UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

SPECIALTY UNDERWRITERS’ ALLIANCE, INC.

(888) 782-4672
(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 requirement for the past 90 days. Yes x      Noo

Indicate by check mark whether the registrant is an accelerated filer (as defined in the Exchange Act Rule 12b-2). Yes o     Nox

As of May 13, 2005, there were 14,680,688 shares of common stock, $0.01 par value, outstanding and 42,376 shares of Class B common stock, $0.01 par value, outstanding.

SPECIALTY UNDERWRITERS’ ALLIANCE, INC.

INDEX

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      Certain statements in this Quarterly Report on Form 10-Q are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements are subject to the safe harbor provisions of this legislation. The Company may, in some cases, use words such as “project,” “believe,” “anticipate,” “plan,” “expect,” “estimate,” “intend,” “should,” “would,” “could,” “will,” or “may,” or other words that convey uncertainty of future events or outcomes to identify these forward-looking statements. Even though the Company believes that its expectations regarding future events are based on reasonable assumptions, forward-looking statements are not guarantees of future performance. Important factors could cause actual results to differ materially from the Company’s expectations contained in its forward-looking statements.

      There are a number of important factors that could cause actual results to differ materially from the results anticipated by these forward-looking statements. These important factors include those that we discuss in Item 3 under the caption “Quantitative and Qualitative Disclosures About Market Risk.” You should read these factors and other cautionary statements as being applicable to all related forward-looking statements wherever they appear. If one or more of these factors materialize, or if any underlying assumptions prove incorrect, our actual results, performance or achievements may vary materially from any future results, performance or achievements expressed or implied by these forward-looking statements. The Company undertakes no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

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PART I — FINANCIAL INFORMATION

Item 1: Financial Statements

      A. Financial Statements of Specialty Underwriters’ Alliance, Inc.

Balance Sheets

The accompanying notes are an integral part of these financial statements.

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Statements of Income and Comprehensive Income
(Unaudited)

The accompanying notes are an integral part of these financial statements.

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Statements of Stockholders’ Equity
(Unaudited)

The accompanying notes are an integral part of these financial statements.

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Statement of Cash Flows
(Unaudited)

The accompanying notes are an integral part of these financial statements.

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NOTES TO FINANCIAL STATEMENTS — SPECIALTY UNDERWRITERS’
ALLIANCE, INC. (dollars in thousands)

Note 1 — Basis of Presentation

      The Condensed Consolidated Financial Statements (unaudited) include the accounts of Specialty Underwriters’ Alliance, Inc. (SUA) and its consolidated subsidiary, SUA Insurance Company. SUA completed an initial public offering (IPO) of its common stock on November 23, 2004. Concurrent with the IPO, SUA completed the acquisition of Potomac Insurance Company of Illinois (Potomac). For accounting purposes Potomac is considered an accounting predecessor. Potomac has subsequently been renamed SUA Insurance Company.

      The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). Certain financial information that is normally included in annual financial statements, including certain financial statements footnotes, prepared in accordance with GAAP, is not required for interim reporting purposes and has been condensed or omitted. These statements should be read in conjunction with the consolidated financial statements and notes thereto included in SUA’s Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2004.

      The interim financial data as of March 31, 2005, and for the three months ended March 31, 2005 and for the three months ended March 31, 2004 is unaudited. However, in the opinion of management, the interim data includes all adjustments, consisting of normal recurring accruals, necessary for a fair statement of the company results for the interim periods. The results of operation for the interim periods are not necessarily indicative of the results to be expected for the full year. Certain reclassifications have been made to prior period financial statement line items to enhance the comparability of the results presented.

      The predecessor financial statements of Potomac reflect Potomac as a participant in the One Beacon Insurance Company (OneBeacon) Amended and Restated Reinsurance Agreement. Under that agreement Potomac ceded all of its insurance assets and liabilities into a pool (Pool) and assumed a 0.5% share of the Pool’s assets and liabilities. On April 1, 2004 Potomac ceased its participation in the Pool and entered into reinsurance agreements whereby Potomac reinsured all of its business written with One Beacon effective as of January 1, 2004. As a result, Potomac will not share in any favorable or unfavorable development of prior losses recorded by it or the Pool after January 1, 2004, unless One Beacon fails to perform on its reinsurance obligation.

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NOTES TO FINANCIAL STATEMENTS — SPECIALTY UNDERWRITERS’
ALLIANCE, INC. (dollars in thousands)

Note 2. Net Loss Per Share

      Net Loss per share was determined by dividing the net loss by the applicable shares outstanding (in thousands):

Note 3. Income Taxes

      As of March 31, 2005 and December 31, 2004 the Company had net operating loss carryforwards of $10,305 and $5,812, respectively. The Company also had, at March 31, 2005 and December 31, 2004, accumulated start-up and organization expenditures of $2,920 that are deductible over a 60 month period. These loss carry forwards and start up and organization expenditures generate a potential asset of $4,497 and $2,969 at March 31, 2005 and December 31, 2004, respectively. The Company has recorded a full valuation allowance against these tax assets until such time as its operating results and future outlook produce sufficient taxable income to realize these tax assets.

Note 4. Commitments

      The Company has entered into an arrangement with Syndicated Services Company, Inc. (“SSC”) for administrative and operation support. The agreement with SSC, dated November 1, 2003, is for a term of 26 months. For the 2005 calendar year the Company will pay SSC a fee of approximately $8,733 in equal monthly installments, commencing January 1, 2005. Either the Company or SSC can terminate the agreement at any time after October 1, 2005 upon 90 days’ written notice.

      On February 3, 2005, the Company entered into a lease agreement for its office space that commences on May 1, 2005 and terminates on April 30, 2020. The Company’s future net lease obligations are $1,432 for years 1 through 5, $2,374 for years 6 through 10 and $2,686 for years 11 through 15.

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NOTES TO FINANCIAL STATEMENTS — SPECIALTY UNDERWRITERS’
ALLIANCE, INC. (dollars in thousands)

Note 5. Stock Options

      The Board of Directors approved the Stock Option Plan during 2004. The Stock Option Plan authorizes the grant of options to certain personnel for up to 850,000 shares of the Company’s common stock. All options granted have ten-year terms and vest ratably over the three-year period following the date of grant. The number of shares available for the granting of options under the Stock Option Plan as of March 31, 2005, was 198,534.

      The following table presents activity under the Stock Option Plan as of March 31, 2005.

      The weighted average fair value per share of options granted in the first quarter of 2005 was $4.23.

      Pro forma information regarding net income and earnings per share is required by FAS No. 123, “Accounting for Stock-Based Compensation” (“FAS 123”) to reflect net income and earnings per share under the fair value method. In December 2002, the FASB issued FAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (“FAS 148”). FAS 148 amends the disclosure requirements of FAS 123 to require prominent disclosure in both annual and interim financial statements regarding the method of accounting for stock-based compensation and the effect of the method used on reported results.

      In December 2004, the FASB issued FAS No. 123 (revised 2004), “Share-Based Payment” (“FAS 123R”). FAS 123R replaces FAS No. 123, “Accounting for Stock-Based Compensation” (“FAS 123”) and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). In April 2005, the SEC amended compliance dates for FASB Statement No. 123R on Employee Stock Options to allow implementation at the beginning of the next fiscal year, instead of the next reporting period, that begins after June 15, 2005.

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NOTES TO FINANCIAL STATEMENTS — SPECIALTY UNDERWRITERS’
ALLIANCE, INC. (dollars in thousands)

      The fair value of options issued is estimated on the date of grant using the binomial lattice option-pricing model, with the following weighted-average assumptions used for grants as of March 31, 2005: dividend yield of 0% expected for five years beginning 2005 and no more than 2% expected for five years beginning 2010, expected volatility of 45%, risk free interest rate of 2.71% to 4.30% and an expected life of 5.63 years.

Note 6. Intangible Assets

      Intangible assets consist of the cost of insurance licenses of Potomac, allocated as part of the purchase, of $10,745. The cost of insurance licenses is an indefinite life intangible asset because they will remain in effect indefinitely as long as the Company complies with relevant state insurance regulations. This intangible asset will not be amortized, but will be evaluated for impairment at least annually.

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NOTES TO FINANCIAL STATEMENTS — SPECIALTY UNDERWRITERS’
ALLIANCE, INC. (dollars in thousands)

Note 7. Unpaid Loss and Loss Adjustment Expenses

      Loss and LAE reserves are estimates of amounts needed to pay claims and related expenses in the future for insured events that have already occurred. The Company establishes estimates of amounts recoverable from its reinsurers in a manner consistent with the claims liability covered by the reinsurance contracts, net of an allowance for uncollectible amounts. The Company’s loss and LAE reserves represent management’s best estimate of reserves based on a composite of the results of the various actuarial methods, as well as consideration of known facts and trends.

      At March 31, 2005 the Company reported gross loss and loss adjustment expense reserves of $95,832 of which $95,537 represented the gross direct loss and loss adjustment expenses reserves of Potomac, which was fully reinsured by OneBeacon. At December 31, 2004 the Company reported gross loss and loss adjustment expense reserves of $95,959, all of which represented the gross direct loss and loss adjustment expense reserves of Potomac, which was fully reinsured by OneBeacon.

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

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the company’s unaudited financial statement and notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the annual audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 filed with the Securities and Exchange Commission. Certain of the information in this discussion and analysis includes forward-looking statements that involve risks and uncertainties. Many factors will cause our actual results to differ materially from those anticipated or implied by these forward-looking statements.

The Company

Overview

      We were formed on April 3, 2003 for the purpose of achieving attractive returns in the specialty program commercial property and casualty insurance business by using an innovative business model. Specialty programs typically serve niche groups of insureds that require highly specialized knowledge of a business class to achieve underwriting profits. This segment has traditionally been underserved by most standard commercial property and casualty insurers, due to the complex business knowledge and the investment required to achieve attractive underwriting profits. Competition in this segment is based primarily on customer service, availability of insurance capacity, specialized policy forms, efficient claim handling and other value-based considerations, rather than price.

      On November 23, 2004 we completed our initial public offering (IPO) and concurrent private placements and completed the acquisition of Potomac Insurance Company of Illinois (Potomac).

      Prior to our IPO, all activities consisted of start-up activities related to our IPO and costs to establish the infrastructure required to commence insurance operations.

      The historic results of Potomac, our accounting predecessor, reflects Potomac’s operations as a member of the OneBeacon Insurance Company (OneBeacon) inter-company pooling arrangement (Pool), under which Potomac ceded all of its insurance business into the Pool and assumed 0.5% of the Pool’s insurance business. On April 1, 2004, effective January 1, 2004, Potomac ceased its participation in the Pool and entered into reinsurance agreements whereby it ceded all of its business to OneBeacon. As a result, Potomac will not share in any favorable or unfavorable development of prior losses recorded by it