Meadowbrook Insurance (MIG) 10-Q 2000 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549

FORM 10-Q

        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarter ended September 30, 2000

or

        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-14094

Meadowbrook Insurance Group, Inc.

(Exact name of registrant as specified in its charter)

Michigan
(State of Incorporation) 38-2626206
(IRS Employer Identification No.)

26600 Telegraph Road, Southfield, Michigan 48034

(Address, zip code of principal executive offices)

(248) 358-1100

(Registrant’s telephone number, including area code)

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        No

The aggregate number of shares of the Registrant’s Common Stock, $.01 par value, outstanding on November 10, 2000 was 8,512,008.

TABLE OF CONTENTS

PART 1 — FINANCIAL INFORMATION
ITEM 1 — FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED STATEMENT OF INCOME
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
CONDENSED CONSOLIDATED BALANCE SHEET
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AND MANAGEMENT REPRESENTATION
ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
PART II – OTHER INFORMATION
	ITEM 1. LEGAL PROCEEDINGS
	ITEM 6. EXHIBITS AND REPORTS ON FORM 8K
SIGNATURES
Amendment to the Articles of Incorporation
Amendment to Revolving Credit Agreement
Statement re computation of per share earnings
Financial Data Schedule

TABLE OF CONTENTS

				PAGE
PART I — FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
			Condensed Consolidated Statement of Income		3-4
			Consolidated Statement of Comprehensive Income		5
			Condensed Consolidated Balance Sheet		6
			Condensed Consolidated Statement of Cash Flows		7
			Notes to Consolidated Financial Statements and Management Representation		8-14
ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS
		OF FINANCIAL CONDITION AND RESULTS OF
		OPERATIONS			15-22
PART II — OTHER INFORMATION
ITEM 1 – LEGAL PROCEEDINGS					23
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K					24
	SIGNATURES				25

2

PART 1 — FINANCIAL INFORMATION
ITEM 1
FINANCIAL STATEMENTS

MEADOWBROOK INSURANCE GROUP, INC.

CONDENSED CONSOLIDATED STATEMENT OF INCOME

For the Nine Months Ended September 30,
(Unaudited)
(in thousands)

			2000			1999
Revenues:
	Net premium earned		$	118,874		$	88,482
	Net commissions and fees			30,589			27,503
	Net investment income			9,823			8,340
		Total Revenues		159,286			124,325
Expenses:
	Loss and loss adjustment expenses			186,246			139,014
	Reinsurance recoveries			(101,455	)		(73,327	)
	Net loss and loss adjustment expenses			84,791			65,687
	Other operating expenses			35,554			30,211
	Salaries and employee benefits			31,609			31,576
	Interest on notes payable			3,895			2,498
	Amortization of intangible assets			1,461			1,155
		Total Expenses		157,310			131,127
		Income (Loss) Before Income Taxes		1,976			(6,802	)
Federal income tax expense (benefit)				249			(3,140	)
	Net income (loss) before cumulative effect of accounting change			1,727			(3,662	)
	Cumulative effect of accounting for insurance related assessments, net of deferred taxes of $879			—			(1,706	)
	Net Income (Loss)		$	1,727		$	(5,368	)
Basic EPS
	Net income (loss) before cumulative effect of accounting change		$	0.20		$	(0.43	)
	Cumulative effect of accounting change			—		$	(0.19	)
	Net income (loss)		$	0.20		$	(0.62	)
Diluted EPS
	Net income (loss) before cumulative effect of accounting change		$	0.20		$	(0.43	)
	Cumulative effect of accounting change			—		$	(0.19	)
	Net income (loss)		$	0.20		$	(0.62	)

The accompanying notes are an integral part of the consolidated financial statements.

3

MEADOWBROOK INSURANCE GROUP, INC.

CONDENSED CONSOLIDATED STATEMENT OF INCOME

For the Quarter Ended September 30,
(Unaudited)
(in thousands)

			2000			1999
Revenues:
	Net premium earned		$	47,777		$	32,541
	Net commissions and fees			9,887			9,307
	Net investment income			3,644			2,863
		Total Revenues		61,308			44,711
Expenses:
	Loss and loss adjustment expenses			68,491			50,784
	Reinsurance recoveries			(34,812	)		(26,800	)
	Net loss and loss adjustment expenses			33,679			23,984
	Other operating expenses			13,997			13,325
	Salaries and employee benefits			10,611			11,517
	Interest on notes payable			1,277			1,037
	Amortization of intangible assets			500			472
		Total Expenses		60,064			50,335
		Income (Loss) Before Income Taxes		1,244			(5,624	)
Federal income tax expense (benefit)				536			(1,768	)
	Net Income (Loss)		$	708		$	(3,856	)
Basic EPS
	Net income (loss)		$	0.08			($0.45	)
Diluted EPS
	Net income (loss)		$	0.08			($0.45	)

The accompanying notes are an integral part of the consolidated financial statements.

4

MEADOWBROOK INSURANCE GROUP, INC.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

For the Nine Months Ended September 30,
(Unaudited)
(in thousands)

				2000
Net income				$	1,727
	Other comprehensive loss, net of tax:
		Unrealized gains on securities:
			Unrealized holding gains arising during the period		1,319
			Less: reclassification adjustment for losses included in net income		135
Other comprehensive income					1,454
Comprehensive income				$	3,181
					1999
Net loss				$	(5,368	)
	Other comprehensive loss, net of tax:
		Unrealized losses on securities:
			Unrealized holding losses arising during the period		(4,824	)
			Less: reclassification adjustment for gains included in net loss		(23	)
Other comprehensive loss					(4,847	)
Comprehensive loss				$	(10,215	)

MEADOWBROOK INSURANCE GROUP, INC.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

For the Quarter Ended September 30,
(Unaudited)
(in thousands)

				2000
Net income				$	708
	Other comprehensive income, net of tax:
		Unrealized gains on securities:
			Unrealized holding gains arising during the period		1,575
			Less: reclassification adjustment for losses included in net income		14
Other comprehensive income					1,589
Comprehensive income				$	2,297
					1999
Net loss				$	(3,856	)
	Other comprehensive loss, net of tax:
		Unrealized losses on securities:
			Unrealized holding losses arising during the period		(1,249	)
			Less: reclassification adjustment for losses included in net loss		25
Other comprehensive loss					(1,224	)
Comprehensive loss				$	(5,080	)

The accompanying notes are an integral part of the consolidated financial statements.

5

MEADOWBROOK INSURANCE GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEET

ASSETS
(in thousands)

			(Unaudited)
			September 30,			December 31,
			2000			1999
Investments:
	Debt securities available for sale, at fair value (cost of $199,046 and $188,755)		$	198,088		$	185,241
	Equity securities available for sale, at fair value (cost of $16,815 and $17,087)			15,737			16,569
Cash and cash equivalents				28,887			23,713
		Total investments and cash and cash equivalents		242,712			225,523
Premiums and agent balances receivable				92,924			85,707
Reinsurance recoverable on:
	Paid losses			19,208			14,051
	Unpaid losses			133,796			101,744
Deferred policy acquisition costs				15,428			10,030
Prepaid reinsurance premiums				47,970			42,073
Intangible assets				31,905			32,885
Other assets				47,732			39,964
		Total assets	$	631,675		$	551,977
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Reserve for losses and loss adjustment expenses			$	288,938		$	229,244
Unearned premiums				114,407			90,095
Notes payable, bank				51,786			58,463
Other liabilities				73,880			73,767
	Total liabilities			529,011			451,569
Contingencies and commitments
Shareholders’ Equity:
Common stock, $.01 par value; authorized 30,000,000 shares:
	8,512,008 shares issued and outstanding			85			85
Additional paid-in capital				67,922			67,907
Retained earnings				36,770			35,809
Note receivable from officer				(759	)		(720	)
Accumulated other comprehensive income				(1,354	)		(2,673	)
	Total shareholders’ equity			102,664			100,408
		Total liabilities and shareholders’ equity	$	631,675		$	551,977

The accompanying notes are an integral part of the consolidated financial statements.

6

MEADOWBROOK INSURANCE GROUP, INC.

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

For the Nine Months Ended September 30,
(Unaudited)
(in thousands)

			2000			1999
Net cash provided by operating activities			$	27,678		$	20,565
Cash flows (used in) provided by investing activities:
	Purchase of debt securities available for sale			(56,665	)		(55,008	)
	Purchase of equity securities available for sale			(669	)		(10,600	)
	Proceeds from sale of debt securities available for sale			46,186			51,328
	Proceeds from sale of equity securities available for sale			931			1,341
	Other investing activities			(2,821	)		(15,949	)
		Net cash used in investing activities		(13,038	)		(28,888	)
Cash flows (used in) provided by financing activities:
	Net (payments) proceeds of bank loan			(6,678	)		16,594
	Dividends paid on common stock			(766	)		(775	)
	Retirement of common stock			—			(2,087	)
	Other financing activities			(2,022	)		—
		Net cash (used in) provided by financing activities		(9,466	)		13,732
Increase in cash and cash equivalents				5,174			5,409
Cash and cash equivalents, beginning of period				23,713			20,510
Cash and cash equivalents, end of period			$	28,887		$	25,919

The accompanying notes are an integral part of the consolidated financial statements.

7

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – Earnings Per Share (EPS)

	For the Nine Months Ended September 30,
	(Unaudited)
	2000		1999
Basic EPS
Net income (loss) before cumulative effect         of accounting change	$	0.20	$	(0.43	)
Cumulative effect of accounting change		—	$	(0.19	)
Net income (loss)	$	0.20	$	(0.62	)
Diluted EPS
Net income (loss) before cumulative effect         of accounting change	$	0.20	$	(0.43	)
Cumulative effect of accounting change		—	$	(0.19	)
Net income (loss)	$	0.20	$	(0.62	)
Weighted average of number of common          shares outstanding:
Basic		8,511,776		8,614,016
Diluted		8,511,776		8,614,016

8

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued.

NOTE 1 – Earnings Per Share (EPS)

	For the Quarter Ended September 30,
	(Unaudited)
	2000		1999
Basic EPS
Net income (loss) before cumulative effect         of accounting change	$	0.08	$	(0.45	)
Cumulative effect of accounting change		—		—
Net income (loss)	$	0.08	$	(0.45	)
Diluted EPS
Net income (loss) before cumulative effect         of accounting change	$	0.08	$	(0.45	)
Cumulative effect of accounting change		—		—
Net income (loss)	$	0.08	$	(0.45	)
Weighted average of number of common          shares outstanding:
Basic		8,512,008		8,553,479
Diluted		8,512,008		8,553,479

NOTE 2 – Commitments & Contingencies

On June 26, 1995, two shareholders and an officer of a former agent (the “Primary Plaintiffs”) of Star Insurance Company (“Star”), and a former spouse of one shareholder and an employee of the former agent (the “Individual Plaintiffs”) initiated legal proceedings against, among others, Star and Meadowbrook, Inc. (“Meadowbrook”) in the District Court for Washoe County, Reno, Nevada. All of the plaintiffs requested injunctive relief, compensatory damages, punitive and exemplary damages, and attorney’s fees in an unspecified amount. The Nevada Insurance Department revoked the licenses of one of the Primary Plaintiffs and one of the Individual Plaintiffs and denied further licensing of the other Primary Plaintiffs.

9

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued.

Meadowbrook and Star vigorously defended themselves and filed counterclaims against the Primary and Individual Plaintiffs. On April 1, 1998, the Court issued an Order dismissing all claims of the Primary Plaintiffs with prejudice.

On January 12, 1999, the remaining claims of the Individual Plaintiffs and the counterclaims of Meadowbrook and Star against the Primary and Individual Plaintiffs were tried. On February 2, 1999, the jury returned a verdict in favor of Meadowbrook and Star against the Primary Plaintiffs and Individual Plaintiffs. In addition, the jury found against the Individual Plaintiffs and in favor of Meadowbrook and Star on their remaining claims. On April 21, 1999, the Court found in favor of Meadowbrook and Star and against the Primary and Individual Plaintiffs on all outstanding claims for equitable relief. A Final Judgement has been entered with the Court. All plaintiffs have filed an appeal with the Nevada Supreme Court.

It is not expected that the outcome of this litigation will have a material impact on the financial condition of the Company.

The Company is involved in other litigation arising in the ordinary course of operations. While the results of litigation cannot be predicted with certainty, management is of the opinion, after reviewing these matters with legal counsel, that the final outcome of such litigation will not have a material effect upon the Company’s financial statements.

NOTE 3 – Cumulative Effect of Accounting Change

As described in our 1998 Annual Report, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position 97-3, “Accounting by Insurance and Other Enterprises for Insurance-Related Assessments” (“SOP 97-3”). SOP 97-3 provides guidance for determining when an entity should recognize a liability for guaranty-fund and other insurance-related assessments, how to measure that liability, and when an asset may be recognized for the recovery of such assessments through premium tax offsets or policy surcharges. As required, the Company adopted SOP 97-3 in the quarter ended March 31, 1999. The adoption of SOP 97-3 resulted in a non-cash after-tax $1.7 million (net of tax of $879,064), or $0.19 per share, cumulative effect accounting change.

NOTE 4 – Reclassifications

Certain amounts in the 1999 notes to consolidated financial statements have been reclassified to conform to the 2000 presentation.

10

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued.

NOTE 5 – Segment Information

Agency Operations

The agency segment was formed in 1955 as Meadowbrook’s original business. The insurance agency places principally commercial insurance, as well as personal property, casualty, life and accident and health insurance, with more than 50 insurance carriers from which it earns commission income. The agency has grown to be one of the largest agencies in Michigan and, with recent acquisitions, expanded into Florida and California.

Program Business

The program business segment is engaged primarily in developing and managing alternative market risk management programs for defined client groups and their members. This includes providing services, such as reinsurance brokering, risk management consulting, claims handling, and administrative services, along with various types of property and casualty insurance coverage, including workers’ compensation, general liability and commercial multiple peril. Insurance coverage is primarily provided to associations or similar groups of members, commonly referred to as programs. A program is a set of coverages and services tailored to meet the specific requirements of a group of clients.

The following table sets forth the segment results (in thousands):

		For the Nine Months Ended September 30,
		2000			1999
Revenues:
	Net earned premiums	$	118,874		$	88,482
	Management fees		18,369			16,046
	Investment income		9,823			8,340
	Program business segment		147,066			112,868
	Agency operations		12,669			11,963
	Intersegment revenue		(449	)		(506	)
	Consolidated revenue	$	159,286		$	124,325
Pre-tax income (loss):
	Program business	$	4,421		$	(5,273	)
	Agency operations		3,088			2,564
	Reconciling items * (see below)		(5,533	)		(4,093	)
	Consolidated pre-tax income (loss)	$	1,976		$	(6,802	)

11

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – continued.

		For the Quarter Ended September 30,
		2000			1999
Revenues:
	Net earned premiums	$	47,777		$	32,541
	Management fees		6,097			6,136
	Investment income		3,644			2,863
	Program business segment		57,518			41,540
	Agency operations		3,930			3,275
	Intersegment revenue		(140	)		(104	)
	Consolidated revenue	$	61,308		$	44,711
Pre-tax income (loss):
	Program business	$	2,317		$	(4,148	)
	Agency operations		702			134
	Reconciling items * (see below)		(1,775	)		(1,610	)
	Consolidated pre-tax income (loss)	$	1,244		$	(5,624	)

* The pre-tax income reconciling items represent other expenses relating to the holding company, amortization and interest expense, which are not allocated among the segments.

12

MANAGEMENT REPRESENTATION

In the opinion of management, the financial statements reflect all adjustments of a normal recurring nature necessary for a fair presentation of the interim periods. Preparation of financial statements under GAAP requires management to make estimates. Actual results could differ from those estimates. Interim results are not necessarily indicative of results expected for the entire year. These financial statements should be read in conjunction with the Company’s 1999 Form 10-K, as filed with the Securities and Exchange Commission.

Certain statements made by the Company in this document may constitute forward-looking statements. Actual results could differ materially from those projected in forward-looking statements. These forward-looking statements involve risk and uncertainties including, but not limited to the following: the frequency and severity of claims; uncertainties inherent in reserve estimates; catastrophic events; a change in the demand for, pricing of, availability or collectability of reinsurance; increased rate pressure on premiums; obtainment of certain rate increases in current market conditions; investment rate of return; changes in and adherence of insurance regulation; obtainment of certain processing efficiencies; changing rates of inflation; and general economic conditions.

13

ITEM 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

For the Periods ended September 30, 2000 and 1999

Meadowbrook Insurance Group, Inc. (the “Company”) is a program-oriented risk management company specializing in alternative risk management solutions for agents, brokers, profession/trade associations, and insureds of all sizes. The Company owns insurance carriers, which are essential elements of the risk management process. Management defines its business segments as agency operations and program business operations based upon differences in products and services.

RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999

Overview

2000 compared to 1999:

Results from operations, excluding the cumulative effect of an accounting change, improved $5.4 million to net income of $1.7 million in 2000 from a loss of $3.7 million in 1999.

Revenues increased $35.0 million, or 28%, to $159.3 million for the nine months ended September 30, 2000 from $124.3 million for the comparable period in 1999. Revenues from program business increased $34.2 million, or 30.3%, to $147.1 million for the nine months ended September 30, 2000 from $112.9 million for the comparable period in 1999. Agency revenues increased $706,000, or 5.9% to $12.7 million for the nine months ended September 30, 2000 from $12.0 million for the comparable period in 1999.

14

MANAGEMENT’S DISCUSSION AND ANALYSIS – continued
For the Periods Ended September 30, 2000 and 1999

Program Business

The following table sets forth the revenues and results from operations for program business (in thousands):

		Nine Months Ended September 30,
		2000		1999
Revenue:
	Net earned premiums	$	118,874	$	88,482
	Management fees		18,369		16,046
	Investment income		9,823		8,340
	Total Revenue	$	147,066	$	112,868
Pre-tax income (loss):
	Program business	$	4,421	$	(5,273	)

2000 compared to 1999:

Revenue from program business increased $34.2 million, or 30.3%, to $147.1 million for the nine months ended September 30, 2000 from $112.9 million for the comparable period in 1999. This increase reflects 34.3% growth in net earned premiums to $118.9 million from $88.5 million for the nine months ended September 30, 2000 and 1999, respectively. This increase reflects the 1999 acquisition of TPA Associates, Inc., which contributed $8.1 million. Excluding the impact of the 1999 acquisition, net earned premium increased 25.8%, or $22.3 million. This $22.3 million increase in net earned premium includes an increase in existing business of $20.0 million. Earned premiums from programs, which were discontinued in 2000, contributed $8.4 million to the growth in earned premium. These increases were offset by a planned reduction of $5.5 million on programs discontinued in 1999 and prior, and a reduction of $600,000 on residual markets and retrospectively rated policies. Management fees grew $2.3 million, or 14.5%, to $18.4 million from $16.1 million. Excluding the 1999 acquisition of TPA Associates, Inc., management fees would be slightly lower reflecting an anticipated decrease in other management fees on a discontinued managed program. The remaining increase in program business revenue reflects an increase in net investment income of $1.5 million, or 17.8%, from $8.3 million for the nine months ended September 30, 1999 to $9.8 million for the comparable period in 2000. This increase in net investment income reflects an increase in average invested assets of $17.2 million, or 9.0%, relating to both the growth in existing business and the acquisition of TPA associates. Also contributing to this increase is the effect of shifting a larger portion of the investment portfolio to taxable securities to maximize after-tax cash flow.

15

MANAGEMENT’S DISCUSSION AND ANALYSIS – continued
For the Periods Ended September 30, 2000 and 1999

Program business for the nine months ended September 30, 2000 generated pre-tax income of $4.4 million, which compares to a pre-tax loss of $5.3 million for the same period in 1999. The 1999 pre-tax loss in program business reflects the impact of the $4.7 million reserve strengthening charge. The 2000 pre-tax income in program business reflects the improved profit margins from management fees as the Company continues to realize the benefits of the expense reductions initiated in late 1999 and have resulted in savings of over $4.0 million for the nine months ended September 30, 2000.

Agency Operations

The following table sets forth the revenues and results from operations for agency operations (in thousands):

	Nine Months Ended September 30,
	2000		1999
Net commission	$	12,669	$	11,963
Pre-tax income	$	3,088	$	2,564

2000 compared to 1999:

Agency commissions for the nine months ended September 30, 2000 increased $706,000, or 5.9%, to $12.7 million from $12.0 million for the same period in 1999. This growth reflects an increase in the volume of business produced. The agency operation pre-tax income increased $524,000, or 20.4%, from $2.6 million for the nine months ended September 30, 1999 to $3.1 million for the comparable period in 2000.

Other Items

Interest Expense

Interest expense was $3,895,000 and $2,498,000 for the nine months ended September 30, 2000 and 1999, respectively. This interest is principally related to the utilization of the Company’s Line of Credit. The increase in interest expense is a result of both a higher average daily loan balance and higher average interest rates during 2000 as compared to 1999. The average daily loan balances at September 30, 2000 and 1999 were $52.1 million and $42.1 million, respectively. The average interest rate increased from approximately 8.3% at September 30, 1999 to approximately 9.1% at September 30, 2000. The outstanding balance on this line was $45.1 million at September 30, 2000 as compared to $55.7 million at December 31, 1999.

Amortization Expense

Amortization expense was $1,461,000 and $1,155,000 for the nine months ended September 30, 2000 and 1999, respectively. This increase in amortization is related to the goodwill recorded on the 1999 acquisition.

16

MANAGEMENT’S DISCUSSION AND ANALYSIS – continued
For the Periods Ended September 30, 2000 and 1999

Taxes

The provision for income taxes was a $249,000 expense for the nine months ended September 30, 2000, and a $3.1 million benefit for the same period in 1999, representing effective tax rates of 12.6% and (46.2%), respectively. During the third quarter taxes were impacted by a one-time adjustment of $332,000 relating to a write off of tax assets. Excluding this adjustment the effective tax rate for the nine months ended September 30, 2000 would have been a benefit of 4.2%. Historically, the Company’s tax rates vary from the 34% corporate rate due to its heavily tax-exempt investment portfolio. Tax exempt securities at September 30, 2000 represented 36.1% of the portfolio, down from 53.1% at year-end, and down from 59.0% at September 30, 1999. The Company has shifted a larger portion of the investment portfolio to taxable debt securities to maximize after-tax investment yields and minimize current outflow related to taxes.

RESULTS OF OPERATIONS FOR THE QUARTER ENDED SEPTEMBER 30, 2000 AND 1999

Overview

2000 compared to 1999:

Results from operations increased $4.6 million, or 118.4%, to net income of $708,000 in 2000 from a net loss of $3.9 million in 1999.

Revenues for the quarter increased $16.6 million, or 37.1%, to $61.3 million in 2000 from $44.7 million in 1999. Revenues from program business increased $16.0 million, or 38.5%, to $57.5 million for the quarter ended September 30, 2000, from $41.5 million for the same quarter in 1999. Agency revenues increased $655,000, or 20.0%, to $3.9 million during the third quarter 2000 from $3.3 million for the comparable period in 1999.

17

MANAGEMENT’S DISCUSSION AND ANALYSIS – continued
For the Periods Ended September 30, 2000 and 1999

Program Business

The following table sets forth the revenues and results from operations for program business (in thousands):

		Quarters Ended September 30,
		2000		1999
Revenue:
	Net earned premiums	$	47,777	$	32,541
	Management fees		6,097		6,136
	Investment income		3,644		2,863
	Total Revenue	$	57,518	$	41,540
Pre-tax income (loss):
	Program business	$	2,317	$	(4,148	)

2000 compared to 1999:

Revenue from program business increased $16.0 million, or 38.5%, to $57.5 million for the three months ended September 30, 2000 from $41.5 million compared to the same period in 1999. This increase reflects a 46.8% growth in net earned premiums to $47.8 million from $32.5 million during the quarter ended September 30, 2000 compared to the same period in 1999. This increase reflects the 1999 acquisition, which contributed $1.4 million. Excluding the impact of the 1999 acquisition, net earned premium increased 45.4%, or $13.8 million. This $13.8 million increase in net earned premium includes an increase in existing business of $12.0 million. Earned premiums from programs, which were discontinued in 2000, contributed $4.5 million to the growth in earned premium. These increases were offset by a planned reduction of $2.4 million on programs discontinued in 1999 and prior, and a reduction of $300,000 on residual markets and retrospectively rated policies. Management fees were flat at $6.1 million for the three months ended September 30, 2000 and 1999. The remaining increase reflects an increase in net investment income of $781,000, or 27.3%, from $2.9 to $3.6 million for the three months ended September 30, 1999 and 2000, respectively. This increase in net investment income reflects an increase in average invested assets of $17.2 million, or 9.0%, relating to both growth in existing business and the acquisition in 1999.

18

MANAGEMENT’S DISCUSSION AND ANALYSIS – continued
For the Periods Ended September 30, 2000 and 1999

Program business for the three months ended September 30, 2000 generated a pre-tax income of $2.3 million, which compares to a pre-tax loss of $4.1 million for the same period in 1999. The improvement in program business reflects:

• A $3.4 million improvement in the net profits on the management fees as a result of both growth in fee based revenue and the impact of the expense reduction initiatives taken in late 1999.

• A $781,000 increase in net investment income.

• A $2.1 million improvement in underwriting results to a loss of $2.9 million for the three months ended September 30, 2000 from $5.0 million for the comparable period in 1999. The third quarter 1999 underwriting results reflect adverse development, and the cumulative effect in the calendar quarter caused by higher than expected loss ratios and the selection of even higher expected loss ratios for the 1999 accident year in the third quarter of 1999.

• The achievement of rate increases in virtually all lines of business.

Agency Operations

The following table sets forth the revenues and results from operations for agency operations (in thousands):

	Quarters Ended September 30,
	2000		1999
Net commission	$	3,930	$	3,275
Pre-tax income	$	702	$	134

2000 compared to 1999:

Agency commissions increased $655,000, or 20%, to $3.9 million for the three months ended September 30, 2000 from $3.3 million in the comparable period in 1999. This growth reflects an increase in the volume of business produced. Agency operations generated pre-tax income of $702,000 in 2000 compared to $134,000 in 1999.

Other Items

Interest Expense

Interest expense was $1,277,000 and $1,037,000 for the three months ended September 30, 2000 and 1999, respectively. This interest is related to the utilization of the Company’s Line of Credit. The increase in interest expense is a result of both a higher average daily loan balance and higher average interest rates during 2000 as compared to 1999. The average daily loan balances during 2000 and 1999 were $48.6 million and $45.9 million, respectively. The average interest rate increased from approximately 9% at September 30, 1999 to approximately 10.5% at September 30, 2000. The outstanding balance on this line was $45.1 million at September 30, 2000, as compared to $55.7 million at December 31, 1999.

19

MANAGEMENT’S DISCUSSION AND ANALYSIS – continued
For the Periods Ended September 30, 2000 and 1999

Amortization Expense

Amortization expense was $500,000 and $472,000 for the three months ended September 30, 2000 and 1999, respectively. This increase in amortization is related to the goodwill recorded on the 1999 acquisition.

Taxes

The provision for income taxes was a $536,000 expense for the three months ended September 30, 2000, and a $1,768,000 benefit for the same period in 1999, representing effective tax rates of 43.1% and (31.4%), respectively. The third quarter was impacted by a one-time adjustment of $332,000 relating to a write off of tax assets. Excluding this adjustment the effective tax rate for the third quarter of 2000 would have been 16.4%. Historically, the Company’s tax rates vary from the 34% corporate rate due to its heavily tax-exempt investment portfolio. Tax exempt securities at September 30, 2000 represented 36.1% of the portfolio, down from 53.1% at year-end, and down from 59.0% at September 30, 1999. The Company has shifted a larger portion of the investment portfolio to taxable debt securities to maximize after-tax investment yields and minimize current outflow related to taxes.

LIQUIDITY AND CAPITAL RESOURCES

The principal sources of funds for the Company are insurance premiums, investment income, proceeds from the maturity and sale of invested assets, risk management fees and agency commissions. Funds are primarily used for the payment of claims, commissions, salaries and employee benefits, and other operating expenses. In addition, the Company has a high volume of intercompany transactions due to the payment of management fees by the insurance subsidiaries to the risk management subsidiaries, which are subject to regulatory approval by state insurance departments.

Cash flow provided by operations for the nine months ended September 30, 2000 and 1999 was $27.7 million and $20.6 million, respectively. At September 30, 2000, the Company held $28.9 million in cash and cash equivalents.

The Company has an unsecured Revolving Line of Credit (“Line of Credit”) totaling $50.0 million, of which $45.1 million was outstanding at September 30, 2000 and $55.7 million was outstanding at December 31, 1999. The Line of Credit expires on August 1, 2002. The Company drew on this Line of Credit during 1999 primarily to meet acquisition and cash flow needs. The Company also has subordinated debt $3.5 million outstanding at terms substantially equivalent to the unsecured bank line.

The Company had agreed to reduce the Line of Credit from $50 million to $40 million by September 30, 2000. Effective September 30, 2000, the Company and the bank group agreed to reduce the Line of Credit to $48 million rather than $40 million. The Company and the bank group have agreed to further reduce the Line of Credit to $33 million by April 30, 2001. The Company is currently engaged in efforts to complete this transaction by April 30, 2001. Effective September 30, 2000, the Company and the bank group have amended the Line of Credit to reflect these changes.

In addition, a non-insurance subsidiary had a Line of Credit with a bank which permits borrowings up to 80% of the accounts receivable which collateralize the line. This Line of Credit will expire March 31, 2001, and is automatically renewable each year. At September 30, 2000, $3.2 million was outstanding under this Line of Credit.

20

MANAGEMENT’S DISCUSSION AND ANALYSIS – continued
For the Periods Ended September 30, 2000 and 1999

One of the Company’s principal corporate objectives is to operate at appropriate leverage ratios.

The Company’s leverage ratios as of September 30, 2000 were 4.2, 3.4, and 2.3 on a gross written premium, gross written excluding fronted business, and net written premium basis, respectively. These ratios are in excess of the Company's targeted leverage ratios of 4.0, 3.0, and 2.0, respectively. The third quarter ratios were impacted by a number of unusual items, primarily the growth in gross written premium associated with the acceleration of premium processing and the new account of $4.7 million which is a retrospectively rated policy in which we take no risk. The Company has taken actions to reduce the leverage ratios – these include termination of under performing programs and utilization of other fronting companies and the purchase of additional reinsurance. Excluding the impact of the terminated programs, the pro-forma leverage ratios on a gross written premium, gross written excluding fronted business, and net written premium basis would have been 3.5, 2.9, and 1.9, respectively. These pro-forma ratios are within the targeted range.

Other matters

The insurance company subsidiaries cede insurance to other insurers under pro rata and excess-of-loss contracts. The Company also assumes insurance from other insurers and reinsurers, both domestic and foreign, under pro rata and excess-of-loss contracts. These reinsurance agreements diversify the Company’s business and minimize its losses arising from large risks or from hazards of an unusual nature. The ceding of insurance does not discharge the original insurer from its primary liability to its policyholder, and in the event that all or any of the reinsuring companies are unable to meet their obligations, the insurance company subsidiaries would be liable for such defaulted amounts. Therefore, the Company is subject to a credit risk with respect to the obligations of its reinsurers. In order to minimize its exposure to significant losses from reinsurer insolvencies, the Company evaluates the financial condition of its reinsurers and monitors the economic characteristics of the reinsurers on an ongoing basis.

The Company receives ceding commissions in conjunction with reinsurance activities. These ceding commissions are offset against the related underwriting expenses and were $28,442,998 and $24,270,087 for the nine months ended September 30, 2000 and 1999, respectively.

The Company has reinsurance recoverables for paid and unpaid losses of $153,004,000. The Company strives to secure reinsurance balances due from non-admitted reinsurers through funds withheld trusts or letters of credit. The largest unsecured reinsurance recoverable is due from a reinsurer with an “A++” A.M. Best rating and accounts for 13% of the total recoverable for paid and unpaid losses. At September 30, 2000 the Company’s total reinsurance recoverables not secured by funds withheld trust or letters of credit from non-admitted reinsurers equaled approximately $4.6 million or 3% of its total reinsurance recoverables. While it is always possible that certain amounts may not be collected, management currently believes that these amounts should be collectible as and when claims are paid.

21

MANAGEMENT’S DISCUSSION AND ANALYSIS – continued
For the Periods Ended September 30, 2000 and 1999

In December, 1996, the Company entered into a five-year joint underwriting agreement with Connecticut Surety Company (CSC), whereby the Company transferred the underwriting risk on the majority of the Company’s existing surety bond business. Effective June 1, 2000, CSC no longer assumes risk on new or renewal business from the Company, however, one of CSC’s subsidiaries continues to act as a general agent for the Company. This new and renewal business is now 100% reinsured to unaffiliated reinsurers with an A.M. Best Rating of “A” or better.

CSC executed a Subordinated Surplus Note in favor of the Company in the principal sum $195,000. 50% of the principal amount is due on May 26, 2001; the outstanding balance, together with all unpaid interest is due on May 26, 2002. Interest is at 9% per annum, with interest payments to be made quarterly, subject to all terms and conditions of the Note. In addition, Connecticut Surety Corporation executed Promissory Notes in favor of the Company in the amounts of $30,000 and $270,000, due on May 26, 2003 and July 14, 2003, respectively. Interest is at 9% per annum, payable semi-annually beginning on December 31, 2000, subject to the terms and conditions of the Notes.

In December, 1998, CSC entered into an agreement with Evergreen National Indemnity Company to transfer the Contract Surety business that it wrote on behalf of Star Insurance Company to Evergreen National Indemnity Company. The agreement provides for the transfer of the underwriting risk on this class of bonds from CSC to Evergreen National.

At September 30, 2000, the Company has approximately $2.5 million (included in the $4.6 million referenced above) of unsecured reinsurance recoveries on unpaid losses due from CSC. This amounts to less than 1.65% of its total reinsurance recoveries. As stated above, there is a possibility that a certain amount may not be collected, management currently believes that these amounts should be fully collectible as and when claims are paid.

22

PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On June 26, 1995, two shareholders and an officer of a former agent (the “Primary Plaintiffs”) of Star, and a former spouse of one shareholder and an employee of the former agent (the “Individual Plaintiffs”) initiated legal proceedings against, among others, Star and Meadowbrook in the District Court for Washoe County, Reno, Nevada. All of the plaintiffs requested injunctive relief, compensatory damages, punitive and exemplary damages, and attorney’s fees in an unspecified amount. The Nevada Insurance Department revoked the licenses of one of the Primary Plaintiffs and one of the Individual Plaintiffs and denied further licensing of the other Primary Plaintiffs.

The Company vigorously defended itself and filed counter-claims against the Primary and Individual Plaintiffs. On April 1, 1998, the Court issued an Order dismissing all claims of the Primary Plaintiffs with prejudice.

On January 12, 1999, the remaining claims of the Individual Plaintiffs and the counterclaims of Meadowbrook and Star against the Primary and Individual Plaintiffs were tried. On February 2, 1999, the jury returned a verdict in favor of Meadowbrook and Star against the Primary Plaintiffs and Individual Plaintiffs. In addition, the jury found against the Individual Plaintiffs and in favor of Meadowbrook and Star on their remaining claims. On April 21, 1999, the Court found in favor of Meadowbrook and Star and against the Primary and Individual Plaintiffs on all outstanding claims for equitable relief. A Final Judgment has been entered with the Court. All plaintiffs have filed an appeal with the Nevada Supreme Court.

It is not expected that the outcome of this litigation will have a material impact on the financial condition of the Company.

The Company is involved in other litigation arising in the ordinary course of operations. While the results of litigation cannot be predicted with certainty, management is of the opinion, after reviewing these matters with legal counsel, that the final outcome of such litigation will not have a material effect upon the Company’s financial statements.

23

PART II – OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8K

(A) The following documents are filed as part of this Report:

Exhibit
No.	Description
3.3	Amendment to the Articles of Incorporation
10.11	Amendment No. 3 to Revolving Credit Agreement between Meadowbrook Insurance Group, Inc. and Comerica Bank dated as of September 30, 2000
11	Statement re computation of per share earnings
27	Financial Data Schedule

(B) Reports on Form 8-K

None.

24

SIGNATURES

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

	Meadowbrook Insurance Group, Inc.
	By: /s/ Robert S. Cubbin
	President, Chief Operating Officer And Acting Chief Financial Officer
Dated: November 10, 2000

25

EXHIBIT INDEX

Exhibit
No.	Description
3.3	Amendment to the Articles of Incorporation
11	Statement re computation of per share earnings
10.11	Amendment No. 3 to Revolving Credit Agreement between Meadowbrook Insurance Group, Inc. and Comerica Bank dated as of September 30, 2000.
27	Financial Data Schedule