Harleysville 10Q 2012 Q1 Quarterly report

Harleysville (HGIC) Inactive 10-Q2012 Q1 Quarterly report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2012

¨	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: 0-14697

HARLEYSVILLE GROUP INC.

(Exact name of registrant as specified in its charter)


Delaware		51-0241172
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

355 Maple Avenue, Harleysville, PA 19438-2297

(Address of principal executive offices) (Zip Code)

215-256-5000

(Registrant’s telephone number, including area code)

N/A

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

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, 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.:

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

At April 30, 2012 27,276,942 shares of common stock of Harleysville Group Inc. were outstanding.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

INDEX


		Page Number

Part I	Financial Information

Item 1.	Financial Statements

	Consolidated Balance Sheets – March 31, 2012 and December 31, 2011		3

	Consolidated Statements of Income – For the three months ended March 31, 2012 and 2011		4

	Consolidated Statements of Comprehensive Income (Loss) – For the three months ended March 31, 2012 and 2011		5

	Consolidated Statement of Shareholders’ Equity – For the three months ended March 31, 2012		6

	Consolidated Statements of Cash Flows – For the three months ended March 31, 2012 and 2011		7

	Notes to Consolidated Financial Statements		8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		22

Item 3.	Quantitative and Qualitative Disclosure About Market Risk		32

Item 4.	Controls and Procedures		33

Part II	Other Information

Item 1.	Legal Proceedings		34

Item 1A.	Risk Factors		36

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		36

Item 6.	Exhibits		38

Item 1.

Financial Statements

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)


	March 31, 2012			December 31, 2011
	(Unaudited)
Assets
Investments:
Fixed maturities:
Held to maturity, at amortized cost (fair value $107,382 and $131,433)	$	101,261		$	124,935
Available for sale, at fair value (amortized cost $2,110,242 and $2,195,221)		2,265,341			2,361,971
Equity securities, at fair value (cost $7 and $7)		7			7
Short-term investments, at cost, which approximates fair value		194,098			129,388

Total investments		2,560,707			2,616,301
Cash		51			36
Premiums receivable		134,446			133,277
Reinsurance recoverables		204,183			245,948
Accrued investment income		23,241			25,629
Deferred policy acquisition costs		94,036			101,256
Prepaid reinsurance premiums		51,200			54,753
Property and equipment, net		12,658			12,763
Deferred income taxes		21,450			15,712
Other assets		62,025			61,394

Total assets	$	3,163,997		$	3,267,069

Liabilities and Shareholders’ Equity
Liabilities:
Unpaid losses and loss settlement expenses (affiliate $117,182 and $132,536)	$	1,728,595		$	1,789,591
Unearned premiums (affiliate $(14,552) and $(14,201)		457,432			460,768
Accounts payable and accrued expenses		87,220			104,258
Due to affiliate		19,390			40,396
Debt (affiliate $18,500 and $18,500)		118,500			118,500

Total liabilities		2,411,137			2,513,513


Shareholders’ equity:
Preferred stock, $1 par value, authorized 1,000,000 shares; none issued
Common stock, $1 par value, authorized 80,000,000 shares; issued 35,513,932 and 35,448,861 shares; outstanding 27,276,942 and 27,246,172 shares		35,514			35,449
Additional paid-in capital		288,251			285,585
Accumulated other comprehensive income		57,085			63,571
Retained earnings		627,979			622,973
Treasury stock, at cost, 8,236,990 and 8,202,689 shares		(255,969	)		(254,022	)

Total shareholders’ equity		752,860			753,556


Total liabilities and shareholders’ equity	$	3,163,997		$	3,267,069

See accompanying notes to consolidated financial statements.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

For the three months ended March 31, 2012 and 2011

(dollars in thousands, except per share data)


	2012			2011

Revenues:
Premiums earned from affiliate (ceded to affiliate, $204,986 and $201,903)	$	198,463		$	199,753
Investment income, net of investment expense		20,076			25,585
Realized investment gains, net:
Total other-than-temporary impairment losses		—			—
Portion of loss recognized in other comprehensive income		—			—
Other realized investment gains, net		58			15,774

Total realized investment gains, net		58			15,774

Other income (affiliate $2,149 and $2,213)		4,665			4,410


Total revenues		223,262			245,522


Losses and expenses:
Losses and loss settlement expenses (ceded to affiliate, $140,802 and $152,054)		136,043			144,195
Amortization of deferred policy acquisition costs		50,109			52,679
Other underwriting expenses		30,623			20,671
Interest expense (affiliate $38 and $32)		1,520			1,514
Other expenses		1,283			969


Total expenses		219,578			220,028


Income before income taxes		3,684			25,494

Income tax expense (benefit)		(1,322	)		7,267


Net income	$	5,006		$	18,227


Per common share:

Basic net income	$	.18		$	.67


Diluted net income	$	.18		$	.66


Cash dividend	$	—		$	.36

See accompanying notes to consolidated financial statements.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

For the three months ended March 31, 2012 and 2011

(in thousands)


	2012			2011

Net income	$	5,006		$	18,227


Other comprehensive income (loss):
Net unrealized investment losses, net of tax benefit of $4,078 and $2,730		(7,573	)		(5,069	)
Recognized net actuarial loss of defined benefit pension plans, net of taxes of $585 and $353		1,087			656

Other comprehensive loss		(6,486	)		(4,413	)


Comprehensive income (loss)	$	(1,480	)	$	13,814

See accompanying notes to consolidated financial statements.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(Unaudited)

For the three months ended March 31, 2012

(dollars in thousands)


	Common Stock				Additional Paid-in Capital		Accumulated Other Comprehensive Income			Retained Earnings		Treasury Stock			Total
	Shares		Amount		Additional Paid-in Capital		Accumulated Other Comprehensive Income			Retained Earnings		Treasury Stock			Total

Balance at December 31, 2011		35,448,861	$	35,449	$	285,585	$	63,571		$	622,973	$	(254,022	)	$	753,556
Net income											5,006					5,006

Other comprehensive loss, net of tax:
Unrealized investment losses, net of reclassification adjustment								(7,573	)							(7,573	)
Defined benefit pension plans:
Recognized net actuarial loss								1,087								1,087


Other comprehensive loss																(6,486	)


Comprehensive loss																(1,480	)

Issuance of common stock:
Incentive plans		65,071		65		1,350										1,415

Tax benefit from stock compensation						655										655

Stock compensation						661										661

Purchase of treasury stock, 34,301 shares													(1,947	)		(1,947	)


Balance at March 31, 2012		35,513,932	$	35,514	$	288,251	$	57,085		$	627,979	$	(255,969	)	$	752,860

See accompanying notes to consolidated financial statements.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

For the three months ended March 31, 2012 and 2011

(in thousands)


	2012			2011

Cash flows from operating activities:
Net income	$	5,006		$	18,227
Adjustments to reconcile net income to net cash provided by operating activities:
Change in receivables, recoverables, unearned premiums and prepaid reinsurance balances		40,813			2,396
Change in affiliate balance		(21,006	)		23,044
Decrease in unpaid losses and loss settlement expenses		(60,996	)		(20,419	)
Deferred income taxes		(2,245	)		5,929
Decrease in deferred policy acquisition costs		7,220			1,656
Amortization and depreciation		3,277			2,551
Realized investment gains, net		(58	)		(15,774	)
Other, net		(12,975	)		(12,701	)


		(40,964	)		4,909
Cash used by the change in the intercompany pooling agreement		—			(33,014	)


Net cash used by operating activities		(40,964	)		(28,105	)


Cash flows from investing activities:
Fixed maturity investments:
Purchases					(2,026	)
Sales or maturities		105,687			63,457
Equity securities:
Purchases					(117,733	)
Sales					57,508
Net (purchases) sales of short-term investments		(64,710	)		35,949
Purchase of property and equipment, net		(121	)		(24	)

Net cash provided by investing activities		40,856			37,131


Cash flows from financing activities:
Issuance of common stock		1,415			144
Purchase of treasury stock		(1,947	)
Dividends paid (to affiliate, $0 and $5,230)					(9,544	)
Excess tax benefits from share-based payment arrangements		655			371

Net cash provided (used) by financing activities		123			(9,029	)

Change in cash		15			(3	)
Cash at beginning of period		36			39

Cash at end of period	$	51		$	36

See accompanying notes to consolidated financial statements.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

(Unaudited)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1 – Basis of Presentation

The financial information for the interim periods included herein is unaudited; however, such information reflects all adjustments which are, in the opinion of management, necessary to a fair presentation of the financial position, results of operations, and cash flows for the interim periods. The results of operations for the interim periods are not necessarily indicative of results to be expected for the full year.

These financial statements should be read in conjunction with the financial statements and notes for the year ended December 31, 2011 included in the Company’s 2011 Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (SEC).

The affiliate transaction disclosures on the face of the financial statements relate to transactions with Harleysville Mutual Insurance Company (the Mutual Company). The Mutual Company owns approximately 53% of the outstanding common stock of Harleysville Group Inc. As used herein, “Harleysville Group” refers to Harleysville Group Inc. and its subsidiaries and the “Company” or “HGI” refers to Harleysville Group Inc.

2 – Merger Agreement

On September 28, 2011, the Mutual Company and HGI entered into an agreement and plan of merger (the Merger Agreement) with Nationwide Mutual Insurance Company (Nationwide) and a subsidiary of Nationwide (Nationals Sub). Pursuant to the Merger Agreement, the Mutual Company will merge into Nationwide with Nationwide as the surviving Company and the policyholders of the Mutual Company will become policyholders and members of Nationwide. In addition, Nationals Sub will merge into HGI with HGI as the surviving company and a wholly-owned subsidiary of Nationwide. As a result of the HGI merger, all outstanding shares of common stock of HGI held by stockholders, other than Nationwide, will be converted into the right to receive $60.00 per share in cash. The Mutual Company has also entered into a voting agreement with Nationwide under which it agreed to vote its 53% interest in HGI in favor of the merger. The Merger Agreement restricts the Mutual Company, HGI and all affiliates from engaging in certain activities and taking certain actions without Nationwide’s approval, including among others, the payment of shareholder dividends by HGI.

The transactions contemplated by the Merger Agreement are subject to customary closing conditions, including, among others, approvals from stockholders of HGI and members/policyholders of the Mutual Company and Nationwide, the Pennsylvania Insurance Department, the Ohio Insurance Department, and various other regulatory bodies. In April 2012, approvals were received from the stockholders of HGI, the members/policyholders of the Mutual Company and Nationwide, and all necessary regulatory bodies. The transactions are expected to close May 1, 2012 (the Closing Date). The Merger Agreement provides certain termination rights. In the event that the agreement is terminated under certain conditions by HGI’s Board of Directors, HGI will be required to pay Nationwide a termination fee of $29.6 million and reimburse Nationwide for its transaction expenses.

3 – Change in Pooling Agreement

The Company’s property and casualty subsidiaries participate in a pooling agreement with the Mutual Company and its property and casualty insurance subsidiary, Harleysville Pennland Insurance Company (Pennland), whereby such subsidiaries and Pennland cede to the Mutual Company all of their insurance business and assume from the Mutual Company an amount equal to their participation in the pooling agreement. All losses and loss settlement expenses and other underwriting expenses are prorated among the parties on the basis of participation in the pooling agreement. The pooling agreement provides for the allocation of premiums, losses and loss settlement expenses and underwriting expenses between Harleysville Group and the Mutual Company. Harleysville Group is not liable for any losses incurred by its subsidiaries, Harleysville Preferred Insurance Company and Harleysville Insurance Company of New Jersey, and the Mutual Company prior to January 1, 1986, the date the pooling agreement became effective. The pooling agreement excludes reinsurance premiums, losses, loss settlement expenses and underwriting expenses voluntarily assumed by the Mutual Company. Harleysville Group’s participation in the pool has been 80% since January 1, 2008.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

(Unaudited)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

Effective January 1, 2011, the Company’s property and casualty subsidiaries and the Mutual Company and Pennland amended their intercompany pooling agreement as it relates to their workers compensation business. The amendment establishes that the financial results associated with the workers compensation business for accident years 2011 and following will be retained 100 percent by the Mutual Company. The financial results of this business for prior accident years will continue to be shared between the Company’s property and casualty subsidiaries, the Mutual Company and Pennland under the existing pool participations. Harleysville Group paid cash of $33 million on January 3, 2011 associated with the transfer of the unearned premium liability on the workers compensation business as of January 1, 2011. Harleysville Group’s unearned premium liability decreased by $40 million and Harleysville Group received a ceding commission of $7 million for expenses that were incurred to generate the business ceded to the Mutual Company, which ceding commission reduced deferred policy acquisition costs.

4 – Share-Based Payments

The Company has several share-based compensation plans. The Company measures compensation expense associated with the plans based on the grant-date fair value of the awards.

The Company has the following share-based compensation plans:

•

The Amended and Restated Equity Incentive Plan (EIP) provides for awards to key employees in the form of stock options, stock appreciation rights (SARs), restricted stock, restricted stock units or any combination of the above.

•

The Employee Stock Purchase Plan (ESPP) provides that a participant may elect to have up to 15% of base pay withheld to purchase shares. The purchase price of the stock is 85% of the lower of the beginning-of-the-subscription period or end-of-the-subscription-period fair market value. There are two subscription periods during each year. In accordance with the terms of the Merger Agreement with Nationwide described in Note 2 of the Notes to Consolidated Financial Statements, no new subscription period was commenced after the date of the Merger Agreement (September 28, 2011) and the Company will terminate the ESPP effective as of the Closing Date.

•

The Directors’ Equity Compensation Plan provides for the grant of equity-based awards to non-employee directors of Harleysville Group Inc. and the Mutual Company. These awards can be in the form of stock options, deferred stock units or restricted stock.

The compensation expense for the various share-based compensation plans that has been charged against income before income taxes was $661,000 and $1,373,000 for the three months ended March 31, 2012 and 2011, respectively, with a corresponding income tax benefit of $222,000 and $453,000, respectively.

No stock option or restricted stock unit grants were made during the first quarter of 2012. During the first quarter of 2011, 225,760 stock options were granted at a Black Scholes weighted average value of $6.63 per option. These options vest 33 1/3% per year over a three year period. Restricted stock unit grants of 125,475 units were also made during the first quarter of 2011 and 30,855 of these units include performance conditions. The weighted average fair value of the grants of the restricted stock units was $37.73 per unit. These awards vest over three years.

In accordance with the terms of the EIP, the Company acquired 34,301 and 86,554 shares of its common stock from employees in connection with stock option exercises and the vesting of restricted stock and restricted stock units during the first quarter of 2012 and 2011, respectively. The stock was received in payment of the exercise price of the stock options and in satisfaction of withholding taxes due upon exercise or vesting.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

(Unaudited)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

As of March 31, 2012, the Company’s total unrecognized compensation cost related to nonvested share-based compensation arrangements and the weighted average period over which the compensation cost is expected to be recognized is as follows:


			Weighted Average
	Unrecognized Compensation Cost		Period of Recognition
	(in thousands)		(in years)
Equity incentive plan awards	$	3,039	1.6

5 – Investments

Fair value accounting guidance defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements.

Fair value measurements are determined under a three-level hierarchy which gives the highest priority to quoted prices in active markets and the lowest priority to unobservable inputs which are based on the Company’s own assumptions. The three levels of the hierarchy are as follows:

Level 1 – Unadjusted quoted market prices for identical assets or liabilities in active markets that the Company has the ability to access.

Level 2 – Inputs other than Level 1 that are based on observable market data. These include quoted prices for similar assets in active markets, quoted prices for identical assets in inactive markets, inputs other than quoted prices that are observable for the asset or liability and inputs that are derived from or corroborated by observable market data.

Level 3 – Inputs that are unobservable, reflecting the Company’s own assumptions.

For investments that have quoted market prices in active markets, the Company uses the quoted market price as fair value and includes these investments in Level 1 of the fair value hierarchy. The Company classifies U.S. Treasury securities and publicly traded equity securities and equity mutual funds as Level 1. When quoted market prices in active markets are not available, the Company relies on a pricing service to estimate fair value. The Company classifies its fixed maturity securities other than U.S. Treasury securities and private placements as Level 2. Non-publicly traded equity securities are classified as Level 3.

The Company utilizes a nationally recognized independent pricing service to obtain fair value estimates for its fixed maturity holdings because of the detailed process it uses in arriving at a fair value estimate. For fixed maturity securities that have quoted prices in active markets, market quotations are provided. For fixed maturity securities that do not trade on a daily basis, the independent pricing service prepares estimates of fair value using a wide array of observable inputs including relevant market information, benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. The observable market inputs that our independent pricing service utilizes include, listed in approximate order of priority: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data including market research publications. Additionally, the independent pricing service uses an Option Adjusted Spread model to develop prepayment and interest rate scenarios.

When the independent pricing service provides a fair value estimate, the Company uses that estimate. At March 31, 2012, the independent pricing service provided a fair value estimate for all of the investments classified as Level 1 investments within the fair value hierarchy and approximately 99% of the investments classified as Level 2 estimates within the fair value hierarchy. The fair value of all Level 2 securities is based on observable market inputs.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

(Unaudited)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

In instances when the independent pricing service is unable to provide a fair value estimate, the Company attempts to obtain a non-binding fair value estimate from a number of broker/dealers and reviews any fair value estimate reported by an independent business news service. In instances where only one broker/dealer provides a fair value estimate for a fixed maturity security, the Company uses that estimate. In instances where the Company is able to obtain fair value estimates from more than one broker/dealer, the Company generally uses the lowest or next to lowest fair value estimate. In instances where neither the independent pricing service nor a broker/dealer is able to provide a fair value estimate, the fair value is based on cash flow analysis and other valuation techniques which utilize significant unobservable inputs and the Company classifies the fixed maturity investment as a Level 3 investment. Level 3 investments represent less than 1% of the Company’s total investment portfolio.

Quotes obtained from third parties are non-binding. The third parties from whom quotes are obtained are knowledgeable market participants that have a detailed understanding of the sector, the security type and the issuer. The non-binding quotes are fair value estimates based on observable market data utilized by these market participants. The Company does not adjust quotes or prices obtained from third parties.

Management reviews, on an ongoing basis, the reasonableness of the methodologies employed by the independent pricing service. As part of the monthly review process, management examines the prices obtained from the independent pricing service. This process routinely involves reviewing any available recent transaction activity reported via various investment research tools. Additionally, the Company tracks changes in credit ratings of all fixed maturity securities on a monthly basis and performs a more in-depth, quarterly evaluation of fixed income securities that are rated below single A by Moody’s and/or S&P. If as a result of its review, management does not believe that a price received with respect to any particular security is a reasonable estimate of the fair value of the security, it will discuss this with the independent pricing service to resolve the discrepancy. Management then determines the appropriate level of classification of each investment within the fair value hierarchy based on its evaluation of the inputs used in determining the fair value.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

(Unaudited)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

The following is a summary of the fair value measurements of applicable Company assets by level within the fair value hierarchy as of March 31, 2012 and December 31, 2011 (and March 31, 2011 for Level 3 unobservable inputs). These assets are measured at fair value on a recurring basis. There were no transfers to or from Levels 1 and 2 of the fair value hierarchy in the first quarter of 2012. The Company’s policy is to recognize transfers between levels as of the end of the reporting period.

		December 31, 2011		December 31, 2011		December 31, 2011		December 31, 2011
			Fair Value Measurements at Reporting Date Using
	March 31, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(in thousands)

Fixed maturities available for sale:
U.S. Treasury securities	$	430,222	$	430,222
Obligations of U.S. government corporations and agencies		8,011			$	8,011
Obligations of states and political subdivisions		1,124,955				1,124,955
Corporate securities		442,796				442,796
Mortgage-backed securities		259,357				259,357

Total available for sale		2,265,341		430,222		1,835,119

Equity securities:
Other		7					$	7

Total equity securities		7						7


Total	$	2,265,348	$	430,222	$	1,835,119	$	7

		December 31, 2011		December 31, 2011		December 31, 2011		December 31, 2011
			Fair Value Measurements at Reporting Date Using
	December 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(in thousands)

Fixed maturities available for sale:
U.S. Treasury securities	$	442,324	$	442,324
Obligations of U.S. government corporations and agencies		8,088			$	8,088
Obligations of states and political subdivisions		1,159,065				1,159,065
Corporate securities		457,877				457,877
Mortgage-backed securities		294,617				294,617

Total available for sale		2,361,971		442,324		1,919,647

Equity securities:
Other		7					$	7

Total equity securities		7						7


Total	$	2,361,978	$	442,324	$	1,919,647	$	7

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

(Unaudited)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)


	Fair Value Measurements Using Significant Unobservable Inputs (Level 3) For the Three Months Ended March 31, 2012
	Fixed Maturities Available for Sale		Equity Securities		Total
	(in thousands)
Balance at January 1, 2012	$	—	$	7	$	7

Balance at March 31, 2012	$	—	$	7	$	7


	Fair Value Measurements Using Significant Unobservable Inputs (Level 3) For the Three Months Ended March 31, 2011
	Fixed Maturities Available for Sale		Equity Securities		Total
	(in thousands)
Balance at January 1, 2011	$	—	$	7	$	7

Balance at March 31, 2011	$	—	$	7	$	7

The amortized cost and estimated fair value of investments in fixed maturity and equity securities are as follows:


	March 31, 2012
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
	(in thousands)
Held to maturity:
Obligations of U.S. government corporations and agencies	$	266	$	15				$	281
Obligations of states and political subdivisions		51,011		2,220					53,231
Corporate securities		49,984		3,886					53,870


Total held to maturity		101,261		6,121					107,382


Available for sale:
U.S. Treasury securities		424,513		6,084	$	(375	)		430,222
Obligations of U.S. government corporations and agencies		7,511		500					8,011
Obligations of states and political subdivisions		1,033,423		91,532					1,124,955
Corporate securities		400,165		42,631					442,796
Mortgage-backed securities		244,630		14,727					259,357


Total available for sale		2,110,242		155,474		(375	)		2,265,341


Total fixed maturities	$	2,211,503	$	161,595	$	(375	)	$	2,372,723


Total equity securities	$	7	$		$			$	7

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

(Unaudited)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)


	December 31, 2011
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
	(in thousands)
Held to maturity:
Obligations of U.S. government corporations and agencies	$	266	$	17				$	283
Obligations of states and political subdivisions		66,670		2,425					69,095
Corporate securities		57,999		4,082	$	(26	)		62,055


Total held to maturity		124,935		6,524		(26	)		131,433


Available for sale:
U.S. Treasury securities		434,308		8,016					442,324
Obligations of U.S. government corporations and agencies		7,523		565					8,088
Obligations of states and political subdivisions		1,059,682		99,402		(19	)		1,159,065
Corporate securities		415,193		42,687		(3	)		457,877
Mortgage-backed securities		278,515		16,102					294,617


Total available for sale		2,195,221		166,772		(22	)		2,361,971


Total fixed maturities	$	2,320,156	$	173,296	$	(48	)	$	2,493,404


Total equity securities	$	7	$	—	$	—		$	7

The amortized cost and estimated fair value of fixed maturity securities at March 31, 2012 by contractual maturity are shown below. Expected maturities may 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
	(in thousands)
Held to maturity:
Due through December 31, 2013	$	31,531	$	32,851
Due 2014 through 2017		59,491		63,820
Due 2018 through 2022		266		281
Due after 2022		9,973		10,430

		101,261		107,382


Available for sale:
Due through December 31, 2013		96,232		98,265
Due 2014 through 2017		968,383		1,023,034
Due 2018 through 2022		476,445		523,500
Due after 2022		324,552		361,185

		1,865,612		2,005,984

Mortgage-backed securities		244,630		259,357

		2,110,242		2,265,341

Total fixed maturities	$	2,211,503	$	2,372,723

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

(Unaudited)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

Realized gross gains (losses) from investments were as follows:


	For the Three Months Ended March 31,
	2012		2011
	(in thousands)

Fixed maturity securities:
Available for sale:
Gross gains	$	58	$	70
Equity securities:
Gross gains				16,499
Gross losses				(795	)


Net realized investment gains	$	58	$	15,774

Harleysville Group held securities with unrealized losses at March 31, 2012 and December 31, 2011 as follows:

		$183,561		$183,561		$183,561
	March 31, 2012
					Length of Unrealized Loss
	Fair Value		Unrealized Losses		Less Than 12 Months
	(in thousands)

Fixed maturities:

U.S. Treasury securities	$	183,561	$	375	$	375


Total temporarily impaired securities	$	183,561	$	375	$	375

		$183,561		$183,561		$183,561
	December 31, 2011
					Length of Unrealized Loss
	Fair Value		Unrealized Losses		Less Than 12 Months
	(in thousands)

Fixed maturities:

Obligations of states and political subdivisions	$	8,976	$	19	$	19

Corporate securities		7,956		29		29


Total temporarily impaired securities	$	16,932	$	48	$	48

All of the fixed maturity securities with an unrealized loss at March 31, 2012 are classified as available for sale and are carried at fair value on the balance sheet.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

(Unaudited)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

less that the amortized cost of the security or where the security’s fair value is below cost and Harleysville Group intends to sell, or more likely than not will be required to sell, the security before recovery of its value. Harleysville Group believes, based on its analysis, that these securities are not other than temporarily impaired. However, depending on developments involving both the issuers and worsening economic conditions, these investments may be written down in the income statement in the future.

There were no impairment charges in the three months ended March 31, 2012 or 2011.

6 – Earnings Per Share

The computation of basic and diluted earnings per share is as follows:


	For the Three Months Ended March 31,
	2012		2011
	(in thousands, except per share data)

Numerator for basic and diluted earnings per share:
Net income	$	5,006	$	18,227

Denominator for basic earnings per share – weighted average shares outstanding		27,599,946		27,388,586

Effect of stock incentive plans		596,415		224,179


Denominator for diluted earnings per share		28,196,361		27,612,765


Basic earnings per share	$	.18	$	.67


Diluted earnings per share	$	.18	$	.66

The following options to purchase shares of common stock were not included in the computation of diluted earnings per share because the exercise price of the options was greater than the average market price:


		For the Three Months Ended March 31,
		2011
		(in thousands)
Number of options		105

7 – Reinsurance

Premiums earned are net of amounts ceded of $33,137,000 and $30,673,000 for the three months ended March 31, 2012 and 2011, respectively. Losses and loss settlement expenses are net of amounts ceded of $1,600,000 and $5,422,000 for the three months ended March 31, 2012 and 2011, respectively. Such amounts ceded do not include the reinsurance transactions with the Mutual Company under the pooling arrangement (described below) which are reflected on the face of the income statements, but do include reinsurance with unaffiliated reinsurers.

Pursuant to the terms of the reinsurance pooling agreement with the Mutual Company, each of the insurance subsidiaries of Harleysville Group Inc. and Harleysville Pennland Insurance Company (Pennland), a subsidiary of the Mutual Company, cede premiums, losses and underwriting expenses on all of their respective

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

(Unaudited)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

business to the Mutual Company which, in turn, retrocedes to such subsidiaries and Pennland a specified portion of premiums, losses and underwriting expenses of the Mutual Company and such subsidiaries and Pennland, excluding the financial results associated with workers compensation business for accident years 2011 and following which is retained 100 percent by the Mutual Company. Because this agreement does not relieve Harleysville Group Inc.’s insurance subsidiaries of primary liability as originating insurers, there is a concentration of credit risk arising from business ceded to the Mutual Company. However, the reinsurance pooling agreement provides for the right of offset. The Mutual Company has an A. M. Best rating of “A” (Excellent).

8 – Cash Flows

There were no cash tax payments in the first quarter of 2012. There were cash tax refunds of $324,000 in the first quarter of 2011. Cash interest payments of $2,908,000 and $2,907,000 were made in the first quarter of 2012 and 2011, respectively.

9 – Segment Information

The performance of the personal lines and commercial lines is evaluated based upon underwriting results as determined under statutory accounting practices (SAP).

Financial data by segment is as follows:


	For the Three Months Ended March 31,
	2012			2011
	(in thousands)
Revenues:
Premiums earned:
Commercial lines	$	144,333		$	149,020
Personal lines		54,130			50,733

Total premiums earned		198,463			199,753
Net investment income		20,076			25,585
Realized investment gains		58			15,774
Other		4,665			4,410

Total revenues	$	223,262		$	245,522


Income before income taxes:
Underwriting loss:
Commercial lines	$	(5,925	)	$	(1,864	)
Personal lines		(4,002	)		(6,141	)

SAP underwriting loss		(9,927	)		(8,005	)
GAAP adjustments		(8,385	)		(9,787	)

GAAP underwriting loss		(18,312	)		(17,792	)
Net investment income		20,076			25,585
Realized investment gains		58			15,774
Other		1,862			1,927

Income before income taxes	$	3,684		$	25,494

The GAAP adjustment of $9,787,000 for the three months ended March 31, 2011 includes the impact on deferred acquisition costs related to the ceding commission received in January 2011 of $6,998,000 related to the change in the intercompany pooling agreement as described in Note 3 of the Notes to Consolidated Financial Statements. The impact was all in commercial lines.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

(Unaudited)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

10 – Comprehensive Income

Comprehensive income for the three months ended March 31, 2012 and 2011 consisted of the following:


	For the Three Months Ended March 31,
	2012			2011
	(in thousands)

Net income	$	5,006		$	18,227
Other comprehensive income:
Unrealized gains (losses) on securities:
Unrealized investment holding gains (losses) arising during period, net of taxes (benefits) of $(4,058) and $2,791		(7,535	)		5,184
Less:
Reclassification adjustment for gains included in net income, net of taxes of $(20) and $(5,521)		(38	)		(10,253	)

Net unrealized investment losses		(7,573	)		(5,069	)

Defined benefit pension plans:
Recognized net actuarial loss, net of taxes of $585 and $353		1,087			656

Other comprehensive loss		(6,486	)		(4,413	)

Comprehensive income (loss)	$	(1,480	)	$	13,814

Accumulated other comprehensive income at March 31, 2012 and December 31, 2011 consisted of the following amounts (which are net of tax):


	March 31, 2012			December 31, 2011
	(in thousands)

Unrealized investment gains	$	100,814		$	108,387
Defined benefit pension plan – net actuarial loss		(43,729	)		(44,816	)

Accumulated other comprehensive income	$	57,085		$	63,571

11 – Pension

Harleysville Group Inc. has a frozen pension plan that covers employees hired before January 1, 2006. The net periodic pension cost for the plan, including the Mutual Company, consists of the following components:


	For the Three Months Ended March 31,
	2012			2011
	(in thousands)
Components of net periodic pension cost:
Interest cost	$	2,847		$	2,964
Expected return on plan assets		(2,907	)		(3,102	)
Recognized net actuarial loss		2,462			1,641

Net periodic pension cost:
Entire plan	$	2,402		$	1,503

Harleysville Group portion	$	1,631		$	918

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

(Unaudited)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

Harleysville Group’s expected portion of the 2012 contribution to the pension plan is $11,580,000. Contributions of $4,710,000 were made in the quarter ended March 31, 2012.

12 – Borrowings

Debt is as follows:


	March 31, 2012		December 31, 2011
	(in thousands)

Notes, 5.75%, due 2013	$	100,000	$	100,000
Demand term-loan payable to the Mutual Company, LIBOR plus 1.25%, due 2013		18,500		18,500


Total debt	$	118,500	$	118,500

The fair value of the notes was $102,690,000 and $103,322,000 at March 31, 2012 and December 31, 2011, respectively, based on quoted market prices for the same or similar debt. The carrying value of the remaining debt approximates fair value.

In March 2012, the Company and the Mutual Company agreed to amend the terms of the loan agreement related to the $18,500,000 loan from the Mutual Company to HGI. Accordingly, the maturity date of the loan is now March 18, 2013 and the interest rate is now LIBOR plus 1.25%.

13 – Shareholders’ Equity

Various states have adopted the National Association of Insurance Commissioners (NAIC) risk-based capital (RBC) standards that require insurance companies to calculate and report statutory capital and surplus needs based on a formula measuring underwriting, investment and other business risks inherent in an individual company’s operations. These RBC standards have not affected the operations of Harleysville Group since each of the Company’s insurance subsidiaries has statutory capital and surplus in excess of RBC requirements.

These RBC standards require the calculation of a ratio of total adjusted capital to Authorized Control Level. Insurers with a ratio below 200% are subject to different levels of regulatory intervention and action. Based upon their 2011 statutory financial statements, the ratio of total adjusted capital to the Authorized Control Level for the Company’s six insurance subsidiaries at December 31, 2011 ranged from 406% to 721%.

14 – Income Taxes

As of March 31, 2012, Harleysville Group had no material unrecognized tax benefits or accrued interest and penalties. The Company’s policy is to account for interest as a component of interest expense and penalties as a component of other expense. Federal tax years 2007 through 2011 were open for examination as of March 31, 2012.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

(Unaudited)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

15 – Contingencies

The Harleysville Group insurance subsidiaries are subject to disputes, including litigation and arbitration, arising in the ordinary course of their insurance business. The Company’s estimates of the costs of settling such matters are reflected in its liability for unpaid losses and loss settlement expenses, and the Company does not believe that the ultimate outcome of such matters will have a material adverse effect on its financial condition or results of operations. However, adverse outcomes of insurance claims are possible and could negatively impact the Company’s financial condition and results of operations in the future.

Harleysville Group is also subject to other non-insurance claims proceedings, lawsuits and claims arising in the normal course of business. The Company does not believe that the ultimate liability associated with these claims will have a material adverse effect on its financial condition or results of operations. However, adverse outcomes are possible and could negatively impact the Company’s financial condition and results of operations in the future.

Harleysville Group is also subject to two class action lawsuits in connection with the Merger Agreement with Nationwide described in Note 2 of the Notes to Consolidated Financial Statements. The Company does not believe that the ultimate liability associated with these lawsuits will have a material adverse effect on its financial condition or results of operations. However, adverse outcomes are possible and could negatively impact the Company’s financial condition and results of operations in the future.

16 – New Accounting Standards

In October 2010, the FASB issued ASU 2010-26, “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts (a consensus of the FASB Emerging Issues Task Force).” This ASU amends FASB Accounting Standards Codification (ASC) Topic 944, Financial Services-Insurance, to address which costs related to the acquisition of new or renewal insurance contracts qualify for deferral. The ASU allows insurance entities to defer costs related to the acquisition of new or renewal insurance contracts that are (1) incremental direct costs of the contract transaction (i.e., would not have occurred without the contract transaction), (2) a portion of the employee’s compensation and fringe benefits related to certain activities for successful contract acquisitions, or (3) direct-response advertising costs as defined in ASC Subtopic 340-20, Other Assets and Deferred Costs – Capitalized Advertising Costs. An insurance entity would expense as incurred all other costs related to the acquisition of new or renewal insurance contracts. The amendments in the ASU are effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2011, and can be applied either prospectively or retrospectively. The Company adopted this guidance prospectively during the first quarter of 2012. During 2012, the Company estimates that pre-tax expenses will increase by approximately $20 million as a lower amount of acquisition costs will be capitalized and amortization of the greater December 31, 2011 balance will continue. During the first quarter of 2011, acquisition costs of $42.5 million would have been capitalized in accordance with the guidance in this ASU, compared to $52.7 million of acquisition costs which were capitalized during that period.

In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” The amendments in this ASU result in common fair value measurement and disclosure in U.S. GAAP and IFRSs. The amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. The amendments include: (1) those that clarify the FASB’s intent about the application of existing fair value measurement and disclosure requirements; and (2) those that change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurement. For public entities, the amendments in this ASU are effective during interim and annual periods beginning after December 15, 2011, and are to be applied prospectively. Early application by public entities is not permitted. The adoption of this ASU did not have a material impact on the Company’s results of operations or financial position.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

(Unaudited)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

In June 2011, the FASB issued ASU 2011-05, “Presentation of Comprehensive Income.” Under the amendments in this ASU, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In December 2011, the FASB amended this guidance to postpone the requirement to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income where the components of net income and the components of other comprehensive income are presented, and reinstate previous guidance related to such reclassifications. For public entities, the amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, and are to be applied retrospectively. Early adoption is permitted. The adoption of this ASU did not have a material impact on the Company’s results of operations or financial position.

In September 2011, the FASB issued ASU 2011-08, “Testing Goodwill for Impairment.” The amendments in this ASU permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in ASC Topic 350, Intangibles-Goodwill and Other. Previous guidance under this topic required an entity to test goodwill for impairment, on at least an annual basis, by comparing the fair value of a reporting unit with its carrying amount. If the fair value of the reporting unit is less than its carrying amount, then the second step of the test must be performed to measure the amount of the impairment loss, if any. Under the amendments in this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. This ASU is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption of this ASU did not have a material impact on the Company’s results of operations or financial position.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

Item 2.

Management’s Discussion and Analysis of Financial Condition

and Results of Operations

Certain of the statements contained herein (other than statements of historical facts) are forward-looking statements. Such forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and include estimates and assumptions related to economic, competitive, legislative and regulatory developments. These forward-looking statements are subject to change and uncertainty which are, in many instances, beyond the Company’s control and have been made based upon management’s expectations and beliefs concerning future developments and their potential effect on Harleysville Group. There can be no assurance that future developments will be in accordance with management’s expectations or that the effect of future developments on Harleysville Group will be those anticipated by management. Actual financial results, including premium levels and underwriting results, could differ materially from those anticipated by Harleysville Group depending on the outcome of certain factors, which may include changes in property and casualty loss trends and reserves; the insurance product pricing environment; changes in applicable law; government regulation and changes therein that may impede the ability to charge adequate rates; performance of and instability in the financial markets; investment losses; fluctuations in interest rates; significant catastrophe events in the geographic regions where we do business; decreased demand for property and casualty insurance; availability and price of reinsurance; the A.M. Best group rating of Harleysville Group; and the status of labor markets in which the Company operates.

Overview

The Company’s net income is primarily determined by four elements:

•

net premium income;

•

investment income and realized investment gains (losses);

•

amounts paid or reserved to settle insured claims; and

•

other income and expense.

Variations in premium income are subject to a number of factors, including:

•

limitations on premium rates arising from the competitive marketplace or regulation;

•

limitations on available business arising from a need to maintain the quality of underwritten risks;

•

the Company’s ability to maintain its A (“Excellent”) group rating by A.M. Best; and

•

the ability of the Company to maintain a reputation for efficiency and fairness in claims administration.

Variations in investment income and realized investment gains (losses) are subject to a number of factors, including:

•

general interest rate levels and financial market conditions;

•

specific adverse events affecting the issuers of debt obligations held by the Company; and

•

changes in the prices of debt and equity securities generally and those held by the Company specifically.

Loss and loss settlement expenses are affected by a number of factors, including:

•

the quality of the risks underwritten by the Company;

•

the nature and severity of catastrophic losses;

•

the availability, cost and terms of reinsurance; and

•

underlying settlement costs, including medical and legal costs.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition

and Results of Operations

(Continued)

Variations in other income and expense are affected by a number of factors, including:

•

the level of premiums written by the Mutual Company and its subsidiaries which are subject to the management fee;

•

the amount of flood insurance written and ceded to the National Flood Insurance Program; and

•

the interest rate on debt issued by the Company.

The Company seeks to manage each of the foregoing to the extent within its control. Many of the foregoing factors are partially, or entirely, outside of the control of the Company.

Critical Accounting Policies and Estimates

The consolidated financial statements are prepared in conformity with U.S. generally accepted accounting principles, which require Harleysville Group to make estimates and assumptions (see Note 1 of the Notes to Consolidated Financial Statements for the year ended December 31, 2011 included in the Company’s 2011 Annual Report on Form 10-K filed with the SEC). Harleysville Group believes that of its significant accounting policies, the following may involve a higher degree of judgment and estimation. The judgments, or the methodology on which the judgments are made, are reviewed quarterly with the Audit Committee.

Liability for Losses and Loss Settlement Expenses. The liability for losses and loss settlement expenses represents estimates of the ultimate unpaid cost of all losses incurred, including losses for claims which have not yet been reported to Harleysville Group. The amount of loss reserves for reported claims is based primarily upon a case-by-case evaluation of the type of risk involved, knowledge of the circumstances surrounding each claim and the insurance policy provisions relating to the type of loss. The amounts of loss reserves for unreported claims and loss settlement expense reserves are determined utilizing historical information by line of insurance as adjusted to current conditions. Inflation is implicitly provided for in the reserving function through analysis of costs, trends and reviews of historical reserving results. Estimates of the liabilities are reviewed and updated on a regular basis using the most recent information on reported claims and a variety of actuarial techniques. It is expected that such estimates will be more or less than the amounts ultimately paid when the claims are settled. Changes in these estimates are reflected in current operations.

Investments. Generally, unrealized investment gains or losses on investments carried at fair value, net of applicable income taxes, are reflected directly in shareholders’ equity as a component of comprehensive income and, accordingly, have no effect on net income. However, if the fair value of an investment in equity securities declines below its cost and that decline is deemed other than temporary, the amount of the decline below cost is charged to earnings. Per Harleysville Group’s current policy, a fixed maturity security is other than temporarily impaired if the present value of the cash flows expected to be collected is less than the amortized cost of the security or where the security’s fair value is below cost and Harleysville Group intends to sell, or more likely than not will be required to sell, the security before recovery of its value. If Harleysville Group does not intend to sell, or more likely than not will not be required to sell, a fixed maturity security whose fair value has declined below its cost, the amount of the decline below cost due to credit-related reasons is charged to earnings and the remaining difference is included in comprehensive income. Harleysville Group monitors its investment portfolio and at least quarterly reviews investments that have experienced a decline in fair value below cost to evaluate whether the decline is other than temporary. Such evaluations consider, among other things, the magnitude and reasons for a decline, the prospects for the fair value to recover in the near term and Harleysville Group’s intent to retain the investment for a period of time sufficient to allow for a recovery in value. Future adverse investment market conditions, or poor operating results of underlying investments, could result in an impairment charge in the future.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition

and Results of Operations

(Continued)

The severe downturn in the public debt and equity markets in recent years, reflecting uncertainties associated with the mortgage crisis, worsening economic conditions, widening of credit spreads, bankruptcies and government intervention in large financial institutions, has resulted in significant realized and unrealized losses in our investment portfolio in the past. Depending on market conditions going forward, we could incur additional realized and unrealized losses in future periods.

The fair value of equity securities is based on the closing market value. The fair value of mutual fund holdings is based on the closing net asset value reported by the fund. The fair value of fixed maturities is based upon data supplied by an independent pricing service. It can be difficult to determine the fair value of non-traded securities, but Harleysville Group does not own a material amount of non-traded securities.

Policy Acquisition Costs. Currently, policy acquisition costs, such as commissions, premium taxes and certain other underwriting expenses, that are incremental and directly related to the successful acquisition of insurance contracts are deferred and amortized over the effective period of the related insurance policies and in proportion to the premiums earned. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value. The estimation of net realizable value takes into account the premium to be earned, related investment income over the claim paying period, expected losses and loss settlement expenses, and certain other costs expected to be incurred as the premium is earned. Future changes in estimates, the most significant of which is expected losses and loss settlement expenses, may require adjustments to deferred policy acquisition costs. If the estimation of net realizable value indicates that the deferred acquisition costs are not recoverable, they would be written off and further analyses would be performed to determine if an additional liability would need to be accrued.

Contingencies. Besides claims related to its insurance products, Harleysville Group is subject to proceedings, lawsuits and claims in the normal course of business. Harleysville Group assesses the likelihood of any adverse outcomes to these matters as well as potential ranges of probable losses. There can be no assurance that actual outcomes will be consistent with those assessments.

The application of certain of these critical accounting policies to the periods ended March 31, 2012 and 2011 is discussed in greater detail below.

Results of Operations

On September 28, 2011, the Mutual Company and HGI entered into an agreement and plan of merger (the Merger Agreement) with Nationwide the Mutual Company Insurance Company (Nationwide) and a subsidiary of Nationwide (Nationals Sub). Pursuant to the Merger Agreement, the Mutual Company will merge into Nationwide with Nationwide as the surviving Company and the policyholders of the Mutual Company will become policyholders and members of Nationwide. In addition, Nationals Sub will merge into HGI with HGI as the surviving company and a wholly-owned subsidiary of Nationwide. As a result of the merger, all outstanding shares of common stock of HGI held by stockholders, other than Nationwide, will be converted into the right to receive $60.00 per share in cash. The Mutual Company has also entered into a voting agreement with Nationwide under which it agreed to vote its 53% interest in HGI in favor of the merger. The Merger Agreement restricts the Mutual Company, HGI and all affiliates from engaging in certain activities and taking certain actions without Nationwide’s approval, including among others, the payment of shareholder dividends by HGI.

The transactions contemplated by the Merger Agreement are subject to customary closing conditions, including, among others, approvals from stockholders of HGI and members/policyholders of the Mutual Company and Nationwide, the Pennsylvania Insurance Department, the Ohio Insurance Department, and various other regulatory bodies. In April 2012, approvals were received from the stockholders of HGI, the members/policyholders of the Mutual Company and Nationwide, and all necessary regulatory bodies. The transactions are expected to close May 1, 2012. The Merger Agreement provides certain termination rights. In the event that the agreement is terminated under certain conditions by HGI’s Board of Directors, HGI will be required to pay Nationwide a termination fee of $29.6 million and reimburse Nationwide for its transaction expenses.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition

and Results of Operations

(Continued)

Premiums earned decreased $1.3 million, or 0.6%, during the three months ended March 31, 2012 compared to the same period in the prior year primarily due to a decrease of $4.7 million in premiums earned for commercial lines, partially offset by an increase of $3.4 million in premiums earned for personal lines. The decrease in premiums earned for commercial lines was 3.1%, primarily due to lower exposures. The increase in premiums earned for personal lines was 6.7%, primarily due to higher average premiums.

Investment income decreased $5.5 million for the three months ended March 31, 2012 compared to the same period in the prior year primarily due to lower invested assets, a lower investment yield on fixed income securities and short-term investments, and lesser dividends on equity securities.

Net realized investment gains decreased $15.7 million for the three months ended March 31, 2012, compared to the three months ended March 31, 2011, primarily due to realized gains on the sale of equity mutual funds in 2011. There were no impairment charges in the three months ended March 31, 2012 or 2011.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition

and Results of Operations

(Continued)

Harleysville Group held securities with unrealized losses at March 31, 2012 as follows:


					Length of Unrealized Loss
	Fair Value		Unrealized Losses		Less Than 12 Months
	(in thousands)

Fixed maturities:

U.S. Treasury securities	$	183,561	$	375	$	375


Total temporarily impaired securities	$	183,561	$	375	$	375

All of the fixed maturity securities with an unrealized loss at March 31, 2012 are classified as available for sale and are carried at fair value on the balance sheet.

The unrealized losses on fixed maturity investments were primarily due to an increase in interest rates on U.S. Treasury Securities rather than a decline in credit quality. Per Harleysville Group’s current policy, a fixed maturity security is other than temporarily impaired if the present value of the cash flows expected to be collected is less than the amortized cost of the security or where the security’s fair value is below cost and Harleysville Group intends to sell, or more likely than not will be required to sell, the security before recovery of its value. Harleysville Group believes, based on its analysis, that these securities are not other than temporarily impaired. However, depending on developments involving both the issuers and worsening economic conditions, these investments may be written down in the income statement in the future.

An insurance company’s statutory combined ratio is a standard measure of underwriting profitability. This ratio is the sum of (1) the ratio of incurred losses and loss settlement expenses to net earned premium; (2) the ratio of expenses incurred for commissions, premium taxes, administrative and other underwriting expenses to net written premium; and (3) the ratio of dividends to policyholders to net earned premium. The combined ratio does not reflect investment income, federal income taxes or other non-operating income or expense. A ratio of less than 100 percent generally indicates underwriting profitability. Harleysville Group’s statutory combined ratio for the three months ended March 31, 2012 was 105.0% compared to 112.3% for the three months ended March 31, 2011, which includes 4.5% due to the impact of the statutory treatment of the ceding commission received on the unearned premiums ceded to the Mutual Company on January 1, 2011. Excluding the impact of the pool transfer, the statutory combined ratio was 107.8% for the three months ended March 31, 2011. The 2012 period includes 0.8 points of catastrophe losses. The 2011 period includes unusually severe winter weather resulting in losses not meeting the catastrophe definition, as well as 4.5 points of catastrophe losses.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition

and Results of Operations

(Continued)

The statutory combined ratios by line of business for the three months ended March 31, 2012 and March 31, 2011 are shown below.


	For the Three Months Ended March 31,
	2012			2011
Commercial:
Automobile		107.3	%		100.3	%
Commercial multi-peril		103.7	%		117.6	%
Other commercial		108.9	%		87.2	%
Total commercial		102.8	%		113.1	%
Total commercial excluding the impact of the pool transfer					106.0	%

Personal:
Automobile		121.8	%		110.7	%
Homeowners		102.8	%		121.4	%
Other personal		75.4	%		74.0	%
Total personal		110.5	%		112.8	%

Total personal and commercial		105.0	%		112.3	%

Total personal and commercial excluding the impact of the pool transfer					107.8	%

The commercial lines statutory combined ratio decreased to 102.8% for the three months ended March 31, 2012 from 106.0%, excluding the impact of the pool transfer, for the three months ended March 31, 2011. Catastrophe losses in commercial lines represented 0.8 points of the combined ratio in the three months ended March 31, 2012 compared to 3.7 points in the three months ended March 31, 2011. Favorable development in the workers compensation line of business reduced the commercial lines combined ratio by 2.7 points and 2.5 points for the three months ended March 31, 2012 and 2011, respectively.

The personal lines statutory combined ratio decreased to 110.5% for the three months ended March 31, 2012 from 112.8% for the three months ended March 31, 2011. Catastrophe losses in the personal lines represented 0.9 points of the combined ratio in the three months ended March 31, 2012 compared to 6.8 points in the three months ended March 31, 2011.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition

and Results of Operations

(Continued)

The following table presents the liability for unpaid losses and loss settlement expenses by major line of business:


	March 31, 2012		December 31, 2011
	(in thousands)

Commercial:
Automobile	$	269,030	$	272,590
Workers compensation		293,349		307,453
Commercial multi-peril		676,140		679,849
Other commercial		147,564		144,983

Total commercial		1,386,083		1,404,875


Personal:
Automobile		89,008		87,714
Homeowners		48,124		49,955
Other personal		3,178		2,860

Total personal		140,310		140,529


Total personal and commercial		1,526,393		1,545,404

Plus reinsurance recoverables		202,202		244,187


Total liability	$	1,728,595	$	1,789,591

The following table presents the increase (decrease) in the estimated ultimate loss and loss settlement expenses attributable to insured events of prior years for the three months ended March 31, 2012 by line of business:


				Accident Years
	Total			2011			2010			2009 and Prior Years
	(in thousands)

Commercial:
Automobile	$	(1,071	)	$	415		$	(93	)	$	(1,393	)
Workers compensation		(3,841	)					804			(4,645	)
Commercial multi-peril		(3,566	)		125			64			(3,755	)
Other commercial		(1,305	)		128			(142	)		(1,291	)

Total commercial		(9,783	)		668			633			(11,084	)


Personal:
Automobile		1,057			(112	)		1,861			(692	)
Homeowners		(1,405	)		(1,977	)		569			3
Other personal		288			104			70			114

Total personal		(60	)		(1,985	)		2,500			(575	)


Total net development	$	(9,843	)	$	(1,317	)	$	3,133		$	(11,659	)

There was $9.8 million of net favorable development in the provision for insured events of prior years for the three months ended March 31, 2012, of which $9.7 million was in commercial lines and $0.1 million was in personal lines. The favorable development primarily related to the 2001 through 2009 accident years as a result of lower than

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition

and Results of Operations

(Continued)

expected claim severity experienced broadly across all lines of business, particularly workers compensation, commercial multi-peril, commercial automobile, and other liability, partially offset by adverse development in accident year 2010.

There was $13.1 million of net favorable development in the provision for insured events of prior years for the three months ended March 31, 2011, of which $12.5 million was in commercial lines and $0.6 million was in personal lines. The favorable development primarily related to the 2003 through 2008 accident years as a result of lower than expected claim severity experienced broadly across all lines of business, particularly commercial multi-peril, commercial and personal automobile, and workers compensation, partially offset by adverse development in accident year 2010.

Harleysville Group records the actuarial best estimate of the ultimate unpaid losses and loss settlement expenses incurred. The estimate represents the actuarially determined expected amount of future payments on all loss and loss settlement expenses incurred on or before March 31, 2012. Actuarial loss reserving techniques and assumptions, which rely on historical information as adjusted to reflect current conditions, have been consistently applied, after including consideration of recent case reserve activity, during the periods presented. Changes in the estimate of the liability for unpaid losses and loss settlement expenses reflect actual payments and evaluations of new information and data since the last reporting date. These changes correlate with actuarial trends.

The following table presents the liability for unpaid losses and loss settlement expenses (LAE) by case and incurred but not reported (IBNR) reserves by line of business as of March 31, 2012:


	Case		IBNR			LAE Liability		IBNR (Incl. LAE)		Total Liability
	(in thousands)
Commercial:
Automobile	$	89,515	$	128,514		$	51,001	$	179,515	$	269,030
Workers compensation		127,010		122,854			43,485		166,339		293,349
Commercial multi-peril		186,282		307,049			182,809		489,858		676,140
Other commercial		31,579		79,893			36,092		115,985		147,564

Total commercial		434,386		638,310			313,387		951,697		1,386,083


Personal:
Automobile		41,719		31,271			16,018		47,289		89,008
Homeowners		15,691		23,695			8,738		32,433		48,124
Other personal		985		1,743	��		450		2,193		3,178

Total personal		58,395		56,709			25,206		81,915		140,310


Total net liability		492,781		695,019			338,593		1,033,612		1,526,393


Reinsurance recoverables		126,152		75,681			369		76,050		202,202


Total gross liability	$	618,933	$	770,700		$	338,962	$	1,109,662	$	1,728,595

Reinsurance recoverables were $204.2 million and $245.9 million at March 31, 2012 and December 31, 2011, respectively. Of these amounts, $99.9 million and $137.7 million, respectively, or 49% and 56%, respectively, of the recoverables were due from governmental bodies, regulatory agencies or quasi-governmental pools and reinsurance facilities where Harleysville Group believes there is limited credit risk. The remainder of the reinsurance recoverables are

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition

and Results of Operations

(Continued)

principally due from reinsurers rated A- or higher by the A.M. Best Company. Ceded reinsurance contracts do not relieve Harleysville Group’s primary obligation to its policyholders. Consequently, an exposure exists with respect to reinsurance recoverables to the extent that any reinsurer is unable to meet its obligation or disputes the liabilities assumed under the reinsurance contract. From time to time, Harleysville Group may encounter such disputes with its reinsurers. In addition, the creditworthiness of our reinsurers could deteriorate in the future due to adverse events affecting the reinsurance industry, such as a large number of major catastrophes.

Effective January 1, 2012, the Company’s subsidiaries and the Mutual Company and its wholly owned subsidiary renewed the top layer of its property catastrophe reinsurance program and decreased reinsurance coverage in the layer from 75% to 64.35%. Accordingly, effective January 1, 2012, pursuant to the terms of the property catastrophe treaties, the maximum recovery would be $357.8 million for any catastrophe involving an insured loss equal to or greater than $525.0 million. Harleysville Group’s pooling share of this maximum recovery would be $286.3 million for any catastrophe involving an insured loss of $420.0 million or greater.

Because of the nature of insurance claims, there are uncertainties inherent in the estimates of ultimate losses. Harleysville Group’s reorganization of its claims operation in recent years has resulted in new people and processes involved in settling claims. As a result, more recent statistical data reflects different patterns than in the past and gives rise to uncertainty as to the pattern of future loss settlements. There are uncertainties regarding future loss cost trends particularly related to medical treatments and automobile repair. Court decisions, regulatory changes and economic conditions can affect the ultimate cost of claims that occurred in the past. Accordingly, the ultimate liability for unpaid losses and loss settlement expenses will likely differ from the amount recorded at March 31, 2012.

The property and casualty industry has had substantial aggregate loss experience from claims related to asbestos-related illnesses, environmental remediation, product liability, mold, and other uncertain exposures. Harleysville Group has not experienced significant losses from such claims.

In the first quarter of 2012, Harleysville Group had income before income taxes of $3.7 million, compared to $25.5 million in the first quarter of 2011. The decrease in income before income taxes of $21.8 million for the three months ended March 31, 2012, as compared to the same period in 2011, was primarily due to lesser investment income and realized gains in the 2012 period compared to the 2011 period. The increase in other underwriting expenses in the first quarter of 2012 is primarily due to the adoption of new accounting guidance (ASU 2010-26) related to the capitalization of acquisition costs.

The income tax expense for the three month periods ended March 31, 2012 and 2011 includes a tax benefit of $2.8 million and $3.4 million, respectively, related to tax-exempt investment income.

Liquidity and Capital Resources

Operating activities used net cash of $41.0 million and $28.1 million for the three months ended March 31, 2012 and 2011, respectively. The 2011 amount includes $33.0 million paid in connection with the change to the intercompany pooling agreement effective January 1, 2011. The remaining change of $45.9 million is due to a decrease in underwriting cash flow, including the change in the due to affiliate balance.

Investing activities provided $40.9 million and $37.1 million of net cash for the three months ended March 31, 2012 and 2011, respectively. The change is primarily due to greater net sales of investments in the 2012 period due to the decrease in cash provided by operating activities, partially offset by the increase in cash provided by financing activities.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition

and Results of Operations

(Continued)

Financing activities provided $0.1 million and used $9.0 million of net cash for the three months ended March 31, 2012 and 2011, respectively. The change is primarily due to the decrease in dividends paid.

Harleysville Group’s investment strategy is designed to complement and support the insurance operations. Harleysville Group considers projected cash flow (premiums, investment income, reinsurance programs, liability payout patterns, general expenses, large seasonal obligations, intercompany transfers, etc.) to assure that sufficient liquidity exists within Harleysville Group and the Mutual Company. Maintaining a regular maturity schedule in readily marketable securities is an essential part of addressing liquidity. This regular maturity schedule is maintained in all interest rate environments. After-tax yield will be maximized consistent with safety and liquidity considerations by investment in taxable or tax-exempt securities, depending on Harleysville Group’s tax position. Proceeds from the maturities of fixed income securities in the first quarter of 2012 were reinvested in short-term investments.

Harleysville Group Inc. had $30.9 million of cash and marketable securities at March 31, 2012 which is available for general corporate purposes including dividends, debt service, capital contributions to subsidiaries, acquisitions and the repurchase of stock. On August 6, 2010, the Board of Directors authorized the Company to repurchase up to 800,000 shares of its outstanding common stock over a two year period in the open market or in privately negotiated transactions. Additionally, the Board authorized the Company to make purchases under the terms of a Rule 10b5-1 trading plan, which allows the Company to purchase its shares at times when it ordinarily would not be in the market because of self-imposed trading blackout periods, such as the time preceding its quarterly earnings releases, or because its officers are in possession of material, non-public information. The Company repurchased shares in open market transactions from the public float and did not repurchase shares from the Mutual Company. As of March 31, 2012, the Company had repurchased 245,084 shares under this authorization, leaving 554,916 shares authorized to be repurchased. Provisions in the Merger Agreement with Nationwide restrict the Company from repurchasing further shares. Harleysville Group has no other material commitments for capital expenditures as of March 31, 2012.

As a holding company, the Company’s principal source of cash for the payment of dividends is dividends from its insurance subsidiaries. The Company’s insurance subsidiaries are subject to state laws that restrict their ability to pay dividends. The Company’s insurance subsidiaries did not declare or pay dividends to the Company in 2012.

The timing of future cash payments associated with unpaid losses and loss settlement expenses and contractual obligations pursuant to debt agreements is not expected to be materially different from that disclosed in the Company’s annual report on Form 10-K for fiscal year 2011.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

Item 3.

Quantitative and Qualitative Disclosure

about Market Risk

Harleysville Group’s market risk generally represents the risk of gain or loss that may result from the potential change in the fair value of Harleysville Group’s investment portfolio as a result of fluctuations in prices and interest rates. Harleysville Group attempts to manage its interest rate risk by maintaining an appropriate relationship between the average duration of the investment portfolio and the approximate duration of its liabilities. Changes to Harleysville Group’s market risk since December 31, 2011 are reflected within Management’s Discussion and Analysis of Financial Condition and Results of Operations and within the financial statements contained within this Form 10-Q.

Harleysville Group has maintained approximately the same duration of its investment portfolio to its liabilities from December 31, 2011 to March 31, 2012.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

Item 4.

Controls and Procedures

(a)

Evaluation of disclosure controls and procedures. Our management, under the supervision and with the participation of the chief executive officer and the chief financial officer, has evaluated the effectiveness of our disclosure controls and procedures as required by Rule 13a-15(b) or Rule 15d-15(b) of the Securities Exchange Act of 1934, as amended, as of March 31, 2012, which is the end of the period covered by this quarterly report on Form 10-Q. Based on that evaluation, the chief executive officer and chief financial officer have concluded that these disclosure controls and procedures are effective to provide that (a) material information relating to us, including our consolidated subsidiaries, is made known to these officers by other employees of us and our consolidated subsidiaries, particularly material information related to the first quarter of 2012, for which this periodic report is being prepared; and (b) this information is recorded, processed, summarized, evaluated and reported, as applicable, within the time periods specified in the rules and forms of the SEC.

(b)

Change in internal control over financial reporting. There was no change in the Company’s internal control over financial reporting that occurred during the first quarter of 2012 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

PART II. OTHER INFORMATION

ITEM 1.

Legal Proceedings

Stockholder Lawsuits

Louisiana Municipal Police Employees Retirement System v. Harleysville Group Inc., et al.

On October 4, 2011, the Company, the Mutual Company, the Company’s directors, Nationwide and a subsidiary of Nationwide (Merger Sub) were named as defendants in a putative class action complaint in the Court of Chancery of the State of Delaware, captionedLouisiana Municipal Police Employees Retirement System v. Harleysville Group Inc., et al.That action, purportedly brought on behalf of a class of stockholders, alleges that the Company’s directors breached their fiduciary duties of care, loyalty, good faith, candor and independence. The complaint further alleges that the Company’s directors, through their acts, transactions and courses of conduct, are attempting to unfairly deprive stockholders of the true value of their investment in the Company. The complaint further alleges that there exists an imbalance and disparity of knowledge between our directors and our public stockholders which makes it inherently unfair for the Company’s directors to benefit from their own interests to the exclusion of maximizing stockholder value. The complaint further alleges that the Company’s directors failed to disclose to the plaintiffs all material information necessary to cast an informed stockholder vote on the proposed transaction. The complaint further alleges that Nationwide and Merger Sub aided and abetted the claimed breaches of fiduciary duties by our directors. The plaintiff seeks injunctive and other equitable relief, including a request that the court enjoin us from consummating the Merger, as well as damages, fees and costs. To date, by agreement of the parties, the Company has not filed an answer to this complaint.

Eric H. Berger v. Harleysville Group Inc., et al.

On October 6, 2011, the Company, the Mutual Company, the Company’s directors, Nationwide and Merger Sub were named as defendants in a putative class action complaint in the Court of Chancery of the State of Delaware, captionedEric H. Berger v. Harleysville Group Inc., et al.That action, purportedly brought on behalf of a class of stockholders, alleges that the Company’s directors breached their fiduciary duties of care, loyalty, good faith, candor and independence. The complaint further alleges that the directors, through their acts, transactions and courses of conduct, are attempting to unfairly deprive our stockholders of the true value of their investment in the Company. The complaint further alleges that there exists an imbalance and disparity of knowledge between the Company’s directors and its public stockholders which makes it inherently unfair for the Company’s directors to benefit from their own interests to the exclusion of maximizing stockholder value. The complaint further alleges that the directors failed to disclose to the plaintiffs all material information necessary to cast an informed stockholder vote on the proposed transaction. The complaint further alleges that Nationwide and Merger Sub aided and abetted the claimed breaches of fiduciary duties by the Company’s directors. The plaintiff seeks injunctive and other equitable relief, including a request that the court enjoin the Company from consummating the Merger, as well as damages, fees and costs. To date, by agreement of the parties, the Company has not filed an answer to this complaint.

Consolidated Stockholder Lawsuits

The plaintiffs in both the Louisiana Municipal Police Employees Retirement System and the Berger cases are represented by the same law firm. On October 21, 2011, the Court of Chancery of Delaware entered an order agreed to by counsel for the plaintiffs and counsel for the Company, the Mutual Company, the Company’s directors, Nationwide and Merger Sub consolidating both cases. On January 3, 2012, the plaintiffs filed their Consolidated Amended Class Action Complaint, which adds allegations about the sale process, asserting that there was not a vigorous enough effort to find other buyers at a higher price together with alleged disclosure shortfalls, all by reference to the preliminary proxy statement filed by the Company with the SEC on December 23, 2011. To date, by agreement of the parties, the Company has not filed an answer to the Consolidated Amended Class Action Complaint.

Policyholder Lawsuits

After the announcement of the Merger Agreement, the Mutual Company received five letters on behalf of purported policyholders objecting to the merger of the Mutual Company into Nationwide (the Parent Merger). Six lawsuits were filed against the Mutual Company brought by purported policyholders challenging the proposed transaction. Initially, Nationwide was named as a defendant in three of these suits. Since their initial filing, three of the lawsuits against the Mutual Company have been dismissed and the remaining three consolidated into one action. For additional procedural history regarding the original policyholder actions, please see the Harleysville Group Definitive Proxy Statement, filed in March 2012.

On January 20, 2012, pursuant to a Court Order, plaintiffs filed a Consolidated Class Action and Derivative Complaint (the CCADC) on behalf of the three plaintiffs with continuing lawsuits against the Mutual Company. The CCADC contains nine claims variously stated as being derivative and/or class in nature: (1) declaratory and injunctive relief contending that the Merger and the Parent Merger (the Mergers) are fundamentally unfair; (2) declaratory and injunctive relief contending that the draft proxy statement for the policyholders-members of the Mutual Company, which was filed by the Mutual Company with the Pennsylvania Insurance Department on December 23, 2011, is materially misleading; (3) declaratory relief contending that the Merger Agreement prevents the Special Litigation Committee formed by the Mutual Company’s board of directors from performing its authorized function; (4) equitable relief contending that the Mutual Company has been effectively demutualized; (5) breach of duty by the Mutual Company’s directors; (6) aiding and abetting a breach of duty by the Mutual Company’s directors, Nationwide and Merger Sub; (7) unjust enrichment against the Mutual Company’s directors, the two directors of the Company who are only directors of the Company, the Mutual Company, Nationwide and Merger Sub; (8) constructive trust against the Mutual Company, Nationwide and Merger Sub; and (9) declaratory and injunctive relief to enjoin enforcement of allegedly unlawful provisions of the Merger Agreement against Nationwide and the Company. On January 31, 2012, all defendants filed preliminary objections to the CCADC.

In response to the demands and complaints, the Mutual Company’s Board of Directors established a Special Litigation Committee to investigate the claims set forth in the demands and complaints and to determine the most appropriate actions for the Mutual Company to take in response to them. The Special Litigation Committee consists of three newly appointed independent directors of the Mutual Company. None of the members of the Special Litigation Committee own any stock of the Company. On February 8, 2012, the Court issued an Order which granted the Special Litigation Committee’s motion to have until March 1, 2012 to issue its report on its investigation.

On March 1, 2012, the Special Litigation Committee issued a report of its investigation, which concluded that: (1) the Mutual Company directors had fulfilled their fiduciary obligations and had not breached their duties of care and loyalty in negotiating and entering into the Merger Agreement with Nationwide; (2) the Merger Agreement transaction is intrinsically fair and satisfies the standards of both fair process and fair result; (3) the derivative claims filed by the plaintiffs lack merit; (4) it is in the best interests of the Mutual Company that the plaintiffs’ derivative claims be dismissed; (5) the Parent Merger is in the best interests of the Mutual Company, including its policyholders; and (6) substantial delay in the consummation of the Parent Merger would be damaging to the Mutual Company and, therefore, the Parent Merger should proceed without further disruption. On the same day, the Special Litigation Committee filed a motion to dismiss the derivative claims contained in the CCADC.

Following a hearing held on April 19-20, 2012, on April 23, 2012 the Court issued an Order which (1) denied the plaintiffs’ motion for preliminary injunction because plaintiffs failed to show they would be irreparably harmed if the Parent Merger was consummated since any harm the policyholders may suffer can be recompensed with money damages and since plaintiffs failed to show that the proxy statement submitted to members/policyholders contained false statements of material fact or that material facts were omitted from the proxy statement; (2) determined, at such time, not to impose a constructive trust over the merger consideration to be paid to directors and officers of the Mutual Company who are defendants under the CCADC; (3) granted, in part, the defendants’ motion to dismiss for lack of irreparable harm with respect to (a) the plaintiffs’ request to enjoin the Mutual Company policyholder vote; (b) to require the Mutual Company to issue a new proxy statement; and (c) to strike certain provisions from the Merger Agreement; and (4) found the Court lacked jurisdiction to impose a constructive trust over the merger consideration to be paid to the stockholders of the Company who are not parties to the CCADC.

ITEM 1A.

Risk Factors

The business, results of operations and financial condition, and therefore the value of Harleysville Group’s securities, are subject to a number of risks. Some of those risks are set forth in the Company’s annual report on Form 10-K for fiscal year 2011, filed with the SEC on March 14, 2012. There has been no material change from the risk factors as previously disclosed in the Company’s annual report on Form 10-K for the fiscal year ended December 31, 2011.

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities⁽¹⁾


Period	Total Number of Shares Purchased⁽²⁾		Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs

January 1 – January 31, 2012		-0-				-0-		554,916
February 1 – February 29, 2012		33,958	$	56.75		-0-		554,916
March 1 – March 31, 2012		343	$	57.54		-0-		554,916

(1)

On August 6, 2010, the Board of Directors authorized the Company to repurchase up to 800,000 shares of its outstanding common stock over a two year period in the open market or in privately negotiated transactions. Additionally, the Board authorized the Company to make purchases under the terms of a Rule 10b5-1 trading plan, which allows the Company to purchase its shares at times when it ordinarily would not be in the market because of self-imposed trading blackout periods, such as the time preceding its quarterly earnings releases, or because its officers are in possession of material, non-public information. The Company repurchased shares in open market transactions from the public float, and did not repurchase shares from the Mutual Company. As of March 31, 2012, the Company had repurchased 245,084 shares under this authorization, leaving 554,916 shares authorized to be repurchased. Provisions in the Merger Agreement with Nationwide restrict the Company from repurchasing further shares.

(2)	In accordance with the terms of its Equity Incentive Plan, the Company acquired all of the above shares from employees in connection with the vesting of restricted stock and restricted stock units. The stock was received in satisfaction of withholding taxes due upon vesting.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

PART II. OTHER INFORMATION

(Continued)


Item 6.	a.	Exhibits

		10L2*	Fourth Amendment to Loan Agreement effective March 15, 2012 by and between Harleysville Group Inc. and Harleysville Mutual Insurance Company.

		31.1*	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

		31.2*	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

		32.1*	Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

		32.2*	Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

		101.INS**	XBRL Instance Document.

		101.SCH**	XBRL Taxonomy Extension Schema Document.

		101.CAL**	XBRL Taxonomy Extension Calculation Linkbase Document.

		101.LAB**	XBRL Taxonomy Extension Label Linkbase Document.

		101.PRE**	XBRL Taxonomy Extension Presentation Linkbase Document.

		101.DEF**	XBRL Taxonomy Extension Definition Linkbase Document.

*	Filed herewith.

**	Furnished and not filed herewith.

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	Harleysville Group Inc.

Date: April 30, 2012	By:	/s/ ARTHUR E. CHANDLER
		Arthur E. Chandler Senior Vice President and Chief Financial Officer (principal financial officer)

HARLEYSVILLE GROUP INC. AND SUBSIDIARIES

EXHIBIT INDEX


Exhibit No.		Description of Exhibits

10L2*		Fourth Amendment to Loan Agreement effective March 15, 2012 by and between Harleysville Group Inc. and Harleysville Mutual Insurance Company.

31.1*		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2*		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1*		Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2*		Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS**		XBRL Instance Document.

101.SCH**		XBRL Taxonomy Extension Schema Document.

101.CAL**		XBRL Taxonomy Extension Calculation Linkbase Document.

101.LAB**		XBRL Taxonomy Extension Label Linkbase Document.

101.PRE**		XBRL Taxonomy Extension Presentation Linkbase Document.

101.DEF**		XBRL Taxonomy Extension Definition Linkbase Document.

*	Filed herewith.

**	Furnished and not filed herewith.

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	8th grade Bad

Large accelerated filer

Accelerated filer

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company