in the Company’s Annual Report on Form 10-K, which was filed with the U.S. Securities and Exchange Commission on March 8, 2013.

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.

During the second quarter of 2013, management changed its accounting policy related to the classification of premium amortization and discount accretion recognized in its convertible bond portfolio. The Company previously reported amortization/accretion related to its convertible bond portfolio as a component of net investment income. The Company’s convertible bond portfolio is reported at estimated fair value with changes in fair value reported as a realized gain or loss. Due to the nature of convertible securities, certain securities may be purchased at a significant premium (commonly referred to as “conversion premium”) as a result of the underlying value of the issuer’s common stock, and the conversion premium can have a significant impact on net investment income as it is amortized. Management believes the conversion premium is reflective of the fair value of the convertible security at acquisition and should be reflected as a component of the change in fair value reported as a realized gain or loss. As a result, the Company has changed its policy for recognizing amortization/accretion related to its convertible bond portfolio and will report amortization/accretion as a component of the change in estimated fair value in net realized investment gains (losses) on the consolidated statements of operations and comprehensive income (loss). This change in accounting policy had no impact of the Company’s consolidated financial position or results of operations. Prior period amounts have not been reclassified as the amounts were immaterial.

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.

8

3. Agreement and Plan of Merger with ProAssurance Corporation

On September 23, 2013, EIHI entered into an Agreement and Plan of Merger (the “Merger Agreement”) with ProAssurance Corporation (“ProAssurance”) and PA Merger Company, a wholly owned subsidiary of ProAssurance (“Acquisition Sub”), pursuant to which, upon the terms and subject to the conditions set forth in the Merger Agreement, Acquisition Sub will merge with and into EIHI, with EIHI surviving the merger as a wholly owned subsidiary of ProAssurance.

The merger is expected to be finalized in January 2014. On the effective date of the merger, each share of EIHI common stock issued and outstanding immediately prior to the effective date, including any allocated and unallocated shares held by EIHI’s employee stock ownership plan and any shares of restricted stock, will be automatically cancelled and converted into the right to receive $24.50 in cash (the “Cash Consideration”). Each option to purchase shares of EIHI common stock issued and outstanding immediately prior to the closing date, whether or not vested and exercisable, will be cancelled and converted into the right to receive the product of (i) the number of shares of EIHI common stock that would have been acquired upon the exercise of such stock option, multiplied by (ii) the excess, if any, of the Cash Consideration over the exercise price to acquire a share of EIHI common stock under such stock option.

Consummation of the merger is subject to customary conditions, including (i) the approval of EIHI’s shareholders, (ii) receipt of antitrust and insurance regulatory approvals, (iii) the absence of any law, order or injunction prohibiting the merger, (iv) the accuracy of each party’s representations and warranties (subject to customary materiality qualifiers), and (v) each party’s compliance with its covenants and agreements contained in the Merger Agreement. In addition, ProAssurance’s obligation to consummate the merger is subject to no occurrence, circumstance, or combination thereof, shall have occurred that, individually or in the aggregate, has, or is reasonably likely to have, a material adverse effect on EIHI. The merger is not subject to any financing condition.

4. Earnings Per Share

Basic earnings per share are computed by dividing net income (loss) by the weighted average number of shares outstanding for the respective period. Diluted earnings per share are computed by dividing net income (loss) by the weighted average number of shares outstanding for the period, including dilutive potential common shares outstanding for the period.

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, 2013 and 2012 were as follows (in thousands, except share and per share data):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Net income for basic and diluted earnings per share	$	3,692		$	2,786		$	9,928		$	7,056
Less: Dividends declared—common and unvested restricted share units		(794	)		(552	)		(2,376	)		(1,620	)
Undistributed earnings		2,898			2,234			7,552			5,436
Percent allocated to common shareholders		98.5	%		98.1	%		98.5	%		98.1	%
		2,855			2,192			7,439			5,333
Add: Dividends declared—common shares		782			543			2,340			1,589
	$	3,637		$	2,735		$	9,779		$	6,922
Denominator for basic earnings per share		7,586,843			7,480,526			7,558,707			7,539,870
Effect of dilutive securities		54,228			146,340			38,907			139,633
Denominator for diluted earnings per common share		7,641,071			7,626,866			7,597,614			7,679,503
Basic earnings per share	$	0.48		$	0.37		$	1.29		$	0.92
Diluted earnings per share	$	0.48		$	0.36		$	1.29		$	0.90
Cash dividends per share	$	0.11		$	0.07		$	0.31		$	0.21

The following table provides a summary of the equity awards that were not included in the Company’s earnings per share calculation because to do so would have been anti-dilutive:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Total outstanding equity awards		1,427,585			1,387,000			1,427,585			1,387,000
Dilutive equity awards		(54,228	)		(146,340	)		(38,907	)		(139,633	)
Equity awards excluded from earnings per share calculation		1,373,357			1,240,660			1,388,678			1,247,367

9

5. 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 sheets as of September 30, 2013 and December 31, 2012:

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 can access. An example of a Level 1 input utilized to measure fair value includes the closing price of one share of common stock on an active exchange market. The Company considers U.S. Treasuries and equity securities as Level 1 assets.

Level 2—Represents financial assets whose fair value is determined based upon: quoted market prices for similar assets in active markets; quoted market prices for identical assets in inactive markets; inputs other than quoted market prices that are observable for the asset such as interest rates or yield curves; or other inputs derived principally from or corroborated from other observable market information. An example of a Level 2 input utilized to measure fair value, specifically for the Company’s fixed income portfolio, is “matrix pricing.” “Matrix pricing” relies on observable inputs from active markets other than quoted market prices including, but not limited to, benchmark securities and yields, latest reported trades, quotes from brokers or dealers, issuer spreads, bids, offers, and other relevant reference data to determine fair value. “Matrix pricing” is used to measure the fair value of fixed income securities where obtaining individual quoted market prices is impractical. The Company considers U.S. Government agencies, municipal bonds, corporate bonds, mortgage-backed securities, collateralized mortgage obligations, asset-backed securities, 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 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, 2013 and December 31, 2012, excluding the segregated portfolio cell reinsurance segment (in thousands):

			Fair Value Measurements at Reporting Date Using
	9/30/2013		Level 1		Level 2		Level 3
Fixed income securities—available for sale:
U.S. Treasuries and government agencies	$	19,996	$	12,779	$	7,217	$	—
States, municipalities, and political subdivisions		43,926		—		43,926		—
Corporate securities		17,655		—		17,655		—
Residential mortgage-backed securities		23,529		—		23,529		—
Commercial mortgage-backed securities		161		—		161		—
Collateralized mortgage obligations		14,326		—		14,326		—
Other structured securities		1,023		—		1,023		—
Convertible bonds		29,616		—		29,616		—
Equity securities—available for sale		14,178		14,178		—		—
Total	$	164,410	$	26,957	$	137,453	$	—

10

			Fair Value Measurements at Reporting Date Using
	12/31/2012		Level 1		Level 2		Level 3
Fixed income securities—available for sale:
U.S. Treasuries and government agencies	$	15,865	$	10,743	$	5,122	$	—
States, municipalities, and political subdivisions		45,150		—		45,150		—
Corporate securities		10,285		—		10,285		—
Residential mortgage-backed securities		28,434		—		28,434		—
Commercial mortgage-backed securities		167		—		167		—
Collateralized mortgage obligations		17,122		—		17,122		—
Other structured securities		1,023		—		1,023		—
Convertible bonds		19,747		—		19,747		—
Equity securities—available for sale		15,588		15,588		—		—
Total	$	153,381	$	26,331	$	127,050	$	—

There were no transfers between Level 1 and Level 2 securities for the three and nine months ended September 30, 2013.

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. 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 did not adjust security prices during the three and nine months ended September 30, 2013 and 2012. Management has controls in place to validate the reasonableness of fair values provided by the independent pricing service, including testing the fair value of a sample of securities on a quarterly basis by comparing fair values from different pricing sources. Fixed income securities include U.S. Treasuries, agencies backed by the U.S. Government, municipal bonds, corporate bonds, mortgage-backed securities, collateralized mortgage obligations, and asset-backed securities.

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 exchange traded funds and equity securities of natural gas companies for which there is an active market and quoted market prices; therefore, the Company has classified its equity securities as Level 1 securities. The estimated fair values of the Company’s exchange traded funds are based on published net asset value (“NAV”) per share.

The estimated fair value of the Company’s equity securities, excluding equity securities in the segregated portfolio cell reinsurance segment, as of September 30, 2013 and December 31, 2012, by investment strategy and/or industry, are as follows (in thousands):

	2013		2012
Large growth fund	$	3,768	$	3,156
Foreign large blend fund		621		554
Diversified emerging markets fund		823		911
Large value fund		4,299		7,062
Foreign large value fund		424		378
Foreign large growth fund		2,135		1,881
Natural gas industry		1,672		1,263
Financial institutions		434		383
Other		2		—
Total	$	14,178	$	15,588

Other long-term investments include the Company’s interest in various limited partnerships, including a low volatility multi-strategy fund of funds, a structured finance opportunity fund, and an open-ended investment fund. 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 partnerships’ NAV. 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. The Company considers its limited partnership investments as Level 3 investments.

11

As of September 30, 2013 and December 31, 2012, the estimated fair values of the Company’s limited partnership investments, by investment strategy, were as follows (in thousands):

	2013		2012
Multi-strategy fund of funds	$	7,578	$	6,063
Structured finance opportunity fund		3,451		3,278
Open-ended investment fund		693		633
Total	$	11,722	$	9,974

The activity in the Company’s limited partnership investments for the three and nine months ended September 30, 2013 and 2012 was as follows (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013		2012
Balance, beginning of period	$	11,732		$	10,657		$	9,974	$	10,209
Contributions		—			—			1,000		—
Withdrawals		—			(1,243	)		—		(1,243	)
Unrealized change in interest		(10	)		290			748		738
Balance, end of period	$	11,722		$	9,704		$	11,722	$	9,704

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.

6. 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, 2013 and December 31, 2012 (in thousands):

September 30, 2013	Cost or Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
U.S. Treasuries and government agencies	$	23,575	$	253	$	(82	)	$	23,746
States, municipalities, and political subdivisions		43,030		1,196		(300	)		43,926
Corporate securities		46,725		138		(315	)		46,548
Residential mortgage-backed securities		24,054		236		(761	)		23,529
Commercial mortgage-backed securities		149		12		—			161
Collateralized mortgage obligations		14,485		88		(247	)		14,326
Other structured securities		1,018		13		(8	)		1,023
Total fixed income securities		153,036		1,936		(1,713	)		153,259
Equity securities		17,684		5,558		(139	)		23,103
Total fixed income and equity securities	$	170,720	$	7,494	$	(1,852	)	$	176,362

December 31, 2012	Cost or Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
U.S. Treasuries and government agencies	$	19,780	$	364	$	(5	)	$	20,139
States, municipalities, and political subdivisions		42,942		2,239		(31	)		45,150
Corporate securities		36,624		321		(4	)		36,941
Residential mortgage-backed securities		27,983		481		(30	)		28,434
Commercial mortgage-backed securities		148		19		—			167
Collateralized mortgage obligations		17,009		172		(59	)		17,122
Other structured securities		1,000		23		—			1,023
Total fixed income securities		145,486		3,619		(129	)		148,976
Equity securities		20,462		2,877		(139	)		23,200
Total fixed income and equity securities	$	165,948	$	6,496	$	(268	)	$	172,176

12

Corporate securities include an investment in a fixed income mutual fund with a cost and estimated fair value of $38,767 and $38,491, respectively, as of September 30, 2013 and a cost and estimated fair value of $26,600 and $26,656 as of December 31, 2012. The fixed income mutual fund’s investment objective is to provide a total return that is consistent with the preservation of capital through investing in high grade U.S. Dollar fixed income securities with a maximum maturity not exceeding five years.

Other structured securities held as of September 30, 2013 and December 31, 2012 include two asset-backed securities collateralized by auto loan receivables and one security in an equipment trust made up of fixed retail installment contracts and retail installment loans.

The amortized cost and estimated fair value of fixed income securities and convertible bonds, excluding the Company’s investment in the fixed income mutual fund, as of September 30, 2013, by contractual maturity, are shown below (in thousands). Expected maturities could differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties.

	Amortized Cost		Estimated Fair Value
Less than one year	$	12,863	$	13,524
One through five years		46,436		48,244
Five through ten years		22,535		23,201
Greater than ten years		17,393		18,473
Mortgage/asset-backed securities		39,727		39,039
Total	$	138,954	$	142,481

The gross unrealized losses and estimated fair value of fixed income and equity securities, excluding those securities in the segregated portfolio cell reinsurance segment, classified as available-for-sale by category and length of time an individual security has been in a continuous unrealized position as of September 30, 2013 and December 31, 2012 are as follows (in thousands):

	Less Than 12 Months							12 Months or More							Total
September 30, 2013	Estimated Fair Value		Gross Unrealized Losses			# of Securities		Estimated Fair Value		Gross Unrealized Losses			# of Securities		Estimated Fair Value		Gross Unrealized Losses			# of Securities
U.S. Treasuries and government agencies	$	2,952	$	(82	)		9	$	—	$	—			—	$	2,952	$	(82	)		9
States, municipalities, and political subdivisions		13,249		(300	)		62		—		—			—		13,249		(300	)		62
Corporate securities		11,451		(95	)		11		—		—			—		11,451		(95	)		11
Residential mortgage-backed securities		16,064		(761	)		20		—		—			—		16,064		(761	)		20
Collateralized mortgage obligations		9,173		(233	)		17		799		(14	)		4		9,972		(247	)		21
Other structured securities		10		(8	)		1		—		—			—		10		(8	)		1
Total fixed income securities		52,899		(1,479	)		120		799		(14	)		4		53,698		(1,493	)		124
Equity securities		1,142		(139	)		6		—		—			—		1,142		(139	)		6
Total fixed income and equity securities	$	54,041	$	(1,618	)		126	$	799	$	(14	)		4	$	54,840	$	(1,632	)		130

13

	Less Than 12 Months							12 Months or More							Total
December 31, 2012	Estimated Fair Value		Gross Unrealized Losses			# of Securities		Estimated Fair Value		Gross Unrealized Losses			# of Securities		Estimated Fair Value		Gross Unrealized Losses			# of Securities
U.S. Treasuries and government agencies	$	594	$	(5	)		1	$	—	$	—			—	$	594	$	(5	)		1
States, municipalities, and political subdivisions		3,922		(31	)		17		—		—			—		3,922		(31	)		17
Residential mortgage-backed securities		11,922		(30	)		10		—		—			—		11,922		(30	)		10
Collateralized mortgage obligations		4,943		(56	)		9		122		(3	)		2		5,065		(59	)		11
Total fixed income securities		21,381		(122	)		37		122		(3	)		2		21,503		(125	)		39
Equity securities		1,034		(135	)		11		—		—			—		1,034		(135	)		11
Total fixed income and equity securities	$	22,415	$	(257	)		48	$	122	$	(3	)		2	$	22,537	$	(260	)		50

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 sheets and consolidated statement of operations and comprehensive income (loss), 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.

Management has evaluated the unrealized losses related to its fixed income securities and determined that they are primarily due 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, 2013.

Management has evaluated the unrealized losses related to its equity securities and determined that they are primarily related to the current market conditions and not due to underlying issues related to the issuer or the industry in which the issuer operates. The equity securities have been in an unrealized loss position for less than twelve months and none of the securities had an estimated fair value less than 80% of its cost basis. The Company does not intend to sell the equity securities and it is not more likely than not that the Company will be required to sell the equity securities before recovery of their cost bases; therefore, management does not consider the equity securities to be other-than-temporarily impaired as of September 30, 2013.

The following table provides information related to net realized investment gains for the three and nine months ended September 30, 2013 and 2012 (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Gross realized investment gains:
Fixed income securities	$	3		$	2		$	10		$	190
Convertible bonds		256			492			1,102			921
Equity securities		1,253			38			1,576			498
Other		—			5			—			5
Gross realized investment gains		1,512			537			2,688			1,614
Gross realized investment losses:
Fixed income securities		(41	)		—			(42	)		—
Convertible bonds		(8	)		(63	)		(35	)		(86	)
Equity securities		—			—			(10	)		(52	)
Other		—			—			—			(641	)
Gross realized investment losses		(49	)		(63	)		(87	)		(779	)
Other-than-temporary investment impairments		—			(40	)		—			(127	)
Change in fair value of convertible bonds		792			589			561			803
Net realized investment gains	$	2,255		$	1,023		$	3,162		$	1,511

14

Other-than-temporary impairments recognized for the three months ended September 30, 2012 reflect one mutual fund that had been in and unrealized loss position for more than twelve months. Other-than-temporary impairments recognized for the nine months ended September 30, 2012 reflect two mutual funds that had been in and unrealized loss position for more than twelve months.

Net investment income for the three and nine months ended September 30, 2013 and 2012 was as follows (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Fixed income and convertible bond securities	$	1,048		$	964		$	3,023		$	3,025
Equity securities		116			90			251			260
Cash and cash equivalents		2			3			8			22
Other		—			28			62			126
Gross investment income		1,166			1,085			3,344			3,433
Investment expenses		(211	)		(193	)		(566	)		(527	)
Net investment income	$	955		$	892		$	2,778		$	2,906

7. Reserves for Unpaid Losses and Loss Adjustment Expenses

The following table provides a summary of the activity in the Company’s reserves for unpaid losses and LAE for the three and nine months ended September 30, 2013 and 2012 (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013		2012
Balance, beginning of period	$	123,365		$	111,521		$	117,728	$	106,077
Reinsurance recoverables on unpaid losses and LAE		14,073			14,539			15,084		11,805
Net balance, beginning of period		109,292			96,982			102,644		94,272
Incurred related to:
Current year		28,990			28,549			84,268		76,877
Prior year		(42	)		(700	)		404		(542	)
Total incurred		28,948			27,849			84,672		76,335
Paid related to:
Current year		15,183			13,181			28,157		25,246
Prior year		11,257			10,952			47,359		44,663
Total paid		26,440			24,133			75,516		69,909
Net balance, end of period		111,800			100,698			111,800		100,698
Reinsurance recoverables on unpaid losses and LAE		14,666			14,987			14,666		14,987
Balance, end of period	$	126,466		$	115,685		$	126,466	$	115,685

Incurred losses by segment were as follows for the three and nine months ended September 30, 2013 and 2012, respectively (in thousands):

Three Months Ended September 30, 2013

	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Total
Incurred related to:
Current year, gross of discount	$	23,406		$	5,789		$	29,195
Current period discount		(50	)		(155	)		(205	)
Prior year, gross of discount		—			(188	)		(188	)
Accretion of prior period discount		—			146			146
Total incurred	$	23,356		$	5,592		$	28,948

15

Three Months Ended September 30, 2012

	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Total
Incurred related to:
Current year, gross of discount	$	22,544		$	6,327		$	28,871
Current period discount		(179	)		(143	)		(322	)
Prior year, gross of discount		—			(781	)		(781	)
Accretion of prior period discount		—			81			81
Total incurred	$	22,365		$	5,484		$	27,849

16

Nine Months Ended September 30, 2013

	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Total
Incurred related to:
Current year, gross of discount	$	69,387		$	17,376		$	86,763
Current period discount		(1,927	)		(568	)		(2,495	)
Prior year, gross of discount		—			(1,726	)		(1,726	)
Accretion of prior period discount		1,546			584			2,130
Total incurred	$	69,006		$	15,666		$	84,672

Nine Months Ended September 30, 2012

	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Total
Incurred related to:
Current year, gross of discount	$	61,979		$	17,384		$	79,363
Current period discount		(1,929	)		(557	)		(2,486	)
Prior year, gross of discount		—			(2,361	)		(2,361	)
Accretion of prior period discount		1,430			389			1,819
Total incurred	$	61,480		$	14,855		$	76,335

For the three and nine months ended September 30, 2013 and 2012, the estimates of ultimate losses and LAE for prior accident periods produced from our actuarial methods were reasonably consistent, in the aggregate, with the estimates we prepared as of December 31, 2012. During the second quarter of 2013, however, there were some deviations, by accident year, between the actuarial indications and recorded reserves. Based on consideration of the credibility of the higher than expected loss experience on older accident periods and the robustness of the recent accident period loss ratio, management adjusted the spread of the recorded reserves by accident period to align the reserves with the actuarial indications during the second quarter of 2013. In the aggregate, the Company did not recognize any development on prior accident period workers compensation insurance reserves for the three and nine months ended September 30, 2013.

The Company recognized favorable development in its segregated portfolio cell reinsurance segment of $188 and $1,726 for the three and nine months ended September 30, 2013, respectively, compared to favorable development of $781 and $2,361 for the same periods in 2012. The favorable development primarily reflects the impact of claim settlements for amounts at, or less than, previously established case and IBNR reserves. 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.

8. Segment Information

The Company currently operates in three business segments.

Workers’ Compensation Insurance

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

17

Net premiums earned in the workers’ compensation insurance segment for the three and nine months ended September 30, 2013 and 2012 were as follows (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Guaranteed cost policies	$	27,601	$	24,629	$	81,310	$	69,813
Dividend policies		4,711		5,144		13,982		13,893
Deductible policies		1,905		1,523		5,750		4,717
Retrospectively-rated policies		1,661		1,885		4,913		4,395
Total	$	35,878	$	33,181	$	105,955	$	92,818

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, asset management and segregated portfolio management services. The Company outsources the asset management and segregated portfolio cell management services to a third party. 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 following table provides the fee revenue generated by the segregated portfolio cell reinsurance segment that is included in the Company’s workers’ compensation insurance and corporate/other segments for the three and nine months ended September 30, 2013 and 2012, respectively (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Workers’ compensation insurance segment	$	1,610	$	1,231	$	5,119	$	4,095
Corporate/other segment		33		194		300		629
Total	$	1,643	$	1,425	$	5,419	$	4,724

The fee revenue earned by the workers’ compensation insurance and corporate/other segments is included in acquisition and other underwriting expenses in the consolidated statements of operations and comprehensive income (loss).

The Company is a preferred shareholder in certain of the segregated portfolio cells. For those segregated portfolio cells in which the Company participates, the Company shares in the operating and investment results of those cells and recognizes its share of the segregated portfolio dividend in the consolidated statements of operations and comprehensive income (loss).

The Company’s share of the segregated portfolio dividend, which is included in the corporate/other segment, was as follows for the three and nine months ended September 30, 2013 and 2012, respectively (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Segregated portfolio dividend income	$	401	$	256	$	1,158	$	778

Corporate/Other

The corporate/other segment primarily includes the expenses of EIHI, the third party administration activities of the Company, and the results of operations of Eastern Re, as well as certain eliminations necessary to reconcile the segment information to the consolidated statements of operations and comprehensive income (loss). The Company cancelled the remaining reinsurance contracts at Eastern Re in 1999 on a run-off basis and continues to have exposure for outstanding claims as of September 30, 2013. The corporate/other segment also included the Company’s interest in a segregated portfolio cell with an unaffiliated primary carrier that wrote insurance coverage for sprinkler contractors, known as “SprinklerPro”. The Company non-renewed the SprinklerPro contract on a run-off basis effective April 1, 2009. The Company commuted the SprinklerPro contract during the second quarter of 2012 and recognized a realized loss of $641,000, which is included in net realized investment gains (losses) for the nine months ended September 30, 2012.

18

The following table represents the segment results for the three months ended September 30, 2013 (in thousands):

	Workers’ Compensation Insurance			Segregated Portfolio Cell Reinsurance		Corporate/ Other			Total
Revenue:
Net premiums earned	$	35,878		$	9,251	$	—		$	45,129
Net investment income		863			70		22			955
Change in equity interest in limited partnerships		(48	)		—		38			(10	)
Net realized investment (losses) gains		1,651			8		596			2,255
Other revenue		—			—		29			29
Total revenue		38,344			9,329		685			48,358
Expenses:
Losses and LAE incurred		23,356			5,592		—			28,948
Acquisition and other underwriting expenses		2,672			2,787		(33	)		5,426
Other expenses		5,740			96		2,032			7,868
Amortization of intangibles		—			—		160			160
Policyholder dividend expense		297			12		—			309
Segregated portfolio dividend expense		—			842		(401	)		441
Total expenses		32,065			9,329		1,758			43,152
Income (loss) before income taxes		6,279			—		(1,073	)		5,206
Income tax expense (benefit)		1,710			—		(196	)		1,514
Net income (loss)	$	4,569		$	—	$	(877	)	$	3,692
Total assets	$	367,333		$	77,315	$	(27,329	)	$	417,319

The following table represents the segment results for the three months ended September 30, 2012 (in thousands):

	Workers’ Compensation Insurance		Segregated Portfolio Cell Reinsurance		Corporate/ Other			Total
Revenue:
Net premiums earned	$	33,181	$	8,216	$	—		$	41,397
Net investment income		749		75		68			892
Change in equity interest in limited partnerships		258		—		32			290
Net realized investment (losses) gains		1,022		40		(39	)		1,023
Other revenue		—		—		84			84
Total revenue		35,210		8,331		145			43,686
Expenses:
Losses and LAE incurred		22,365		5,484		—			27,849
Acquisition and other underwriting expenses		3,198		2,482		(194	)		5,486
Other expenses		5,090		54		1,080			6,224
Amortization of intangibles		—		—		202			202
Policyholder dividend expense		467		26		—			493
Segregated portfolio dividend expense		—		285		(256	)		29
Total expenses		31,120		8,331		832			40,283
Income (loss) before income taxes		4,090		—		(687	)		3,403
Income tax expense (benefit)		1,003		—		(386	)		617
Net income (loss)	$	3,087	$	—	$	(301	)	$	2,786
Total assets	$	332,694	$	68,124	$	(21,875	)	$	378,943

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The following table represents the segment results for the nine months ended September 30, 2013 (in thousands):

	Workers’ Compensation Insurance		Segregated Portfolio Cell Reinsurance		Corporate/ Other			Total
Revenue:
Net premiums earned	$	105,955	$	27,027	$	—		$	132,982
Net investment income		2,419		226		133			2,778
Change in equity interest in limited partnerships		575		—		173			748
Net realized investment gains		2,413		148		601			3,162
Other revenue		—		—		163			163
Total revenue		111,362		27,401		1,070			139,833
Expenses:
Losses and LAE incurred		69,006		15,666		—			84,672
Acquisition and other underwriting expenses		8,357		8,090		(300	)		16,147
Other expenses		16,911		289		4,391			21,591
Amortization of intangibles		—		—		480			480
Policyholder dividend expense		763		44		—			807
Segregated portfolio dividend expense		—		3,312		(1,158	)		2,154
Total expenses		95,037		27,401		3,413			125,851
Income (loss) before income taxes		16,325		—		(2,343	)		13,982
Income tax expense (benefit)		4,804		—		(750	)		4,054
Net income (loss)	$	11,521	$	—	$	(1,593	)	$	9,928
Total assets	$	367,333	$	77,315	$	(27,329	)	$	417,319

The following table represents the segment results for the nine months ended September 30, 2012 (in thousands):

	Workers’ Compensation Insurance		Segregated Portfolio Cell Reinsurance		Corporate/ Other			Total
Revenue:
Net premiums earned	$	92,818	$	23,800	$	—		$	116,618
Net investment income		2,385		249		272			2,906
Change in equity interest in limited partnerships		620		—		118			738
Net realized investment gains (losses)		1,618		506		(613	)		1,511
Other revenue		—		—		239			239
Total revenue		97,441		24,555		16			122,012
Expenses:
Losses and LAE incurred		61,480		14,855		—			76,335
Acquisition and other underwriting expenses		8,793		7,227		(629	)		15,391
Other expenses		14,790		218		3,111			18,119
Amortization of intangibles		—		—		605			605
Policyholder dividend expense		652		63		—			715
Segregated portfolio dividend expense		—		2,192		(778	)		1,414
Total expenses		85,715		24,555		2,309			112,579
Income (loss) before income taxes		11,726		—		(2,293	)		9,433
Income tax expense (benefit)		3,278		—		(901	)		2,377
Net income (loss)	$	8,448	$	—	$	(1,392	)	$	7,056
Total assets	$	332,694	$	68,124	$	(21,875	)	$	378,943

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9. Segregated Portfolio Cell Reinsurance Segment

The segregated portfolio cell reinsurance segment includes the Company’s 18 alternative market programs, which are included in the Company’s consolidated financial position and results of operations. The segregated portfolio cell reinsurance segment’s assets and liabilities as of September 30, 2013 and December 31, 2012, which are included in the Company’s consolidated balance sheets, were as follows (unaudited):

	September 30, 2013		December 31, 2012
ASSETS
Investments:
Fixed income securities, at estimated fair value (amortized cost, $32,863; $30,874)	$	32,644	$	30,931
Equity securities, at estimated fair value (cost, $7,039; $7,043)		8,925		7,612
Total investments		41,569		38,543
Cash and cash equivalents		2,252		1,495
Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses		4,218		4,716
Deferred acquisition costs		5,396		4,160
Other assets		5,277		4,361
Due from affiliates, net		18,603		12,803
Total assets	$	77,315	$	66,078
LIABILITIES
Reserves for unpaid losses and loss adjustment expenses	$	29,491	$	28,295
Unearned premium reserves		20,024		14,817
Accounts payable and accrued expenses		104		3
Segregated portfolio cell dividend payable		20,805		17,353
Policyholder dividends payable		164		150
Due to affiliates, net		6,698		5,435
Total liabilities		77,286		66,053
SHAREHOLDERS’ EQUITY
Preferred stock outstanding		29		25
Total shareholders’ equity		29		25
Total liabilities and shareholders’ equity	$	77,315	$	66,078

10. 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.

Shareholder Demand Related to Merger with ProAssurance

The Company has received letters from attorneys purporting to represent shareholders of the Company and demanding certain actions be taken as a result of the proposed acquisition of the Company by ProAssurance Corporation (“ProAssurance”). The letters claim that the proposed acquisition is the result of a flawed process and is fundamentally unfair to the Company, the shareholder and other public shareholders of the Company. The demands request that the Company’s Board of Directors 1) undertake all appropriate and available methods to maximize shareholder value and remove any conflicts of interest that have clouded the transaction process, 2) revise the proposed acquisition as structured in the merger agreement to eliminate the deal protection devices, including, but not limited to, the restrictions on the Board’s ability to seek bona-fide offers set forth in the merger agreement and reduction of the termination fee, 3) address alleged deficiencies in the Proxy statement, 4) refrain from consummating the proposed acquisition whereby the Company’s public shareholders will be cashed out of their Company stock for inadequate consideration, and 5) take appropriate legal action against each of the members of the Company’s Board of Directors.

It is reasonably possible that others could initiate additional actions or litigation against the Company with respect to the proposed merger. The Company disagrees with the assertions made in the letters and expects to respond fully and vigorously defend any subsequent litigation.

AIG Arbitration

On September 6, 2011, the Company served a written demand (the “Arbitration Demand”) initiating arbitration proceedings against various AIG Companies under 24 reinsurance treaties pursuant to which the Company reinsured AIG Companies for certain pollution

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liability risks related to underground storage tanks for the policy years 1990 through 1999 (the “Treaties”). The Treaties were cancelled by Eastern Re in 1999. In the Arbitration Demand, the Company seeks an award from the arbitration panel compelling AIG Companies to permit the Company to examine the bases for certain paid losses and loss reserves ceded by AIG Companies to Eastern Re under the Treaties. The Company believes that the Treaties permit such an audit.

On October 3, 2011, AIG Companies responded to the Arbitration Demand by advising that they will seek an award from the arbitration panel of approximately $1,900 plus future amounts that may become due under the Treaties before the final hearing in the arbitration. Both the Company and AIG Companies seek attorney’s fees and costs in the arbitration. Both the Company and AIG Companies have appointed arbitrators.

During the first quarter of 2012, the Company received quarterly claims data from AIG Companies that reflected unfavorable claim development under the reinsurance treaties. The Company is unable to substantiate the reliability of the claims data reported by AIG Companies and, as a result, has not adjusted its consolidated financial statements for the amounts reported by AIG Companies. The Company continues to believe it has adequately reserved the claims at issue.

The Company commenced an audit of the claims covered under the Treaties during the third quarter of 2012. Following the claim audit, the Company requested additional files and further information from AIG Companies in order to allow the Company to complete the audit. AIG Companies have not provided the requested information, which the Company is now pursuing in the arbitration. Once received, the information will be evaluated to determine whether such information would cause the Company to revise its estimates or position with respect to the pending arbitration.

During the second quarter of 2013, an umpire was selected in the arbitration and an organizational meeting was held. Both parties submitted Position Statements which stated their respective positions and requested relief. In addition to seeking a full audit, the Company is seeking an order from the arbitration panel granting it all appropriate relief relating to or arising from the incorrect, improper, or untimely billings that AIG has sent to the Company. Subject to the results of the audit and discovery, the relief the Company seeks may include a refund of payments the Company has already made to AIG Companies under the treaties as well as an award in the Company’s favor for the damages it has suffered. AIG Companies is seeking approximately $4,100, which AIG Companies contends is the total the Company owes under 14 of 24 reinsurance treaties the parties entered into between 1989 and 1999. At the organizational meeting, the final hearing was set for the week of March 31, 2014. Following the meeting, the arbitration panel approved a schedule for the arbitration.

It is reasonably possible that the final outcome of the arbitration could go against the Company, which could result in a material, adverse effect on the Company’s results of operations and financial condition.

Eastern Alliance Insurance Co. v. Managepoint, LLC, d/b/a Management 2000 Group, Inc., a/k/a Management, Inc.

Eastern Alliance brought this action against Managepoint, Inc., Managepoint, LLC, and Management 2000 Group, Inc. (collectively, the “Defendants”) to recover amounts due and owing under five workers’ compensation deductible insurance policies issued to the Defendants.

On November 21, 2012, the Defendants filed a complaint, denying Eastern Alliance’s assertion that they operate as the same entity, and thus, are liable for the debts of the other, and renouncing any liability for any amounts set forth in the complaint. The Defendants also raised a number of affirmative defenses, including that Eastern Alliance breached its duty of good faith and fair dealing by, among other things, failing to obtain required approvals to settling workers’ compensation claims and improperly invoicing, collecting, and retaining various overpayments by the Defendants.

On June 12, 2013, Eastern Alliance and the Defendants entered into a Settlement Agreement and Mutual Release (the “Settlement”) related to the above matter.

11. Subsequent Events

Management performed an evaluation of subsequent events through the issuance date of the consolidated financial statements and determined there were no recognized or unrecognized subsequent events that would require an adjustment and/or additional disclosure in the consolidated financial statements as of September 30, 2013.

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

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the unaudited interim consolidated financial statements of Eastern Insurance Holdings, Inc. (the “Company”) and the related notes thereto included in Item 1 of this Part 1. The information contained in this quarterly report is not a complete description of the Company’s business or the risks associated with an investment in the Company’s common stock. You should carefully review and consider the various disclosures made by the Company in this quarterly report and in the Company’s Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission on March 8, 2013.

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;

• expenses incurred in connection with the proposed merger with ProAssurance and any merger-related litigation;

• diversion of management time on merger-related issues;

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

• the effects of terrorist related insurance legislation and laws;

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

• the cost, availability and collectibility of reinsurance;

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

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

• the effects of mergers, acquisitions and dispositions;

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

• changes in the underwriting criteria that we use resulting from competitive pressures;

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

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

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

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

• adverse litigation or arbitration results including, without limitation, the AIG Arbitration; and

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

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

Overview

The Company reported net income of $3.7 million for the three months ended September 30, 2013, compared to net income of $2.8 million for the same period in 2012. The Company’s consolidated combined ratio was 94.6% for the three months ended September 30, 2013, compared to 97.2% for the same period in 2012.

The Company’s results of operations for the three months ended September 30, 2013, when compared to the same period in 2012, primarily reflect the following:

• A 9.0% increase in net premiums earned, which primarily reflects new business, renewal rate increases and an increase in the renewal retention rate. New business totaled $30.9 million for the first nine months of 2013, renewal rate increases were 5.5% and the renewal retention rate increased from 83.9% in 2012 to 84.9% in 2013.

• An increase in net realized investment gains, from $1.0 million in 2012 to $2.3 million in 2013. Net realized investment gains in 2013 include an increase in the estimated fair value of the Company’s convertible bond portfolio totaling $792,000, compared to $589,000 in 2012. The Company also recognized realized gains totaling $1.2 million related to the sale of a mutual fund during the third quarter of 2013.

• A decrease in the consolidated loss ratio, from 67.3% to 64.1%, which primarily reflects a decrease in the accident period loss ratio in both the workers’ compensation insurance and segregated portfolio cell reinsurance segments.

• An increase in the consolidated expense ratio, from 28.8% to 29.8%, which primarily reflects expenses related to the merger transaction totaling approximately $900,000.

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, one-half of the premiums would be earned in the current calendar year and the other half would be earned in the following calendar year. 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

24

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, 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.

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.

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.

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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 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 and segregated portfolio cell reinsurance, 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, 2013, 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, 2013 and December 31, 2012, the Company’s reserves for unpaid losses and LAE were reduced by $7.0 million and $6.5 million, respectively, related to the effects of discounting.

The Company’s reserves for unpaid losses and LAE in its workers’ compensation insurance, segregated portfolio cell reinsurance and corporate/other segments as of September 30, 2013 (unaudited) and December 31, 2012 are summarized below (in thousands):

September 30, 2013	Workers’ Compensation Insurance			Segregated Portfolio Cell Reinsurance			Corporate / Other		Total
Case reserves and unallocated LAE reserves	$	50,755		$	10,636		$	—	$	61,391
Case incurred development and IBNR		41,506			15,670			206		57,382
Amount of discount		(5,658	)		(1,315	)		—		(6,973	)
Net reserves before reinsurance recoverables		86,603			24,991			206		111,800
Reinsurance recoverables on unpaid losses and LAE		10,166			4,500			—		14,666
Reserves for unpaid losses and LAE	$	96,769		$	29,491		$	206	$	126,466

December 31, 2012	Workers’ Compensation Insurance			Segregated Portfolio Cell Reinsurance			Corporate / Other		Total
Case reserves and unallocated LAE reserves	$	42,376		$	8,986		$	—	$	51,362
Case incurred development and IBNR		42,042			15,537			206		57,785
Amount of discount		(5,277	)		(1,226	)		—		(6,503	)
Net reserves before reinsurance recoverables		79,141			23,297			206		102,644
Reinsurance recoverables on unpaid losses and LAE		10,086			4,998			—		15,084
Reserves for unpaid losses and LAE	$	89,227		$	28,295		$	206	$	117,728

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“Other Than Temporary” Investment Impairments

Unrealized investment gains or losses on investments carried at estimated fair value, net of applicable income taxes, are reflected directly in shareholders’ equity as a component of accumulated other 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 at the balance sheet date. The amount written down is recorded as a realized loss in the consolidated statements of operations and comprehensive income (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. The Company recorded other-than-temporary impairments, excluding impairments in the segregated portfolio cell reinsurance segment, of $0 and $40,000 for the three months ended September 30, 2013 and 2012, respectively. The Company recorded other-than-temporary impairments, excluding impairments in the segregated portfolio cell reinsurance segment, of $0 and $127,000 for the nine months ended September 30, 2013 and 2012, respectively. There were no other-than-temporary impairments in the segregated portfolio cell reinsurance segment in 2013 or 2012.

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% of its cost for a continuous period of 6 months, 2) an equity security’s market value is less than 50% of its cost, regardless of the amount of time the security’s market value has been below cost, and 3) an equity security’s market value has been less than cost for a continuous period of 12 months or more, 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.

As of September 30, 2013, the Company held equity securities, excluding equity securities in the segregated portfolio cell reinsurance segment, with gross unrealized losses of $139,000, none of which were in an unrealized loss position for more than twelve months. The Company does not intend to sell the equity securities and it is not more likely than not that the Company will be required to sell the equity securities before recovery of their cost bases; therefore, management does not consider the equity securities to be other-than-temporarily impaired as of September 30, 2013. Adverse investment market conditions, or poor operating results of underlying investments, could result in impairment charges in the future.

Fixed income securities. A fixed income security is considered to be other-than-temporarily impaired when the security’s estimated 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 (loss), and the portion of the other-than-temporary impairment that is not credit related is included in other comprehensive income (loss). 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.

As of September 30, 2013, the Company held fixed income securities, excluding fixed income securities in the segregated portfolio cell reinsurance segment, with gross unrealized losses of $1.5 million, of which $14,000 were in an unrealized loss position for more than twelve months. Management has evaluated the unrealized losses related to those fixed income securities and determined that they are primarily due 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, 2013. Adverse investment market conditions, or poor operating results of underlying investments, could result in impairment charges in the future.

27

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 (loss).

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, 2013 to its workers’ compensation insurance segment.

The Company performs its annual goodwill impairment test as of September 30.

Management determined that goodwill was not impaired as of September 30, 2013, based on the planned merger with ProAssurance. The acquisition price of $24.50 per share reflects a premium of 15.8% to the Company’s common stock trading price immediately preceding the announcement ($21.16 on September 23, 2013 and a premium 51.3% to the Company’s September 30, 2013 tangible diluted book value of $16.19. Based on these qualitative factors, management determined that it was not more likely than not that the Company’s goodwill was impaired and, therefore, the two-step impairment analysis was considered unnecessary.

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, 2013, the Company recorded a net deferred tax asset of $3.6 million. 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.

As of September 30, 2013, the Company has not recognized any future tax benefit related to its foreign operations at Eastern Re. The unrecognized tax benefit, which represents the excess of the tax basis over the amount for financial reporting (i.e., outside basis difference) of Eastern Re, was $9.5 million and $10.5 million as of September 30, 2013 and December 31, 2012, respectively. The outside basis difference primarily arises from losses at Eastern Re recognized for financial statement purposes, which have not yet been recognized for tax purposes.

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.

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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, 2013 and 2012 (unaudited, in thousands):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2013			2012		2013		2012
Net premiums written	$	46,405		$	45,026	$	149,398	$	133,396
Net premiums earned	$	45,129		$	41,397	$	132,982	$	116,618
Net investment income		955			892		2,778		2,906
Change in equity interest in limited partnerships		(10	)		290		748		738
Net realized investment gains		2,255			1,023		3,162		1,511
Other revenue		29			84		163		239
Consolidated revenue	$	48,358		$	43,686	$	139,833	$	122,012

The increase in consolidated revenue from 2012 to 2013 primarily reflects the following:

• An increase in net premiums earned reflecting new business, renewal rate increases, and an improvement in the renewal retention rate, partially offset by a decrease in audit premium.

• An increase in net realized gains, primarily reflecting the performance of the convertible bond portfolio and realized gains related to the aforementioned sale of a mutual fund in the third quarter of 2013. Net realized investment gains for the nine months ended September 30, 2012 include a realized loss of $641,000 related to the commutation of the SprinklerPro program.

The components of consolidated net income, by segment, for the three and nine months ended September 30, 2013 and 2012 were as follows (unaudited, in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Workers’ compensation insurance	$	4,569		$	3,087		$	11,521		$	8,448
Segregated portfolio cell reinsurance		—			—			—			—
Corporate/other		(877	)		(301	)		(1,593	)		(1,392	)
Consolidated net income	$	3,692		$	2,786		$	9,928		$	7,056

The increase in consolidated net income primarily reflects the increase in net premiums earned, net realized investment gains, and a decrease in the workers’ compensation insurance segment’s combined ratio from 2012 to 2013.

WORKERS’ COMPENSATION INSURANCE

The following table represents the operations of the workers’ compensation insurance segment for the three and nine months ended September 30, 2013 and 2012 (unaudited, in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Revenue:
Direct premiums written	$	49,309		$	48,407		$	158,474		$	143,581
Reinsurance premiums assumed		1,334			840			4,056			2,313
Ceded premiums written (1)		(13,518	)		(11,864	)		(45,366	)		(39,367	)
Net premiums written		37,125			37,383			117,164			106,527
Change in unearned premiums		(1,247	)		(4,202	)		(11,209	)		(13,709	)
Net premiums earned		35,878			33,181			105,955			92,818
Net investment income		863			749			2,419			2,385
Change in equity interest in limited partnerships		(48	)		258			575			620
Net realized investment gains		1,651			1,022			2,413			1,618
Total revenue		38,344			35,210			111,362			97,441
Expenses:
Losses and LAE incurred		23,356			22,365			69,006			61,480
Acquisition and other underwriting expenses		2,672			3,198			8,357			8,793
Other expenses		5,740			5,090			16,911			14,790
Policyholder dividend expense		297			467			763			652
Total expenses		32,065			31,120			95,037			85,715
Income before income taxes		6,279			4,090			16,325			11,726
Income tax expense		1,710			1,003			4,804			3,278
Net income	$	4,569		$	3,087		$	11,521		$	8,448

(1) Ceded premiums written include premiums ceded to the segregated portfolio cell reinsurance segment of $10,524 and $8,763 and $35,872 and $30,098 for the three and nine months ended September 30, 2013 and 2012, respectively.

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The workers’ compensation insurance ratios were as follows for the three and nine months ended September 30, 2013 and 2012:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Loss and LAE ratio		65.1	%		67.4	%		65.1	%		66.2	%
Expense ratio		23.5	%		25.0	%		23.9	%		25.4	%
Policyholder dividend expense ratio		0.8	%		1.4	%		0.7	%		0.7	%
Combined ratio		89.4	%		93.8	%		89.7	%		92.3	%

Premiums

The increase in direct premiums written primarily reflects new business, renewal rate increases, and an improvement in the renewal retention rate, partially offset by a decrease in audit premium from customers. New business totaled $30.9 million for the first nine months of 2013, renewal rate increases were 5.5% and the renewal retention rate increased from 83.9% in 2012 to 84.9% in 2013. For the three and nine months ended September 30, 2013, the Company recognized audit premium returned to customers totaling $59,000 and audit premium from customers of $1.9 million, respectively, in the aggregate, related to its traditional and alternative market books of business, compared to audit premium from customers of $1.6 million and $3.6 million, respectively, for the same periods in 2012. The Company’s traditional book of business recognized audit premium from customers of $267,000 and $1.8 million, respectively, for the three and nine months ended September 30, 2013, compared to audit premium from customers of $1.5 million and $3.4 million, respectively, for the same periods in 2012. In addition to audit premium from customers, the Company increased its estimated of earned but unbilled premium (“EBUB estimate”) by $400,000 and $650,000, respectively, during the three and nine months ended September 30, 2012. There was no EBUB adjustment in 2013.

Net Investment Income

The increase in net investment income primarily reflects the change in accounting policy related to the classification of amortization/accretion in the Company’s convertible bond portfolio, partially offset by a decrease in the average yield on the fixed income portfolio. Net premium amortization totaling $251,000 and $809,000 related to the convertible bond portfolio was included in net realized investment gains for the three and nine months ended September 30, 2013. The average yield on the fixed income portfolio was 2.16% as of September 30, 2013, compared to 2.84% as of September 30, 2012.

Net Realized Investment Gains

The increase in net realized investment gains from 2012 to 2013 primarily reflects a realized gain related to the sale of a mutual fund holding in the third quarter of 2013 and an increase related to the change in fair value of the Company’s convertible bond portfolio. The fair value of the convertible bond portfolio increased $792,000 and $561,000 for the three and nine months ended September 30, 2013, respectively, compared to $589,000 and $803,000, respectively, for the same periods in 2012. The realized gain related to the sale of the mutual fund holding totaled $611,000. The proceeds from the sale were reinvested in the Company’s convertible bond portfolio. Net realized investment gains for the three and nine months ended September 30, 2013 include net premium amortization of $251,000 and $809,000, respectively, related to the convertible bond portfolio.

Losses and LAE

The decrease in the calendar period loss ratio primarily reflects a decrease in accident period loss experience from 2012 to 2013. Audit premium, including the impact of the EBUB estimate, reduced the loss ratio by 0.5 percentage points and 4.1 percentage points for the three months ended September 30, 2013 and 2012, respectively, and 1.2 percentage points and 3.1 percentage points for the nine months ended September 30, 2013 and 2012, respectively. There was no prior year accident period reserve development, in the aggregate, in 2013 or 2012. In 2013, however, there were some deviations, by accident period, between the actuarial indications and recorded reserves. Based on consideration of the credibility of the higher than expected loss experience on older accident periods and the robustness of the recent accident period loss ratio, management adjusted the spread of the recorded reserves by accident period to align the reserves with the actuarial indications.

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Acquisition and Other Underwriting Expenses and Other Expenses

The acquisition and other underwriting expense ratio was 7.5% and 9.6% for the three months ended September 30, 2013 and 2012, respectively, and 7.9% and 9.5% for the nine months ended September 30, 2013 and 2012, respectively. The decrease from 2012 to 2013 primarily reflects an increase in fee-based revenue from the segregated portfolio cell reinsurance segment.

The other expense ratio was 16.0% and 15.4% for the three months ended September 30, 2013 and 2012, respectively, and 16.0% and 15.9% for the nine months ended September 30, 2013 and 2012, respectively. The increase in the other expense ratio for the three months ended September 30, 2013 primarily reflects the decrease in audit premium from customers.

Policyholder Dividends

Policyholder dividend expense reflects the underlying loss experience of dividend paying policies. As of September 30, 2013 and 2012, 9.7% and 12.1%, respectively, of all policies were written on a dividend policy basis.

Tax Expense

The effective tax rate was 27.2% and 24.5% for the three months ended September 30, 2013 and 2012, respectively, and 29.4% and 28.0% for the nine months ended September 30, 2013 and 2012, respectively. The primary difference between the statutory rate of 35.0% and the effective tax rate reflects tax-exempt income on municipal bond securities and the tax benefit associated with workers’ compensation insurance business ceded to Eastern Re. The increase in the effective tax rate from 2012 to 2013 primarily reflects a decrease in tax-exempt income on municipal bond securities as a percentage of pre-tax income.

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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, 2013 and 2012 (unaudited, in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Revenue:
Reinsurance premiums assumed	$	10,524		$	8,763		$	35,872		$	30,098
Ceded premiums written		(1,244	)		(1,120	)		(3,638	)		(3,229	)
Net premiums written		9,280			7,643			32,234			26,869
Change in unearned premiums		(29	)		573			(5,207	)		(3,069	)
Net premiums earned		9,251			8,216			27,027			23,800
Net investment income		70			75			226			249
Net realized investment gains		8			40			148			506
Total revenue		9,329			8,331			27,401			24,555
Expenses:
Losses and LAE incurred		5,592			5,484			15,666			14,855
Acquisition and other underwriting expenses		2,787			2,482			8,090			7,227
Other expenses		96			54			289			218
Policyholder dividend expense		12			26			44			63
Segregated portfolio dividend expense (1)		842			285			3,312			2,192
Total expenses		9,329			8,331			27,401			24,555
Net income (1)	$	—		$	—		$	—		$	—

(1) The workers’ compensation insurance 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 results of operations 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 LAE incurred, acquisition and other underwriting expenses, other expenses and policyholder dividend expense 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, 2013 and 2012:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Loss and LAE ratio		60.4	%		66.7	%		58.0	%		62.4	%
Expense ratio		31.2	%		30.9	%		31.0	%		31.3	%
Policyholder dividend expense ratio		0.1	%		0.3	%		0.1	%		0.3	%
Combined ratio		91.7	%		97.9	%		89.1	%		94.0	%

Reinsurance Premiums Assumed

The increase in reinsurance premiums assumed primarily reflects new business of $4.9 million, renewal rate increases of 5.7%, and an increase in the renewal retention rate, partially offset by a decrease in audit premium. The renewal retention rate increased from 91.9% in 2012 to 92.3% in 2013. Reinsurance premiums assumed includes audit premium returned to customers totaling $326,000 and audit premium from customers totaling $91,000 for the three and nine months ended September 30, 2013, compared to audit premium from customers of $93,000 and $181,000 for the same periods in 2012.

Net Investment Income

Net investment income reflects income earned on the segregated portfolio cells’ investments in fixed income and equity mutual funds.

Net Realized Investment Gains

Net realized investment gains for the three and nine months ended September 30, 2013 and 2012 reflect sale activity in the segregated portfolio cells’ investment portfolios. Net realized gains for the nine months ended September 30, 2012 reflect the sale of individual equity securities in the first quarter of 2012, of which the proceeds were reinvested in equity mutual funds.

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Losses and LAE

The decrease in the calendar period loss and LAE ratio primarily reflects a decrease in the accident period loss ratio, partially offset by a decrease in favorable loss reserve development on prior accident periods. The accident period loss ratio was 60.6% and 75.3% for the three months ended September 30, 2013 and 2012, respectively, and 62.1% and 70.7% for the nine months ended September 30, 2013 and 2012, respectively. Favorable loss reserve development totaled $188,000 and $781,000 for the three months ended September 30, 2013 and 2012, respectively, and $1.7 million and $2.4 million for the nine months ended September 30, 2013 and 2012, respectively. The 2012 accident period loss ratio reflected increased claim activity in two segregated portfolio cells during the reporting period.

Acquisition and Other Underwriting Expenses

The expense ratios are consistent with the contractual ceding commissions for the three and nine months ended September 30, 2013 and 2012.

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.

CORPORATE/OTHER

The following table represents the operations of the corporate/other segment for the three and nine months ended September 30, 2013 and 2012 (unaudited, in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Revenue:
Net investment income	$	22		$	68		$	133		$	272
Change in equity interest in limited partnerships		38			32			173			118
Net realized investment gains (losses)		596			(39	)		601			(613	)
Other revenue		29			84			163			239
Total revenue		685			145			1,070			16
Expenses:
Acquisition and other underwriting expenses		(33	)		(194	)		(300	)		(629	)
Other expenses		2,032			1,080			4,391			3,111
Amortization of intangibles		160			202			480			605
Segregated portfolio dividend expense		(401	)		(256	)		(1,158	)		(778	)
Total expenses		1,758			832			3,413			2,309
Loss before income taxes		(1,073	)		(687	)		(2,343	)		(2,293	)
Income tax benefit		(196	)		(386	)		(750	)		(901	)
Net loss	$	(877	)	$	(301	)	$	(1,593	)	$	(1,392	)

Revenue

The increase in revenue for the three months ended September 30, 2013, compared to the same period in 2012, primarily reflects realized gains related to the sale of a mutual fund in the Eastern Re equity security portfolio. Realized losses for the nine months ended September 30, 2012 reflect a loss of $641,000 related to the commutation of the SprinklerPro program.

The decrease in other revenue reflects the non-renewal of third-party administration accounts.

Expenses

The increase in expenses for the three months ended September 30, 2013, compared to the same period in 2012, primarily reflects expenses associated with the merger transaction, which totaled approximately $900,000 in the third quarter 2013.

Income Tax Benefit

The effective tax rate was a benefit of 18.3% and 56.2% for the three months ended September 30, 2013 and 2012, respectively, and 32.0% and 39.9% for the nine months ended September 30, 2013 and 2012, respectively. The decrease in the income tax benefit from 2012 to 2013 primarily reflects the impact of non-deductible transaction expenses, the Company’s annualized effective tax rate adjustment and an increase in non-deductible compensation expense related to the Company’s ESOP.

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CONSOLIDATED FINANCIAL POSITION

Consolidated assets totaled $417.3 million at September 30, 2013, compared to $380.8 million at December 31, 2012. The increase in consolidated assets primarily reflects the following:

• An increase in investments, which primarily reflects net purchases during the nine months ended September 30, 2013 and an increase in the estimated fair value of the convertible bond and equity portfolios, partially offset by a decline in the estimated fair value of the fixed income portfolio. The decline in the fixed income portfolio primarily reflects the impact of rising interest rates.

• An increase in premiums receivable and deferred acquisition costs, which primarily reflects the increase in direct premiums written.

• An increase in federal income taxes recoverable, which primarily reflects 2013 estimated federal income tax payments of $4.0 million and an overpayment of $1.8 million related to the 2012 federal income tax return, partially offset by the estimated federal income tax liability for the nine months ended September 30, 2013.

• An increase in other assets, which primarily reflects an increase in the Company’s segregated portfolio cell equity interest and an increase in prepaid reinsurance in the segregated portfolio cell reinsurance segment. These increases were partially offset by full payment of the outstanding note receivable from Security Life Insurance Company totaling $1.75 million in June 2013.

Consolidated liabilities totaled $273.2 million at September 30, 2013, compared to $244.9 million at December 31, 2012. The increase in consolidated liabilities primarily reflects the following:

• An increase in loss reserves, primarily related to the increase in net premiums earned.

• An increase in unearned premiums, which primarily reflects the increase in direct premiums written.

• An increase in the segregated portfolio cell dividend payable, which reflects positive operating results in the segregated portfolio cell reinsurance segment.

Consolidated equity totaled $144.1 million at September 30, 2013, compared to $135.9 million at December 31, 2012. The increase in consolidated equity primarily reflects the following:

• Net income for the nine months ended September 30, 2013, net of the quarterly shareholder dividend.

• A decrease in accumulated other comprehensive income, which primarily reflects a decrease in net unrealized gains in the fixed income portfolio, partially offset by an increase in net unrealized gains in the equity portfolio.

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 $10.0 million revolving line of credit available to provide additional liquidity if needed. The line of credit matures on May 2, 2014 and may be renewed annually for additional periods expiring on May 1 at the lender’s discretion. Outstanding balances under the line of credit bear interest at an adjustable monthly rate equal to LIBOR plus 2.0% per annum. There were no outstanding balances under the line of credit as of September 30, 2013.

Our domestic insurance subsidiaries’ ability to pay dividends to EIHI is limited by the insurance laws and regulations of Pennsylvania. The maximum annual dividends that the domestic insurance entities may pay without prior approval from the Pennsylvania 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 (“CIMA”) before it can pay any dividend to the Company. During the second quarter of 2013, Eastern Re paid a dividend of $3.0 million to EIHI to fund corporate expenses and shareholder dividend obligations. The dividend was approved by CIMA.

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CASH FLOWS

Cash flows for the nine months ended September 30, 2013 and 2012 were as follows (unaudited, in thousands):

	Nine Months Ended September 30,
	2013			2012
Cash provided by operating activities	$	19,005		$	12,229
Cash used in investing activities		(13,528	)		(11,277	)
Cash used in financing activities		(2,207	)		(4,032	)
	$	3,270		$	(3,080	)

Cash flows from operating activities consist primarily of cash receipts and disbursements related to premiums, investment income, claims and related adjustment expenses, operating expenses, policyholder dividends and income taxes. Cash flows from investing activities consist primarily of purchases and sales of investments and purchases of fixed assets. Cash flows from financing activities primarily consist of cash disbursements for repurchases of the Company’s common stock and shareholder dividends.

The increase in cash flows provided by operating activities primarily reflects the increase in net premiums written and a decrease in claims paid from 2012 to 2013 in relation to net premiums written, partially offset by an increase in estimated federal income tax payments. Estimated federal income tax payments totaled $4.7 million for the nine months ended September 30, 2013, compared to $4.1 million for the same period in 2012. Cash flows from operating activities also reflect full payment of the note receivable from Security Life Insurance Company totaling $1.75 million in June 2013.

Cash used in investing activities for the nine months ended September 30, 2013, compared to the same period in 2012, primarily reflect the purchase of fixed income mutual funds at Eastern Re and in the segregated portfolio cell reinsurance segment, partially offset by an increase in fixed income maturities and proceeds from the sale of mutual funds.

Cash used in financing activities for the nine months ended September 30, 2013 primarily reflects shareholder dividends, while the 2012 financing activities includes both shareholder dividends and $2.4 million in stock repurchases. Cash paid for shareholder dividends increased from 2012 to 2013 as a result of the increase in cash dividends per share from $0.07/share in 2012 to $0.09/share in the first quarter of 2013 and $0.11/share in the second and third quarters of 2013.

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, 2013, 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, 2012. 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 8, 2013.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including the President and Chief Executive Officer, the Executive Vice President, Treasurer and 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 15d—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 and Chief Executive Officer, the Executive Vice President, Treasurer and 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.

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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

Shareholder Demand Related to Merger with ProAssurance

The Company has received letters from attorneys purporting to represent shareholders of the Company and demanding certain actions be taken as a result of the proposed acquisition of the Company by ProAssurance Corporation (“ProAssurance”). The letters claim that the proposed acquisition is the result of a flawed process and is fundamentally unfair to the Company, the shareholder and other public shareholders of the Company. The demands request that the Company’s Board of Directors 1) undertake all appropriate and available methods to maximize shareholder value and remove any conflicts of interest that have clouded the transaction process, 2) revise the proposed acquisition as structured in the merger agreement to eliminate the deal protection devices, including, but not limited to, the restrictions on the Board’s ability to seek bona-fide offers set forth in the merger agreement and reduction of the termination fee, 3) address alleged deficiencies in the Proxy statement, 4) refrain from consummating the proposed acquisition whereby the Company’s public shareholders will be cashed out of their Company stock for inadequate consideration, and 5) take appropriate legal action against each of the members of the Company’s Board of Directors.

It is reasonably possible that others could initiate additional actions or litigation against the Company with respect to the proposed merger. The Company disagrees with the assertions made in the letters and expects to respond fully and vigorously defend any subsequent litigation.

Item 1A. Risk Factors

There are no material changes from the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, SEC File No. 001-32899.

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

Issuer Purchases of Equity Securities

As of September 30, 2013, the Company has repurchased 4,017,105 shares of its common stock. The share repurchases will be held as treasury stock and are available for issuance in connection with the Company’s Stock Incentive Plan. There were no share repurchases during the nine months ended September 30, 2013. The following table provides information with respect to those purchases of our common stock during the nine months ended September 30, 2012.

Period	Total number of shares purchased		Average price paid per share		Total number of shares purchased 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, 2012		—	$	—		—		1,086,567
February 1-29, 2012		—	$	—		—		1,086,567
March 1-31, 2012		—	$	—		—		1,086,567
April 1-30, 2012		—	$	—		—		1,086,567
May 1-31, 2012		166,537	$	14.49		166,537		920,030
June 1-30, 2012		—	$	—		—		920,030
July 1-31, 2012		—	$	—		—		920,030
August 1-31, 2012		—	$	—		—		920,030
September 1-30, 2012		—	$	—		—		920,030
Total		166,537	$	14.49		166,537

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Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

None

Item 5. Other Information

None

Item 6. Exhibits

Exhibits

Exhibit No.	Title
3.1	Articles of Incorporation of Eastern Insurance Holdings, Inc. (Incorporated by reference from Exhibit 3.1 to the Eastern Insurance Holdings, Inc. Registration Statement No. 333-128913 on Form S-1)
3.2	Bylaws of Eastern Insurance Holdings, Inc. (Incorporated by reference from Exhibit 3.2 to the Eastern Insurance Holdings, Inc. Registration Statement No. 333-128913 on Form S-1)
10.1	Retention and Severance Compensation Agreement between and among ProAssurance Group Services Corporation and ProAssurance Corporation and Michael L. Boguski (filed herewith)
10.2	Retention and Severance Compensation Agreement between and among ProAssurance Group Services Corporation and ProAssurance Corporation and Kevin M. Shook (filed herewith)
10.3	Retention and Severance Compensation Agreement between and among ProAssurance Group Services Corporation and ProAssurance Corporation and Robert A. Gilpin (filed herewith)
10.4	Retention and Severance Compensation Agreement between and among ProAssurance Group Services Corporation and ProAssurance Corporation and Suzanne M. Emmet (filed herewith)
10.5	Retention and Severance Compensation Agreement between and among ProAssurance Group Services Corporation and ProAssurance Corporation and Cynthia Sklar (filed herewith)
10.6	Retention and Severance Compensation Agreement between and among ProAssurance Group Services Corporation and ProAssurance Corporation and Harry Talbert (filed herewith)
31.1	Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002
101	Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets as of September 30, 2013 and December 31, 2012, (ii) the Consolidated Statements of Operations and Comprehensive Income (Loss) for the three and nine months ended September 30, 2013 and 2012, (iii) the Consolidated Statements of Changes in Equity for the three and nine months ended September 30, 2013 and 2012, (iv) the Consolidated Statements of Cash Flows for the nine months ended September 30, 2013 and 2012, and (v) the Condensed Notes to Consolidated Financial Statements.

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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: October 31, 2013	By:	/s/ Michael L. Boguski
		Michael L. Boguski,
		President and Chief Executive Officer
Dated: October 31, 2013	By:	/s/ Kevin M. Shook
		Kevin M. Shook,
		Executive Vice President, Treasurer & Chief Financial Officer

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