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EX-32.2 - EXHIBIT 32.2 - SeaBright Holdings, Inc.ex32_2.htm
EX-31.1 - EXHIBIT 31.1 - SeaBright Holdings, Inc.ex31_1.htm
EX-32.1 - EXHIBIT 32.1 - SeaBright Holdings, Inc.ex32_1.htm
EX-31.2 - EXHIBIT 31.2 - SeaBright Holdings, Inc.ex31_2.htm


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

FORM 10-Q

(Mark One)
T   Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2009
or

£   Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from ________ to ________

Commission File Number 001-34204

SeaBright Insurance Holdings, Inc.
(Exact name of registrant as specified in its charter)

Delaware
 
56-2393241
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification No.)

1501 4th Avenue, Suite 2600
Seattle, WA 98101
(Address of principal executive offices, including zip code)

(206) 269-8500
(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 T    No £

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, 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. (Check one):
Large accelerated filer £
Accelerated filer T
Non-accelerated filer £
Smaller reporting company £

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
 
Class
 
Shares outstanding as of November 6, 2009
Common Stock, $0.01 Par Value
 
21,673,286
 


 
 

 

SeaBright Insurance Holdings, Inc.

Index to Form 10-Q

       
Page
Part I.
 
Financial Information
   
         
Item 1.
   
2
         
     
2
         
     
3
         
     
4
         
     
5
         
Item 2.
   
18
         
Item 3.
   
39
         
Item 4.
   
40
         
Part II.
 
Other Information
   
         
Item 1A.
   
41
         
Item 6.
   
41
         
 
42

- 1 -


PART I – FINANCIAL INFORMATION
 
Item 1.    Financial Statements

SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
 
CONDENSED CONSOLIDATED BALANCE SHEETS

   
September 30, 2009
   
December 31, 2008
 
   
(Unaudited)
       
   
(in thousands, except share and per share amounts)
 
ASSETS
           
             
Fixed income securities available for sale, at fair value (amortized cost $579,347 in 2009 and $523,892 in 2008)
  $ 605,408     $ 522,289  
Equity securities available for sale, at fair value (cost $11,333 in 2009 and 2008)
    10,444       8,856  
Preferred stock available for sale, at fair value (cost $851 in 2008)
          360  
Cash and cash equivalents
    24,073       22,872  
Accrued investment income
    6,308       6,054  
Premiums receivable, net of allowance
    12,898       16,374  
Deferred premiums
    167,013       163,322  
Service income receivable
    301       322  
Reinsurance recoverables
    30,892       18,544  
Due from reinsurer
    11,802       9,125  
Receivable under adverse development cover
    3,603       4,179  
Prepaid reinsurance
    6,088       1,619  
Property and equipment, net
    5,750       5,190  
Federal income tax recoverable
    2,438       1,671  
Deferred income taxes, net
    18,801       25,144  
Deferred policy acquisition costs, net
    24,328       23,175  
Intangible assets, net
    1,225       1,225  
Goodwill
    4,324       4,212  
Other assets
    6,240       8,154  
Total assets
  $ 941,936     $ 842,687  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
                 
Liabilities:
               
Unpaid loss and loss adjustment expense
  $ 334,644     $ 292,027  
Unearned premiums
    164,072       155,931  
Reinsurance funds withheld and balances payable
    5,640       1,615  
Premiums payable
    6,215       6,783  
Accrued expenses and other liabilities
    55,098       49,518  
Surplus notes
    12,000       12,000  
Total liabilities
    577,669       517,874  
                 
Commitments and contingencies
               
                 
Stockholders’ equity:
               
Series A preferred stock, $0.01 par value; 750,000 shares authorized; no shares issued and outstanding
           
Undesignated preferred stock, $0.01 par value; 10,000,000 shares authorized; no shares issued and outstanding
           
Common stock, $0.01 par value; 75,000,000 shares authorized; issued and outstanding – 21,673,286 shares at September 30, 2009 and 21,392,854 shares at December 31, 2008
    217       214  
Paid-in capital
    204,036       200,893  
Accumulated other comprehensive income (loss)
    17,344       (4,009 )
Retained earnings
    142,670       127,715  
Total stockholders’ equity
    364,267       324,813  
Total liabilities and stockholders’ equity
  $ 941,936     $ 842,687  

See accompanying notes to unaudited condensed consolidated financial statements.

- 2 -


SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2009
   
2008
   
2009
   
2008
 
   
(in thousands, except share and earnings per share information)
 
Revenue:
                       
Premiums earned
  $ 64,427     $ 68,687     $ 182,460     $ 181,094  
Claims service income (loss)
    293       (79 )     782       751  
Other service income
    36       80       147       179  
Net investment income
    5,888       5,571       17,186       16,852  
Other-than-temporary impairment losses:
                               
Total other-than-temporary impairment losses
          (11,456 )     (258 )     (13,405 )
Less portion of losses recognized in accumulated other comprehensive income (loss)
                       
Net impairment losses recognized in earnings
          (11,456 )     (258 )     (13,405 )
Other net realized gains (losses) recognized in earnings
    292       (221 )      217       (401 )
Other income
    1,986       2,820       6,308       6,271  
      72,922       65,402       206,842       191,341  
Losses and expenses:
                               
Loss and loss adjustment expenses
    42,216       39,154       121,992       101,719  
Underwriting, acquisition and insurance expenses
    18,155       17,350       54,039       50,674  
Interest expense
    140       205       466       666  
Other expenses
    3,529       2,793       10,357       7,146  
      64,040       59,502       186,854       160,205  
Income before taxes
    8,882       5,900       19,988       31,136  
Income tax expense
    2,217       4,119       5,033       12,071  
Net income
  $ 6,665     $ 1,781     $ 14,955     $ 19,065  
                                 
Basic earnings per share
  $ 0.32     $ 0.09     $ 0.72     $ 0.93  
Diluted earnings per share
  $ 0.31     $ 0.08     $ 0.70     $ 0.90  
                                 
Weighted average basic shares outstanding
    20,732,801       20,581,822       20,691,250       20,466,465  
Weighted average diluted shares outstanding
    21,502,272       21,369,033       21,451,959       21,143,263  

See accompanying notes to unaudited condensed consolidated financial statements.

- 3 -


SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

   
Nine Months Ended September 30,
 
   
2009
   
2008
 
   
(in thousands)
 
             
Cash flows from operating activities:
           
Net income
  $ 14,955     $ 19,065  
Adjustments to reconcile net income to cash provided by operating activities:
               
Amortization of deferred policy acquisition costs
    33,736       29,727  
Policy acquisition costs deferred
    (34,889 )     (31,209 )
Provision for depreciation and amortization
    3,856       2,933  
Compensation cost on restricted shares of common stock
    3,229       3,685  
Compensation cost on stock options
    548       734  
Net realized loss on investments
    42       13,806  
Benefit for deferred income taxes
    (1,896 )     (2,901 )
Changes in certain assets and liabilities:
               
Unpaid loss and loss adjustment expense
    42,617       29,571  
Income tax payable
    (931 )     (2,988 )
Reinsurance recoverables, net of reinsurance withheld
    (14,893 )     (2,809 )
Unearned premiums, net of deferred premiums
and premiums receivable
    7,926       (8,768 )
Accrued investment income
    (254 )     (561 )
Other assets and other liabilities
    6,481       (2,232 )
Net cash provided by operating activities
 
­­­­ 60,527
      48,053  
                 
Cash flows from investing activities:
               
Purchases of investments
    (126,978 )     (123,129 )
Sales of investments
    30,225       18,174  
Maturities and redemption of investments
    39,837       57,208  
Purchases of property and equipment
    (1,972 )     (4,059 )
Payment for purchase of subsidiary, net of cash acquired
          (159 )
Net cash used in investing activities
    (58,888 )     (51,965 )
                 
Cash flows from financing activities:
               
Proceeds from exercise of stock options
    31       1,113  
Grant of restricted shares of common stock
    4       4  
Surrender of stock in connection with restricted stock vesting
    (473 )      
Net cash provided by (used in) financing activities
    (438 )     1,117  
                 
Net increase (decrease) in cash and cash equivalents
    1,201       (2,795 )
Cash and cash equivalents at beginning of period
    22,872       20,292  
Cash and cash equivalents at end of period
  $ 24,073     $ 17,497  
                 
Supplemental disclosures:
               
Interest paid on surplus notes
  $ 488     $ 690  
Federal income taxes paid
    7,500       17,735  
Accrued expenses for purchases of investments
    6,793        
                 
The Company purchased all of the capital stock of BWNV for $484. In connection with the acquisition, the following liabilities were assumed:
               
Fair value of assets acquired
  $     $ 1,079  
Cash paid for capital stock
     –       (484 )
Net liabilities assumed
  $     $ 595  

See accompanying notes to unaudited condensed consolidated financial statements.

- 4 -


SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
1.
Basis of Presentation
 
The accompanying unaudited condensed consolidated financial statements include the accounts of SeaBright Insurance Holdings, Inc. (“SIH”) and its wholly owned subsidiaries, SeaBright Insurance Company (“SBIC”), PointSure Insurance Services, Inc. (“PointSure”), Total HealthCare Management, Inc. (“THM”), and Black/White and Associates, Inc., Black/White and Associates of Nevada and Black/White Rockridge Insurance Services, Inc. (referred to collectively as “BWNV”) (collectively, the  “Company,” “we” or “us”). All significant intercompany transactions among these affiliated entities have been eliminated in consolidation.
 
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. The condensed consolidated balance sheet at December 31, 2008 has been derived from the audited financial statements at that date but does not include all of the information and notes required by GAAP for complete financial statements. These unaudited condensed consolidated financial statements and notes should be read in conjunction with the audited financial statements and accompanying notes as of and for the year ended December 31, 2008 included in the Company’s Annual Report on Form 10-K, which was filed with the U.S. Securities and Exchange Commission (the “SEC”) on March 16, 2009.
 
In the opinion of management, the unaudited condensed consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, necessary to state fairly the financial information set forth therein. Results of operations for the three month or nine month periods ended September 30, 2009 are not necessarily indicative of the results expected for the full fiscal year or for any future period.
 
Certain reclassifications have been made to the prior years’ financial statements to conform to classifications used in the current year.
 
2.
Summary of Significant Accounting Policies
 
a.  Use of Estimates
 
The preparation of the unaudited condensed consolidated financial statements in conformity with GAAP requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the unaudited condensed consolidated financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. The Company has used significant estimates in determining unpaid loss and loss adjustment expenses, including losses that have occurred but were not reported to us by the financial reporting date; the amount and recoverability of reinsurance recoverable balances; goodwill and other intangibles; retrospective premiums; earned but unbilled premiums; deferred policy acquisition costs; income taxes; and the valuation and other-than-temporary impairments of investment securities.
 
b.  Goodwill and Other Intangible Assets
 
Goodwill balances are reviewed for impairment at least annually or more frequently if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying value.  A reporting unit is defined as an operating segment or one level below an operating segment.
 
The goodwill impairment test follows a two step process. In the first step, the fair value of a reporting unit is compared to its carrying value. If the carrying value of a reporting unit exceeds its fair value, the second step of the impairment test is performed for purposes of measuring the impairment. In the second step, the fair value of the reporting unit is allocated to all of the assets and liabilities of the reporting unit to determine an implied goodwill value. If the carrying amount of the reporting unit goodwill exceeds the implied goodwill value, an impairment loss would be recognized in an amount equal to that excess, and the charge could have a material adverse effect on the Company’s results of operations and financial position.
 
Management’s determination of the fair value of each reporting unit incorporates multiple inputs including discounted cash flow calculations, the level of the Company’s own share price and assumptions that market participants would make in valuing the reporting unit. Other assumptions include levels of economic capital, future business growth, earnings projections, assets under management for reporting units and the discount rate utilized.
 
- 5 -

 
SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 
The Company completed its annual goodwill assessment for the individual reporting units as of December 31, 2008 and updated the analysis as of September 30, 2009. The conclusion reached as a result of the goodwill impairment testing was that the fair value of each reporting unit, for which goodwill had been allocated, was in excess of the respective reporting unit’s carrying value, and therefore no impairment was necessary. If current market conditions persist through the remainder of 2009, in particular if the Company’s share price remains meaningfully below book value per share, or if the Company’s actions to limit risk associated with its products or investments causes a significant change in any one reporting unit’s fair value, subsequent reviews of goodwill could result in an impairment of goodwill during 2009 or later. The Company will complete its 2009 annual goodwill assessment in the quarter ending December 31, 2009.

c.   Earnings Per Share
 
The following table provides the reconciliation of basic and diluted weighted average shares outstanding used in calculating earnings per share for the three month and nine month periods ended September 30, 2009 and 2008:
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2009
   
2008
   
2009
   
2008
 
   
(in thousands)
 
Basic weighted average shares outstanding
    20,733       20,582       20,691       20,466  
Weighted average shares issuable upon exercise of outstanding stock options and vesting of nonvested restricted stock
    769       787       761       677  
Diluted weighted average shares outstanding
    21,502       21,369       21,452       21,143  

d.  Stock-Based Compensation
 
Total stock-based compensation expense recognized in the unaudited condensed consolidated statements of operations for the three month and nine month periods ended September 30, 2009 and 2008 is shown in the following table. No compensation cost was capitalized during the periods shown.
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2009
   
2008
   
2009
   
2008
 
   
(in thousands)
 
Stock-based compensation expense
related to:
                       
Nonvested restricted stock
  $ 1,085     $ 1,007     $ 3,229     $ 3,685  
Stock options
    197       193       548       734  
Total
  $ 1,282     $ 1,200     $ 3,777     $ 4,419  
                                 
Total related tax benefit
  $ 398     $ 352     $ 1,151     $ 1,328  
 
- 6 -

 
SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
e.  Comprehensive Income (Loss)
 
The following table summarizes the Company’s comprehensive income (loss) for the three month and nine month periods ended September 30, 2009 and 2008:
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2009
   
2008
   
2009
   
2008
 
   
(in thousands)
 
Net income
  $ 6,665     $ 1,781     $ 14,955     $ 19,065  
Reclassification adjustment for net realized (gains) losses recorded into income
    (292 )     11,677       41       13,806  
Tax expense (benefit) related to reclassification adjustment gains (losses)
    102       (4,087 )     (14 )     (4,764 )
Increase (decrease) in unrealized gains/losses on investment securities available for sale
    20,709       (18,947 )     29,702       (28,471 )
Tax benefit (expense) related to unrealized gains (losses)
    (7,242 )     6,562       (10,391 )     9,897  
Tax effect of change in deferred tax asset valuation allowance recorded in comprehensive income
    1,204             2,015        
Total comprehensive income (loss)
  $ 21,146     $ (3,014 )   $ 36,308     $ 9,533  

f.  Recently Issued Accounting Pronouncements
 
In June 2009, the Financial Accounting Standards Board (“FASB”) issued FASB Statement of Financial Accounting Standards (“SFAS”) No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles (“SFAS 168”).  SFAS 168 identifies the sources of accounting principles and the framework for selecting the principles used in preparing the financial statements of nongovernmental entities that are presented in conformity with U.S. GAAP.  SFAS 168 further identifies the FASB Accounting Standards Codification (the “Codification”) as the source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. The Codification does not change existing U.S. GAAP authoritative literature in place as of July 1, 2009.    SFAS 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009.  The Company adopted SFAS 168 as of September 30, 2009, which did not have a material effect on the Company’s consolidated financial condition or results of operations.

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP FAS 115-2/124-2”).  FSP FAS 115-2/124-2 requires entities to separate an other-than-temporary impairment of a debt security into two components when there are credit related losses associated with the impaired debt security for which management asserts that it does not have the intent to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of its cost basis.  The amount of the other-than-temporary impairment related to a credit loss is recognized in earnings, and the amount of the other-than-temporary impairment related to other factors is recorded in other comprehensive loss.  FSP FAS 115-2/124-2 is effective for periods ending after June 15, 2009.  The Company adopted the provisions of FSP FAS 115-2/124-2 in the quarter ended June 30, 2009.  There were no impairments previously recognized on debt securities we owned at December  31, 2008 and therefore, there was no cumulative effect adjustment to retained earnings and other comprehensive income (loss) as a result of adopting this standard.  There were no impairments recognized on debt securities in the three month and nine month periods ended September 30, 2009 and therefore, the adoption of FSP FAS 115-2/124-2 had no effect on the Company’s consolidated financial condition or results of operations.

In April 2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions that are Not Orderly” (“FSP FAS 157-4”).  Under FSP FAS 157-4, if an entity determines that there has been a significant decrease in the volume and level of activity for an asset or liability in relation to the normal market activity for the asset or liability (or similar assets or liabilities), then transactions or quoted prices may not accurately reflect fair value.  In addition, if there is evidence that the transaction for the asset or liability is not orderly, the entity shall place little, if any, weight on that transaction price as an indicator of fair value. FSP FAS 157-4 is effective for periods ending after June 15, 2009. The Company adopted FSP FAS 157-4 in the quarter ended June 30, 2009, which did not have a material effect on the Company’s consolidated financial condition and results of operations.

- 7 -

 
SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 
In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP FAS 107-1 and APB 28-1”).  FSP FAS 107-1 and APB 28-1 requires disclosures about the fair value of financial instruments in interim and annual financial statements.  FSP FAS 107-1 and APB 28-1 is effective for periods ending after June 15, 2009. The Company adopted FSP FAS 107-1 and APB 28-1 in the quarter ended June 30, 2009.  Because  FSP FAS 107-1 and APB 28-1 amends only the disclosure requirements related to the fair value of financial instruments, adoption of FSP 107-1 and APB 28-1 did not affect the Company’s consolidated financial condition and results of operations.

In May 2009, the FASB issued FAS No. 165, “Subsequent Events” (“FAS 165”).  FAS 165 establishes general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or available to be issued.  FAS 165 is effective for periods ending after June 15, 2009.  The Company adopted FAS 165 in the quarter ended June 30, 2009, which did not have a material effect on the Company’s consolidated financial condition and results of operations.

3.
Investments
 
The consolidated cost or amortized cost, gross unrealized gains and losses, and estimated fair value and carrying value of investment securities available-for-sale at September 30, 2009 were as follows:
 
   
Cost or Amortized Cost
   
Gross Unrealized Gains
   
Gross Unrealized Losses
   
Estimated Fair Value
   
Carrying Value
 
   
(in thousands)
 
U.S. Treasury securities
  $ 16,735     $ 591     $ (101 )   $ 17,225     $ 17,225  
Government sponsored agency securities
    30,234       1,300       (31 )     31,503       31,503  
Corporate securities
    87,633       3,583       (120 )     91,096       91,096  
Tax-exempt municipal securities
    312,329       16,694       (396 )     328,627       328,627  
Mortgage pass-through securities
    74,851       4,169             79,020       79,020  
Collateralized mortgage obligations
    14,131       132       (142 )     14,121       14,121  
Asset-backed securities
    43,434       627       (245 )     43,816       43,816  
Total fixed income securities available-for-sale
    579,347       27,096       (1,035 )     605,408       605,408  
Equity securities
    11,333             (889 )     10,444       10,444  
Total investment securities available-for-sale
  $ 590,680     $ 27,096     $ (1,924 )   $ 615,852     $ 615,852  
 
Equity securities consist of investments in exchange-traded funds designed to correspond to the performance of certain indexes based on domestic or international stocks. The Company had no direct investments in individual equity securities at September 30, 2009. Approximately $0.9 of the total unrealized losses at September 30, 2009 were from equity securities that had been impaired for one year or longer.  Based on the low severity of the impairments on the Company’s equity securities, and the significant recent recovery in stock prices, management concluded that the unrealized losses on these equity securities were temporary due to market conditions.
 
For debt securities that are considered other-than-temporarily impaired (“OTTI”) and that the Company does not intend to sell and more likely than not would not be required to sell prior to recovery of the amortized cost basis, the Company recognizes OTTI losses in accordance with the provisions of the Codification. The amount of the OTTI loss is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between a security’s amortized cost basis and the present value of expected future cash flows discounted at the security’s effective interest rate. The amount due to all other factors is recognized in other comprehensive income.    Approximately $0.9 million of the total unrealized losses at September 30, 2009 were from debt securities that had been impaired for one year or longer.  Included in these securities is one security which had an unrealized loss that exceeded 20% of the related security’s book value at September 30, 2009.  As of September 30, 2009, all payments to date are current on these debt securities and the Company expects to fully recover its investment in these securities no later than their scheduled maturities. The Company has no current intent to sell these securities. Therefore, based on management’s review of the financial strength of these debt securities and the Company’s expectation regarding future receipt of principal and interest, management concluded these debt securities were temporarily impaired as of September 30, 2009. For the three and nine months ended September 30, 2009, the Company recognized no OTTI losses related to debt securities.

- 8 -


SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
The following table presents information about investment securities with unrealized losses at September 30, 2009:
 
   
Less Than 12 Months
   
12 Months or More
   
Total
 
Investment Category
 
Aggregate Fair Value
   
Aggregate Unrealized Loss
   
Aggregate Fair Value
   
Aggregate Unrealized Loss
   
Aggregate Fair Value
   
Aggregate Unrealized Loss
 
         
(in thousands)
       
Fixed income securities:
                                   
U.S. Treasury securities
  $ 2,898     $ (101 )   $     $     $ 2,898     $ (101 )
Government sponsored   agency securities (1)
    4,851       (31 )                 4,851       (31 )
Corporate securities
    9,736       (43 )     1,454       (77 )     11,190       (120 )
Tax-exempt municipal securities
                9,480       (396 )     9,480       (396 )
Collateralized mortgage obligations
    1,045       (10 )     644       (132 )     1,689       (142 )
Asset-backed securities
    401             9,745       (245 )     10,146       (245 )
Total fixed income securities
    18,931       (185 )     21,323       (850 )     40,254       (1,035 )
Equity securities
                10,444       (889 )     10,444       (889 )
Total
  $ 18,931     $ (185 )   $ 31,767     $ (1,739 )   $ 50,698     $ (1,924 )

_____________
 (1)
Government sponsored agency securities are not backed by the full faith and credit of the U.S. Government.

The Company regularly reviews its investment portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of its investments. A number of criteria are considered during this process including, but not limited to:  the current fair value as compared to amortized cost or cost, as appropriate, of the security; the length of time the security’s fair value has been below amortized cost or cost; the likelihood that the Company will be required to sell the security before recovery of its cost basis; objective information supporting recovery in a reasonable period of time; specific credit issues related to the issuer; and current economic conditions.
 
In general, the Company reviews all securities that are impaired by 5% or more at the end of the period.  For securities with no stated maturity date, the review focuses on securities that were impaired by 20% or more at the end of the period or had been impaired 10% or more continuously for six months or longer as of the end of the period.  The Company also analyzes the entire portfolio for other factors that might indicate a risk of impairment, including credit ratings and interest rates.  Other-than-temporary impairment losses result in a permanent reduction of the carrying amount of the underlying investment.  Significant changes in the factors considered when evaluating investments for impairment losses could result in a significant change in impairment losses reported in the unaudited condensed consolidated financial statements.

The Company evaluated investment securities with fair values less than amortized cost at September 30, 2009 and determined that it was not necessary to record any OTTI losses in the three month period then ended.  For the nine month period ended September 30, 2009, the Company recognized OTTI losses of $0.3 million related to its investment in preferred stock issued by Fannie Mae and Freddie Mac. For the three month and nine month periods ended September 30, 2008, the Company recognized OTTI losses of $8.3 million and $10.2 million, respectively, related primarily to its investment in preferred stock issued by Fannie Mae and Freddie Mac.  For the three month period ended September 30, 2008, the Company recognized OTTI losses of $3.2 million related to its investment in equity indexed securities exchange-traded funds.

- 9 -


SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
The Company had no direct sub-prime mortgage exposure in its investment portfolio as of September 30, 2009 and approximately $5.4 million of indirect exposure to sub-prime mortgages. As of September 30, 2009, the Company’s portfolio included $211.5 million of insured municipal bonds and $121.9 million of uninsured municipal bonds.
 
The following table provides a breakdown of ratings on the bonds in the Company’s municipal portfolio:
 
     
Insured Bonds
   
Uninsured Bonds
   
Total Municipal Portfolio Based On
 
Rating
   
Insured Ratings
   
Underlying Ratings
   
Ratings
   
Overall Ratings (1)
   
Underlying Ratings
 
     
(in thousands)
 
AAA
    $ 11,562     $ 11,562     $ 19,460     $ 31,022     $ 31,022  
AA+
      24,598       13,334       33,669       58,267       47,003  
AA
      47,985       21,048       23,508       71,493       44,556  
AA-
      47,329       44,322       14,083       61,412       58,405  
A+       33,339       50,921       7,922       41,261       58,843  
A       13,971       26,628       4,358       18,329       30,986  
A-       8,171       17,985       525       8,696       18,510  
BBB+
      -       -       8,607       8,607       8,607  
BBB-
      -       1,155       -       -       1,155  
BB-
      -       -       1,276       1,276       1,276  
Pre-refunded (2)
      23,280       23,280       8,468       31,748       31,748  
Not rated
      1,316       1,316       -       1,316       1,316  
Total
    $ 211,551     $ 211,551     $ 121,876     $ 333,427     $ 333,427  
__________
 
 
(1)
Represents insured ratings on insured bonds and ratings on uninsured bonds.
 
 
(2)
These bonds have been pre-refunded by the issuer depositing highly rated government-issued securities into irrevocable trust funds established for payment of principal and interest.
 
As of September 30, 2009, the Company had no direct investments in any bond insurer and only one bond insurer insured more than 10% of the municipal bond investments in the Company’s portfolio. National Public Finance Guarantee Corporation (“National”) (formerly MBIA) insured $99.3 million of municipal bonds the Company owned at September 30, 2009. National’s ratings as of that date were Baa1 (developing outlook) by Moody’s and A (developing outlook) by Standard & Poor’s and the average underlying rating on those bonds was AA-/A+. The Company does not expect a material impact to its investment portfolio or financial position as a result of the problems currently facing monoline bond insurers.
 
The amortized cost and estimated fair value of fixed income securities available-for-sale at September  30, 2009, by contractual maturity, are set forth below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
 
Maturity
 
Cost or Amortized Cost
   
Estimated Fair Value
 
   
(in thousands)
 
Due in one year or less
  $ 25,665     $ 26,001  
Due after one year through five years
 
­  179,249
   
­  187,370
 
Due after five years through ten years
    221,251       232,960  
Due after ten years
    20,766       22,120  
Securities not due at a single maturity date
 
­ 132,416
   
­ 136,957
 
Total fixed income securities
  $ 579,347     $ 605,408  

- 10 -


SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The consolidated amortized cost of investment securities available-for-sale deposited with various regulatory authorities at September 30, 2009 was $202.5 million.
 
4.
Premiums
 
Direct premiums written totaled $56.9 million and $60.9 million for the three month periods ended September 30, 2009 and 2008, respectively, and $204.4 million and $187.5 million for the nine month periods ended September 30, 2009 and 2008, respectively.
 
Premiums receivable consisted of the following at September 30, 2009 and December 31, 2008:
 
   
September 30, 2009
   
December 31, 2008
 
   
(in thousands)
 
Premiums receivable
  $ 13,420     $ 16,864  
Allowance for doubtful accounts
 
­ (522)
   
­ (490)
 
Premiums receivable, net of allowance
  $ 12,898     $ 16,374  

5. 
Reinsurance
 
a.  Reinsurance Ceded
 
Under reinsurance agreements, the Company cedes various amounts of risk to nonaffiliated insurance companies for the purpose of limiting the maximum potential loss arising from the underlying insurance risks. These reinsurance treaties do not relieve the Company from its obligations to policyholders.
 
Effective October 1, 2009, the Company entered into new reinsurance agreements with nonaffiliated reinsurers wherein it retains the first $500,000 of each loss occurrence.  The next $500,000 of losses per occurrence (in excess of the first $500,000 of losses per occurrence retained by the Company) are 50% reinsured. The new reinsurance program, which is effective through September 30, 2010, provides coverage up to $85.0 million per loss occurrence. The terms and structure of the new reinsurance program are similar to those of the program that expired on September 30, 2009, as more fully described in Note 8 to the consolidated financial statements in Part II, Item 8 of the Company’s annual report on Form 10-K for the year ended December 31, 2008, filed with the SEC on March 16, 2009.
 
Effective January 1, 2009, the Company entered into a new  quota-share reinsurance agreement with a  nonaffiliated reinsurer wherein it cedes 100% of its residual market business assumed from the National Council on Compensation Insurance (the “NCCI”) for policy year 2009.
 
b.  Reinsurance Recoverables and Income Statement Effects
 
Balances affected by reinsurance transactions are reported gross of reinsurance in the accompanying unaudited condensed consolidated balance sheets. Reinsurance recoverables are comprised of the following amounts at September 30, 2009 and December 31, 2008:
 
   
September 30, 2009
   
December 31, 2008
 
   
(in thousands)
 
Reinsurance recoverables on unpaid loss and loss adjustment expenses
  $ 30,562     $ 18,231  
Reinsurance recoverables on paid losses
    330       313  
Total reinsurance recoverables
  $ 30,892     $ 18,544  

- 11 -

 
SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
The effects of reinsurance were as follows for the three month and nine month periods ended September 30, 2009 and 2008:
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2009
   
2008
   
2009
   
2008
 
   
(in thousands)
 
Reinsurance assumed:
                       
Written premiums
  $ 1,862     $ 790     $ 5,201     $ 4,034  
Earned premiums
    2,071       1,282       5,176       5,181  
Losses and loss adjustment expenses incurred
    1,558       872       2,166       3,286  
Commission expenses incurred
    819       527       1,932       2,749  
                                 
Reinsurance ceded:
                               
Written premiums
  $ 6,084     $ 4,454     $ 19,904     $ 10,926  
Earned premiums
    5,520       4,590       15,932       11,074  
Losses and loss adjustment expenses incurred
    3,110       4,827       13,836       7,324  
Commissions earned
    697       571       1,765       1,451  

6.
Unpaid Loss and Loss Adjustment Expenses
 
The following table summarizes the activity in unpaid loss and loss adjustment expense for the three month and nine month periods ended September 30, 2009 and 2008:
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2009
   
2008
   
2009
   
2008
 
   
(in thousands)
 
Beginning balance:
                       
Unpaid loss and loss adjustment expense
  $ 322,728     $ 263,708     $ 292,027     $ 250,085  
Reinsurance recoverables
    (28,032 )     (15,534 )     (18,231 )     (14,034 )
Net balance, beginning of year
    294,696       248,174       273,796       236,051  
Incurred related to:
                               
Current period
    40,783       44,239       116,729       122,660  
Prior periods
    1,433       (5,085 )     4,689       (20,941 )
Receivable under adverse development cover
                574        
Total incurred
    42,216       39,154       121,992       101,719  
Paid related to:
                               
Current period
    (15,588 )     (14,504 )     (31,558 )     (31,048 )
Prior periods
    (17,242 )     (12,725 )     (59,574 )     (46,623 )
Total paid
    (32,830 )     (27,229 )     (91,132 )     (77,671 )
Receivable under adverse development      cover
                (574 )      
Net balance, end of period
    304,082       260,099       304,082       260,099  
Reinsurance recoverable
    30,562       19,557       30,562       19,557  
Unpaid loss and loss adjustment expense
  $ 334,644     $ 279,656     $ 334,644     $ 279,656  

Loss and loss adjustment expenses are net of adjustments to prior years’ loss reserves.  In the three months ended September 30, 2009, the Company recorded $2.1 million of adverse development of prior years’ loss reserves and a reinsurance commutation of $0.7 million, compared with $5.1 million of favorable development in the same period in 2008.  In the nine months ended September 30, 2009, the Company recorded $5.4 million of adverse development of prior years’ loss reserves (which excludes the receivable under adverse development cover) and a reinsurance commutation of $0.7 million, compared with $20.9 million of favorable development in the same period in 2008.  Of the $2.1 million of adverse development in third quarter 2009, $2.4 related to accident year 2007, offset by $0.3 of favorable development in accident years 2003-2006. Approximately 10.5% of the 2007 accident year development related to the Company’s California book of business, 30.1% to state act business other than California and 59.4% to United States Longshore and Harbor Workers Compensation Act (“USL&H”) business.

- 12 -


SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
 
The majority of the reserve releases in 2008 related to the Company’s California book of business and reflected a continuation of lower than anticipated patterns of loss payments in prior accident years as a result of reform legislation enacted there primarily in 2003 and 2004.
 
7. 
Contingencies
 
a.  SBIC is subject to guaranty fund and other assessments by the states in which it writes business. Guaranty fund assessments are accrued at the time premiums are written. Other assessments are accrued either at the time of assessment or in the case of premium-based assessments, at the time the premiums are written, or in the case of loss-based assessments, at the time the losses are incurred. As of September 30, 2009, SBIC had a liability for guaranty fund and other assessments of $3.5 million and a guaranty fund receivable of $3.4 million. These amounts represent management’s best estimate based on information received from the states in which it writes business and may change due to many factors, including the Company’s share of the ultimate cost of current and future insolvencies. The majority of assessments are paid out in the year following the year in which the premium is written or the losses are paid. Guaranty fund receivables and other surcharge items are generally realized by a charge to new and renewing policyholders in the year following the year in which the related assessments were paid.
 
b.  The Company is involved in various claims and lawsuits arising in the ordinary course of business. Management believes the outcome of these matters will not have a material adverse effect on the Company’s consolidated financial position or results of operations.
 
8. 
Share-Based Payment Arrangements
 
At September 30, 2009, the Company had outstanding stock options and nonvested restricted stock granted according to the terms of two equity incentive plans. The stockholders and Board of Directors approved the 2003 Stock Option Plan (the “2003 Plan”) in September 2003, and amended and restated the 2003 Plan in February 2004 and April 2008, and approved the 2005 Long-Term Equity Incentive Plan (the “2005 Plan” and, together with the 2003 Plan, the “Stock Option Plans”) in December 2004, and amended and restated the 2005 Plan in April 2008.
 
As of September 30, 2009, options to purchase 371,968 shares of common stock were outstanding under the 2003 Plan, and no additional shares were reserved for issuance under the 2003 Plan. As of September 30, 2009, 940,020 shares of nonvested restricted stock and options to purchase 856,817 shares of common stock were outstanding under the 2005 Plan and 522,333 shares were reserved for issuance under the 2005 Plan.
 
a.  Stock Options
 
The fair values of stock options granted during the three month and nine month periods ended September 30, 2009 and 2008 were determined on the dates of grant using the Black-Scholes-Merton (“Black-Scholes”) option valuation model with the following weighted average assumptions:
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Expected term (years)
    6.3       6.3       6.3       6.3  
Expected stock price volatility
    35.6 %     29.4 %     34.0 %     29.4 %
                                 
Risk-free interest rate
    2.86 %     3.11 %     2.31 %     3.01 %
Expected dividend yield
                       
                                 
Estimated fair value per option
  $ 4.07     $ 5.20     $ 3.73     $ 5.18  

- 13 -


SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
The following table summarizes stock option activity for the nine months ended September 30, 2009:
 
   
Shares Subject to Options
   
Weighted Average Exercise Price per Share
   
Weighted Average Remaining Contractual Life (years)
   
Aggregate Intrinsic Value (in thousands)
 
Outstanding at December 31, 2008
    1,053,877     $ 11.55       6.7     $ 204  
Granted
    216,202       9.86              
Forfeited
    (28,043 )     13.68              
Exercised
    (4,750 )     6.54              
Cancelled
    (8,501 )     17.13              
Outstanding at September 30, 2009
    1,228,785       11.18       6.5       293  
                                 
Exercisable at September  30, 2009
    805,575       10.28       5.3       920  

The aggregate intrinsic values in the table above are before applicable income taxes and are based on the Company’s closing stock price of $11.42 on September 30, 2009.  Proceeds from the exercise of stock options during the quarter ended September 30, 2009 totaled approximately $31,000.
 
The following table presents additional information regarding options outstanding as of September 30, 2009:
 
     
Options Outstanding
   
Options Exercisable
 
Range of Exercise Prices
   
Number Outstanding
   
Weighted- Average Remaining Contractual Life (years)
   
Weighted- Average Exercise Price
   
Number Outstanding
   
Weighted- Average Exercise Price
 
$  6.54-9.90       499,800     5.5     $ 7.26       371,968     $ 6.54  
10.50-12.54       323,394     6.4       10.63       239,807       10.63  
13.93-15.96       192,391     8.4       14.65       60,095       14.80  
17.16-18.68       213,200     7.1       18.08       133,705       18.01  
        1,228,785     6.5       11.18       805,575       10.28  

b. Restricted Stock
 
The following table summarizes restricted stock activity for the nine months ended September 30, 2009:
 
   
Number of Shares
   
Weighted Average Grant Date Fair Value
 
Outstanding at December 31, 2008
    799,722     $ 16.11  
Granted
    372,315       10.30  
Vested
    (179,625 )     17.57  
Forfeited
    (52,392 )     11.41  
Outstanding at September 30, 2009
    940,020       13.79  

As of September 30, 2009, there was $6.6 million of total unrecognized compensation cost related to nonvested restricted stock granted under the 2005 Plan. That cost is expected to be recognized over a weighted-average period of approximately 23 months.
 
9. 
Fair Values of Assets and Liabilities
 
Estimated fair value amounts, defined as the exit price of willing market participants, have been determined using available market information and other appropriate valuation methodologies. However, considerable judgment is required in developing the estimates of fair value. Accordingly, these estimates are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions or estimating methodologies may have an effect on the estimated fair value amounts.
 
- 14 -


SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
The following methods and assumptions were used by the Company in estimating the fair value disclosures for financial instruments in the accompanying unaudited condensed consolidated financial statements and notes:
 
Cash and cash equivalents, premiums receivable, accrued expenses, other liabilities and surplus notes: The carrying amounts for these financial instruments as reported in the accompanying unaudited condensed consolidated balance sheets approximate their fair values.
 
Investment securities: The Company measures and reports its financial assets and liabilities, including investment securities, in accordance with the Fair Value Measurement and Disclosure Topic of the Codification.  The estimated fair values for available-for-sale securities are generally based on quoted market value prices for securities traded in the public marketplace. The Company also considers the impact of a significant decrease in volume and level of activity for an asset or liability when compared with normal activity. Additional information with respect to fair values of the Company’s investment securities is disclosed in Note  3.
 
Other financial instruments qualify as insurance-related products and are specifically exempted from fair value disclosure requirements.
 
The Company groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
 
 
·
Level 1 – Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Level 1 includes U.S. Treasury securities and equity securities that are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
 
 
·
Level 2– Valuations for assets and liabilities traded in less active dealer or broker markets.  Level 2 valuations are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 2 includes government sponsored agency securities, corporate fixed-income securities, municipal bonds, mortgage pass-through securities, collateralized mortgage obligations and asset-backed securities.
 
 
·
Level 3– Valuations for assets and liabilities that are derived from other valuation methodologies, including discounted cash flow models and similar techniques, and not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities. As of September 30, 2009, the Company had no Level 3 financial assets or financial liabilities.
 
- 15 -


SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
The table below presents the September 30, 2009 balances of assets and liabilities measured at fair value on a recurring basis.
 
   
Total
   
Level 1
   
Level 2
   
Level 3
 
   
(in thousands)
 
Fixed income securities:
                       
U.S. Treasury securities
  $ 17,225     $ 17,225     $     $  
Government sponsored agency securities
    31,503             31,503        
Corporate securities
    91,096             91,096        
Tax-exempt municipal securities
    328,627             328,627        
Mortgage pass-through securities
    79,020             79,020        
Collateralized mortgage obligations
    14,121             14,121        
Asset-backed securities
    43,816             43,816        
Total fixed income securities
    605,408       17,225       588,183        
Equity securities
    10,444       10,444              
Total
  $ 615,852     $ 27,669     $ 588,183     $  

Active markets are those in which transactions occur with sufficient frequency and volume to provide reliable pricing information on an ongoing basis.  Inactive markets are those in which there are few transactions for the asset, prices are not current, or price quotations vary substantially either over time or among market makers, or in which little information is released publicly.  When the market for an investment is judged to be inactive, appropriate adjustments must be made to observable inputs to account for such inactivity.  As of September 30, 2009, the Company’s investment portfolio consisted of securities that it considered to be traded in active markets.  Therefore, no adjustment for market inactivity or illiquidity was necessary.
 
The Company obtains fair value inputs for securities in its investment portfolio from independent, nationally recognized pricing services.  The Company obtains one price per instrument from these pricing services.  The pricing services utilize multidimensional pricing models that vary by asset class and incorporate relevant inputs such as available trade, bid and quote market data for identical or similar instruments, model-based valuation techniques for which significant assumptions were observable and other market information to arrive at a fair value price for each security.  This process takes into consideration the relevance of observable inputs based on factors such as the level of trading activity and the volume and currency of available prices and includes appropriate adjustments for nonperformance and liquidity risks. The Company did not obtain any broker quotes as part of the portfolio valuation process at September 30, 2009.  When broker quotes are obtained, they are usually non-binding.
 
The Company also seeks input from independent portfolio managers and financial advisors engaged by the Company to assist in the management and oversight of its investment portfolio.  The Company and an independent portfolio manager engaged by the Company review such amounts for reasonableness in relation to the following considerations, among others: recent trades of a particular security; the Company’s independent observations of recent developments affecting the economy in general and certain issuers in particular; and fair values from other sources, such as statements from the Company’s custodial banks.  When other evidence indicates a fair value that is significantly different from that provided by an independent pricing service, the Company may challenge the fair value and request further validation and support from the independent pricing service, which may result in a revised fair value from the independent pricing service.  If the Company has independent evidence indicating that a security’s fair value is significantly different from the final value provided by an independent pricing service, it may adjust the fair value accordingly.  The Company did not adjust any of the September 30, 2009 values it obtained from independent pricing services and used those values in developing the fair value measurements in the Company’s unaudited condensed consolidated financial statements as of September 30, 2009.
 
The Company may be required, from time to time, to measure certain other financial assets, such as goodwill, fixed assets and other long-lived assets, at fair value on a non-recurring basis in accordance with GAAP. These adjustments to fair value usually result from write-downs of individual assets. None of these assets have been measured to fair value during 2009.
 
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SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
10. 
Subsequent Events
 
Management has evaluated subsequent events from September 30, 2009 to November 9, 2009, the date which our financial statements have been issued and were available to be issued, and has concluded there were no subsequent events to be reported during this period.  Subsequent events that may occur after November 9, 2009 have not been evaluated in the financial statements as of September 30, 2009.
 
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Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Cautionary Statement
 
You should read the following discussion and analysis in conjunction with our unaudited condensed consolidated financial statements and the related notes thereto included in Item  1 of Part  I of this quarterly report. The information contained in this quarterly report is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this quarterly report and in our other reports filed with the U.S. Securities and Exchange Commission (the “SEC”), including our Annual Report on Form  10-K for the year ended December  31, 2008 filed with the SEC on March 16, 2009.
 
The discussion under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2008, and similar discussions in our other SEC filings, describe some of the important risk factors that may affect our business, results of operations and financial condition. You should carefully consider those risks, in addition to the other information in this report and in our other filings with the SEC, before deciding to purchase, hold or sell our common stock.
 
Some of the statements in this Item 2 and elsewhere in this quarterly report may include forward-looking statements that reflect our current views with respect to future events and financial performance. These statements include forward-looking statements both with respect to us specifically and the insurance sector in general. Statements that include the words “expect,” “intend,” “plan,” “believe,” “project,” “estimate,” “may,” “should,” “anticipate,” “will” and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the federal securities laws or otherwise.
 
All forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in these statements. We believe that these factors include but are not limited to the following:
 
 
greater frequency or severity of claims and loss activity, including as a result of catastrophic events, than our underwriting, reserving or investment practices anticipate based on historical experience or industry data;
 
 
our dependency on a concentrated geographic market;
 
 
changes in the availability, cost or quality of reinsurance and failure of our reinsurers to pay claims timely or at all;
 
 
changes in regulations or laws applicable to us, our subsidiaries, brokers or customers;
 
 
potential downgrades in our rating or changes in rating agency policies or practices;
 
 
ineffectiveness or obsolescence of our business strategy due to changes in current or future market conditions;
 
 
unexpected issues relating to claims or coverage and changes in legal theories of liability under our insurance policies;
 
 
increased competition on the basis of pricing, capacity, coverage terms or other factors;
 
 
developments in financial and capital markets that adversely affect the performance of our investments;
 
 
loss of the services of any of our executive officers or other key personnel;
 
 
our inability to raise capital in the future;
 
 
our status as an insurance holding company with no direct operations;
 
 
our reliance on independent insurance brokers;
 
 
increased assessments or other surcharges by states in which we write policies;
 
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our potential exposure to losses if Lumbermens Mutual Casualty Company (“LMC”) were to be placed into receivership;
 
 
the effects of acquisitions that we may undertake;
 
 
failure of our customers to pay additional premium under our retrospectively rated policies;
 
 
the effects of acts of terrorism or war;
 
 
cyclical changes in the insurance industry;
 
 
changes in accounting policies or practices;
 
 
changes in general economic conditions, including inflation and other factors;
 
 
a prolonged severe downturn, or continuing recession or sustained loss of consumer confidence; and
 
 
significant declines in interest rates on our investment securities for a sustained period of time, deterioration of the underlying issuers’ credit or declines in the stock market.
 
The foregoing factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this quarterly report. We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.
 
If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary materially from what we project. Any forward-looking statements you read in this quarterly report reflect our views as of the date of this quarterly report with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. Before making an investment decision, you should carefully consider all of the factors identified in this quarterly report that could cause actual results to differ.
 
Additional information concerning these and other factors is contained in our SEC filings, including, but not limited to, our 2008 Annual Report on Form 10-K.
 
Overview
 
We are a specialty provider of multi-jurisdictional workers’ compensation insurance and, on a limited basis, commercial general liability insurance. We are domiciled in Illinois, commercially domiciled in California and headquartered in Seattle, Washington. We are licensed in 49 states and the District of Columbia to write workers’ compensation and other lines of insurance. Traditional providers of workers’ compensation insurance provide coverage to employers under one or more state workers’ compensation laws, which prescribe benefits that employers are obligated to provide to their employees who are injured arising out of or in the course of employment. We focus on employers with complex workers’ compensation exposures and provide coverage under multiple state and federal acts, applicable common law or negotiated agreements. We also provide traditional state act coverage in markets we believe are underserved. Our workers’ compensation policies are issued to employers who also pay the premiums. The policies provide payments to covered, injured employees of the policyholder for, among other things, temporary or permanent disability benefits, death benefits and medical and hospital expenses. The benefits payable and the duration of such benefits are set by statute and vary by jurisdiction and with the nature and severity of the injury or disease and the wages, occupation and age of the employee.
 
SeaBright Insurance Holdings, Inc. (“SIH”) was formed in 2003 by members of our current management and entities affiliated with Summit Partners, a leading private equity and venture capital firm, for the purpose of acquiring from LMC and certain of its affiliates the renewal rights and substantially all of the operating assets and employees of the Eagle Insurance Companies (“Eagle”) (the “Acquisition”). Eagle began writing specialty workers’ compensation insurance policies in the mid-1980’s. The Acquisition gave us renewal rights to an existing portfolio of business, representing a valuable asset given the renewal nature of our business, and a fully operational infrastructure that would have taken many years to develop. These renewal rights gave us access to Eagle’s customer lists and the right to seek to renew Eagle’s continuing in-force insurance contracts.
 
In the Acquisition, we also acquired 100% of the issued and outstanding capital stock of Kemper Employers Insurance Company (“KEIC”) and PointSure. We acquired KEIC, a shell company with no in-force policies or employees, solely for the purpose of acquiring its workers’ compensation licenses in 43 states and the District of Columbia and for its certification with the United States Department of Labor. Subsequent to the Acquisition, KEIC was renamed “SeaBright Insurance Company.” SeaBright Insurance Company received an “A–” (Excellent) rating from A.M. Best following the completion of the Acquisition.
 
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To minimize our exposure to any past business underwritten by KEIC, we entered into an adverse development cover agreement in connection with the Acquisition. Under the terms of this agreement, we and LMC are required to indemnify each other with respect to the development of KEIC’s insurance liabilities as they existed at the date of the Acquisition. Accordingly, if KEIC’s insurance liabilities increase, LMC must indemnify us in the amount of the increase. If KEIC’s insurance liabilities decrease, we must share with LMC the positive development of those reserves. To support LMC’s obligations under the adverse development cover, LMC funded a trust account at the time of the Acquisition in the amount of $1.6 million as collateral for LMC’s potential future obligations to us under the adverse development cover. The minimum amount that must be maintained in the trust account is equal to the greater of (a) $1.6 million or (b) 102% of the then existing quarterly estimate of LMC’s total obligations under the adverse development cover. The amount on deposit in the trust account was approximately $3.8 million at September 30, 2009 and $2.8 million at December 31, 2008. If LMC is placed into receivership and the amount held in the collateralized reinsurance trust is inadequate to satisfy the obligations of LMC to us under the adverse development cover, it is unlikely that we would recover any future amounts owing by LMC to us.
 
Our operations and financial performance may be impacted by changes in the U.S. economy. The significant downturn in the U.S. economy since 2007 led to lower reported payrolls, which has had a negative impact on our gross premiums written and earned premiums. If our customers reduce their workforce levels, the level of workers’ compensation insurance coverage they require and, as a result the premiums that we charge, would be reduced, and if our customers cease operations, they will not renew their policies. It is uncertain if economic conditions will deteriorate further, or when economic conditions will improve. A prolonged recession could further reduce payrolls, which could have a significant negative impact on our business, financial condition or results of operations.
 
Principal Revenue and Expense Items
 
We derive our primary revenue from premiums earned, net investment income, net realized gains and losses from investments and other income. Our primary expense items are loss and loss adjustment expenses, underwriting, acquisition and insurance expenses, and interest expense.
 
Premiums Earned
 
Gross premiums written include all premiums billed and unbilled by an insurance company during a specified policy period. Premiums are earned over the terms of the related policies according to reports of actual payroll amounts received periodically from our insureds. At the end of each accounting period, the portions of premiums that are not yet earned are included in unearned premiums and are realized as revenue in subsequent periods over the remaining terms of the policies. Our policies typically have terms of 12 months. Thus, for example, for a policy that is written on July 1, 2008 and for which payrolls are earned ratably throughout the year, one-half of the premiums would be earned in 2008 and the other half would be earned in 2009.
 
Our gross premiums written is the sum of both direct premiums and assumed premiums before the effect of ceded reinsurance. Assumed premiums are premiums that we have received from an authorized state-mandated pool. Net premiums written is the difference between gross premiums written and premiums ceded or paid to reinsurers (ceded premiums written). Premiums earned is the earned portion of our net premiums written.
 
There can be significant variability in our premiums earned. Gross written premium for each policy is based on estimated payroll, by worker classification, for the policy period multiplied by the appropriate premium rate per $100 of covered payroll for each classification. Premium adjustment factors may also be applied to reflect the historical loss experience of the account or other considerations. At policy expiration, we perform audits to determine actual payrolls for the policy period. If audited payrolls equal the payrolls estimated at inception, there would typically be no audit adjustment. However, if audited payrolls exceed estimated payrolls, an additional premium would be billed, which would increase our earned premium. Conversely, if audited payrolls were less than estimated payrolls, premium would be returned and earned premium would be reduced. To more accurately track our earned premium during the policy period, all of our accounts report payroll, typically monthly, which generally results in actual payrolls being reported for each period. The form and frequency of payroll reporting are factored into our earned premium calculation. The estimated annual premium is prorated for any periods for which we do not have actual reported payrolls. If actual reported payrolls were running significantly higher (or lower) than estimated payrolls for a period, gross written premium would be earned faster (or slower) than if premiums were earned on an estimated daily pro-rata basis. Also, we may endorse a policy mid-term to adjust the estimated premium for significant changes in the insureds business, either increasing or decreasing gross written premium and earned premium. We also write retrospectively rated policies, where the ultimate premium is based on the insured’s loss experience, which contributes to the volatility of our earned premiums.
 
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We earn our direct premiums written from our maritime, alternative dispute resolution (“ADR”) and state act customers. We also earn a small portion of our direct premiums written from employers who participate in the Washington State United States Longshore and Harbor Workers Compensation Act (“USL&H”) Assigned Risk Plan (the “Washington USL&H Assigned Risk Plan”). We immediately cede 100% of those premiums, net of our expenses, and 100% of the losses in connection with that business back to the Washington USL&H Assigned Risk Plan. References to direct premiums written generally exclude premiums from the Washington USL&H Assigned Risk Plan because such business is not indicative of our core business or material to our results of operations.  Effective January 1, 2009, we entered into a new quota share reinsurance agreement with a non-affiliated reinsurer where we cede 100% of our assumed premiums related to our National Council on Compensation Insurance (“NCCI”) book of business. This reinsurance policy is effective for policy year 2009.
 
Net Investment Income and Realized Gains and Losses on Investments
 
We invest our statutory surplus and the funds supporting our insurance liabilities (including unearned premiums and unpaid loss and loss adjustment expense) in cash, cash equivalents, fixed income securities and, to a lesser degree, in equity securities. Our investment income includes interest earned on our invested assets. Realized gains and losses on invested assets are reported separately from net investment income. We earn realized gains when invested assets are sold for an amount greater than their amortized cost in the case of fixed maturity securities and recognize realized losses when investment securities are written down as a result of an other-than-temporary impairment or sold for an amount less than their carrying value. Other-than-temporarily impaired (“OTTI”) losses are reported separately on the statements of operations and are broken out between those losses with an income statement impact and those with an impact to accumulated other comprehensive income on the balance sheet.
 
Other Income
 
Other income is derived primarily from the operations of our wholly owned subsidiary companies, including PointSure Insurance Services, Inc. (“PointSure”), (including Black/White and Associates, Inc.,  Black/White and Associates of Nevada and Black/White Rockridge Insurance Services, Inc., referred to collectively as “BWNV”, its wholly owned subsidiaries), our wholesale broker and third party administrator, and Total HealthCare Management (“THM”), a provider of medical bill review, utilization review, nurse case management and related services.
 
Loss and Loss Adjustment Expenses
 
Loss and loss adjustment expenses represent our largest expense item and include (1) claim payments made, (2) estimates for future claim payments and changes in those estimates for current and prior periods and (3) costs associated with investigating, defending and adjusting claims. For further information regarding our loss and loss adjustment expenses, including amounts paid and unpaid, see discussion under the heading “Critical Accounting Policies, Estimates and Judgments – Unpaid Loss and Loss Adjustment Expenses” in this Item 2 of Part I of this quarterly report.
 
Underwriting, Acquisition and Insurance Expenses
 
In our insurance subsidiary, we refer to the expenses that we incur to underwrite risks as underwriting, acquisition and insurance expenses. Underwriting expenses consist of commission expenses, premium taxes and fees and other underwriting expenses incurred in writing and maintaining our business. We pay commission expense in our insurance subsidiary to brokers for the premiums that they produce for us. We pay state and local taxes based on premiums; licenses and fees; assessments; and contributions to workers’ compensation security funds. Other underwriting expenses consist of general administrative expenses such as salaries and employee benefits, rent and all other operating expenses not otherwise classified separately, and boards, bureaus and assessments of statistical agencies for policy service and administration items such as rating manuals, rating plans and experience data. Certain of these costs that vary with and are primarily related to the acquisition of insurance contracts (“deferred acquisition costs”) are initially deferred and amortized over the typical policy term of 12 months. Therefore, with respect to deferred acquisition costs, there are timing differences between when the costs are incurred or paid and when the related expense is recognized in our unaudited condensed consolidated statements of operations.
 
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Interest Expense
 
We incur interest expense on $12.0 million in surplus notes that our insurance subsidiary issued in May 2004. The interest expense is paid quarterly in arrears. The interest expense for each interest payment period is based on the three-month LIBOR rate two London banking days prior to the interest payment period plus 400 basis points.  The interest rate at September 30, 2009 was 4.4%.
 
Results of Operations
 
Three Months and Nine Months Ended September 30, 2009 and 2008
 
Gross Premiums Written.  Gross premiums written consists of direct premiums written and premiums assumed from the NCCI residual markets.  The number of customers we service, in-force payrolls and in-force premiums represent some of the factors we consider when analyzing gross premiums written.

Gross premiums written for the three months ended September 30, 2009 totaled $58.7 million, a decrease of $3.0 million, or 4.9%, from $61.7 million of gross premiums written in the same period of 2008.  Gross premiums written for the nine months ended September 30, 2009 totaled $209.6 million, an increase of $18.1 million, or 9.5%, over $191.5 million of gross premiums written in the same period of 2008.  Much of the increase in gross premiums written resulted from premium growth related to our “program” book of business. Program business, which includes alternative markets and small maritime programs, contributed $22.9 million or 126.5% of the total gross premium increase for the nine months ended September 30, 2009. The increase in program business was offset by a net $4.8 million decrease in our core product lines.  Excluding work we perform as the servicing carrier for the Washington USL&H Assigned Risk Plan, the total number of customers we serviced increased from over 1,000 at September 30, 2008 to over 1,400 at September 30, 2009. Approximately 23% of the customer increase related to our “core” book of business and approximately 77% of the increase related to our program business. By design, our program business will have a larger number of customers with a smaller average premium size than our core book of business. Total in-force payrolls, one of the factors used in determining premium charges, increased 14.5% from $6.2 billion at September 30, 2008 to $7.1 billion at September 30, 2009. California continues to be our largest market, accounting for approximately $119.5 million, or 39.9%, of our in-force premiums at September 30, 2009. This represents an increase of $9.9 million, or 9.0%, from approximately $109.6 million of in-force premiums in California, or 39.7%, of in-force premiums, at September 30, 2008.

The following is a summary of our top five markets based on direct premiums written:

   
Nine Months Ended September 30,
 
   
2009
   
2008
 
   
Direct Premiums Written
   
%
   
Direct Premiums Written
   
%
 
   
($ in thousands)
 
California
  $ 84,496       41.1 %   $ 74,454       39.2 %
Louisiana
    18,278       8.9       14,938       7.9  
Illinois
    17,697       8.6       14,954       7.9  
Texas
    13,349       6.5       13,628       7.2  
Alaska
    11,626       5.7       12,576       6.6  
Total
  $ 145,446       70.8 %   $ 130,550       68.8 %

Premiums assumed from the NCCI residual markets for the three months and nine months ended September 30, 2009 increased $1.1 million, or 137.5% to $1.9 million from $0.8 million for the same period in 2008.  For the nine months ended September 30, 2009, premiums assumed from the NCCI residual markets increased by $1.2 million, or 30.0% to $5.2 million compared to $4.0 million during the same period in 2008.

We experienced significant reductions in our California premium rates from 2003 to 2008. In 2007, in response to continued reductions in California workers’ compensation claim costs, we filed with the California Insurance Commissioner our new rates reflecting an average reduction of 14.2% from prior rates for new and renewal insurance policies written in California on or after July 1, 2007. This action was the eighth California rate reduction we had filed since October 1, 2003, resulting in a net cumulative reduction of our California rates of approximately 54.8%. On August 15, 2008, the Workers’ Compensation Insurance Rating Bureau of California (the “WCIRB”) submitted a filing with the California Insurance Commissioner recommending a 16.0% increase in advisory pure premium rates on new and renewal policies effective on or after January 1, 2009. The filing was based on a review of loss and loss adjustment experience through March 31, 2008. In response to this recommendation, on October 24, 2008, the California Insurance Commissioner approved a 5.0% increase in advisory pure premium rates, effective January 1, 2009. With the California Department of Insurance approval, we adopted this 5.0% increase effective January 1, 2009.
 
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On March 27, 2009, the WCIRB submitted a filing with the California Insurance Commissioner recommending a 24.4% increase in advisory pure premium rates on new and renewal policies effective on or after July 1, 2009. On April 23, 2009, the WCIRB amended its filing to reduce the proposed rate increase to 23.7%. A public hearing on the proposed rate increase was held on April 28, 2009. Following the hearing, the California Insurance Commissioner issued a press release in which he urged the WCIRB to withdraw the portion of its requested rate increase related to recent decisions by the Workers’ Compensation Appeals Board (estimated to be approximately 6%) until the judicial process related to these decisions has concluded. A second hearing on medical treatment costs was held on June 8, 2009. On July 8, 2009, the California Insurance Commissioner announced his rejection of any increase in advisory pure premium rates.  Rating decisions made by the California Insurance Commissioner are advisory only and insurance companies may choose whether or not to adopt, approved or disapproved rates. After completing an internal study of our California loss costs, on June 23, 2009, we filed with the California Department of Insurance revised rates for new and renewal workers' compensation insurance policies written in the state of California on or after August 1, 2009. The new rates reflected an average increase of 10.6% from prior rates and were in response to increased projected medical costs and recent decisions by the Workers' Compensation Appeals Board.  On July 7, 2009, the California Department of Insurance approved our filing for the rate increase. We are unable to predict the impact that  the  rate increase  adopted by us in California might have on our future financial position and results of operations. If other insurers do not adopt similar rate increases, this rate increase may have a negative effect on our ability to compete in California. On August 18, 2009, the WCIRB submitted a filing with the California Insurance Commissioner recommending a 22.8% increase in advisory pure premium rates on new and renewal policies effective on or after January 1, 2010. A public hearing on the proposed rate increase was held on October 6, 2009. The California Insurance Commissioner is expected to announce his decision regarding the proposed rate increase by mid-November 2009.
 
Rate reductions have also been adopted in other states in which we operate. For example, in Alaska we adopted rate decreases of 7.6% and 10.9% effective January 1, 2009 and 2008, respectively. In Louisiana, we adopted commissioner-approved rate decreases of 17.4% (pending approval) and 8.6% effective May 1, 2009 and 2008, respectively. In Hawaii, we adopted rate decreases of 5.8% and 19.3% effective February 1, 2009 and 2008, respectively. In Texas, we adopted rate decreases of 10.0% and 7.7% effective May 1, 2009 and January 1, 2008, respectively. In Florida, we adopted rate decreases of 18.6% and 18.4% effective January 1, 2009 and 2008, respectively. We have adopted rate increases of 2.5%, 3.5% and 4.0% in Illinois effective April 1, 2009 and January 1, 2009 and 2008, respectively. In Arizona we adopted rate increases of 7.9% and 4.1% effective October 1, 2008 and January 1, 2008, respectively.
 
Net Premiums Written.  Net premiums written totaled $52.7 million for the three months ended September 30, 2009 compared to $57.2 million in the same period in 2008, representing a decrease of $4.5 million, or 7.9%. For the nine months ended September 30, 2009, net premiums written totaled $189.7 million, an increase of $9.1 million, or 5.0%, from $180.6 million in the same period of 2008. The decrease in net premiums written for the three months ended September 30, 2009 was primarily attributable to an increase in ceded premiums due to the addition of a new reinsurance treaty under which we cede off the residual market business, beginning with policy year 2009, that we are obligated to assume from the NCCI. The increase in net premiums written for the nine months ended September 30, 2009 was primarily attributable to the increase in gross written premiums, offset in part by $9.0 million in premiums ceded related to the increased ceding rate of the 2008 reinsurance contracts due primarily to an increase in limits at the lower and upper ends of the program, as well as the addition of a new reinsurance treaty related to the residual market business.
 
Net Premiums Earned.  Net premiums earned totaled $64.4 million for the three months ended September 30, 2009 compared to $68.7 million for the same period in 2008, representing a decrease of $4.3 million, or 6.2%. For the nine months ended September 30, 2009, net premiums earned totaled $182.5 million, an increase of $1.4 million, or 0.8%, from $181.1 million in the same period of 2008.  We record the entire annual policy premium as unearned premium when written and earn the premium over the life of the policy, which is generally twelve months. Consequently, the amount of premiums earned in any given year depends on when during the current or prior year the underlying policies were written and the actual reported payroll of the underlying policies. Our direct premiums earned decreased $4.2 million, or 5.8%, to $67.9 million for the three months ended September 30, 2009 from $72.1 million for the same period in 2008 due to the decrease in gross premiums written discussed above as well as reductions in reported payrolls driven mainly by the effects of the current economic recession. Our direct premiums earned for the nine months ended September 30, 2009 increased $6.2 million, or 3.3%, to $193.2 million from $187.0 million for the same period in 2008.  Premiums earned in the three month and nine month periods of 2009 were also reduced by net adjustments of $2.5 million and $3.5 million, respectively, on retrospectively rated policies due to favorable loss results on those policies.
 
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The following is a summary of our top five markets based on direct premiums earned:

   
Nine Months Ended September 30,
 
   
2009
   
2008
 
   
Direct Premiums Earned
   
%
   
Direct Premiums Earned
   
%
 
   
($ in thousands)
 
California
  $ 77,192       40.0 %   $ 74,791       40.0 %
Louisiana
    19,493       10.1       16,331       8.7  
Illinois
    16,357       8.5       19,228       10.3  
Alaska
    11,897       6.2       12,309       6.6  
Texas
    11,315       5.9       10,940       5.9  
Total
  $ 136,254       70.7 %   $ 133,599       71.5 %

Net premiums earned are also affected by premiums ceded under reinsurance agreements. Ceded premiums earned for the three months ended September 30, 2009 totaled $5.5 million compared to $4.6 million for the same period in 2008, representing an increase of $0.9 million, or 19.6%.  Ceded premiums earned for the nine months ended September 30, 2009 totaled $15.9 million compared to $11.1 million for the same period in 2008, representing an increase of $4.8 million, or 43.2%.  An increase in ceded premiums earned is a decrease to our overall net premiums earned. Included in net premiums earned for the nine months ended September 30, 2009 is an increase in the amount of premiums we involuntarily assume on residual market business from the NCCI, which operates residual market programs on behalf of many states. Effective January 2009, we cede 100% of NCCI assumed business for policy year 2009, which totaled $1.5 million and $3.1 million for the three months and nine months ended September 30, 2009, respectively.

Net Investment Income.  Net investment income was $5.9 million for the three months ended September 30, 2009 compared to $5.6 million for the same period in 2008, representing an increase of $0.3 million, or 5.7%.  Net investment income was $17.2 million for the nine months ended September 30, 2009 compared to $16.9 million for the same period in 2008, representing an increase of $0.3 million, or 2.0%.  Average invested assets for the three months ended September 30, 2009 increased $82.4 million, or 15.4%, from $534.6 million in 2008 to $617.0 million in 2009.  For the nine months ended September 30, 2009 average invested assets increased $75.1 million, or 14.4%, from $522.1 million in 2008 to $597.2 million in 2009.  Our yield on average invested assets for the three months ended September 30, 2009 was approximately 3.8% compared to approximately 4.2% for the same period in 2008.  For the nine months ended September 30, 2009, our yield on average invested assets was 3.8% compared to approximately 4.3% for the same period in 2008.

Other-Than-Temporary Impairment Losses.  Other-than-temporary impairment losses totaled $0.0 and $0.3 million for the three month and nine month periods ended September 30, 2009, respectively, compared to $11.5 million and $13.4 million for the same periods in 2008.  The majority of impairment losses in both years related to our investments in preferred stock issued by Fannie Mae and Freddie Mac.  In July 2009, we liquidated our holdings of these stocks at a slight realized gain of $6,000 after considering the lowered cost basis resulting from the 2008 and 2009 impairment losses.
 
Service Income.  Service income totaled $0.3 million for the three months ended September 30, 2009 compared to no service income for the same period in 2008. For the nine months ended September 30, 2009, service income remained flat at $0.9 million from the same period of 2008. Our service income results primarily from service arrangements we have with LMC and other companies for claims processing, policy administration, and administrative services that we perform for them.
 
Other Income.  Other income totaled $2.0 million for the three months ended September 30, 2009 compared to $2.8 million for the same period in 2008, representing a decrease of $0.8 million, or 29.6%. For the nine months ended September 30, 2009, other income totaled $6.3 million, flat when compared to the same period of 2008.  Other income is derived primarily from the operations of PointSure (including BWNV), our wholesale broker and third party administrator, and THM, our provider of medical bill review, utilization review, nurse case management and related services.
 
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Loss and Loss Adjustment Expenses.  Loss and loss adjustment expenses totaled $42.2 million for the three months ended September 30, 2009 compared to $39.2 million for the same period in 2008, representing an increase of $3.0 million, or 7.8%.  For the nine months ended September 30, 2009, loss and loss adjustment expenses totaled $122.0 million, compared to $101.7 million for the same period in 2008, representing an increase of $20.3 million, or 19.9%. Our net loss ratio, which is calculated by dividing loss and loss adjustment expenses less claims service income by premiums earned, for the three months ended September 30, 2009 was 65.1% compared to 57.1% for the same period in 2008.  Our net loss ratio for the nine months ended September 30, 2009 was 66.4% compared to 55.8% for the same period in 2008.  The increase in our net loss ratio for the three months ended September 30, 2009 is primarily attributable to $5.1 million in favorable loss development in the three months ended September 30, 2008 compared to $2.1 million of unfavorable loss development (related to accident years 2003 through 2007) in the three months ended September 30, 2009.  The increase in our net loss ratio for the nine months ended September 30, 2009 was primarily the result of $20.9 million in favorable loss development in the nine months ended September 30, 2008 compared to $5.9 million of unfavorable loss development in the nine months ended September 30, 2009. Our direct net loss reserves are net of reinsurance and exclude reserves associated with KEIC and the business that we involuntarily assume from the NCCI.

As discussed under the heading “Critical Accounting Policies, Estimates and Judgments – Unpaid Loss and Loss Adjustment Expenses – Actuarial Loss Reserve Estimation Methods” in this Item 2, we use an expected loss ratio (“ELR”) method to establish the loss reserves for the current accident year.   Once the accident year is complete and begins to age, the ELR method is blended with the actual paid and incurred losses to determine the revised estimated ultimate losses for the accident year.
 
Accident year 2009 is incomplete, as only nine months of the year have been earned as of September 30, 2009.  An expected loss ratio was established for each jurisdiction and type of loss (indemnity, medical, ALAE).  The expected loss ratio was multiplied by the booked accident year earned premium to produce the ultimate loss to date.  The expected loss ratio selections are reviewed quarterly with each internal IBNR study.  Given the short experience period for the current accident year, the expected loss ratios are usually maintained at least through the first 12 months of the accident year and revised as the underlying data matures.  There were no changes to the expected loss ratio selections for accident year 2009 when compared to June 30, 2009 results.
 
While there was some movement in the calculated ultimate values related to accident year 2008, it was not significant and, as a result, the ultimate loss estimates did not change from the June 30, 2009 estimates.  Due to the relative immaturity of accident year 2008 (age 21 months as of September 30, 2009), and the longer tail nature of the workers compensation line of business, the actual results for this accident year are still subject to volatility.  This volatility could still result in changes to the ultimate loss estimates, upward or downward, in the future periods.
 
For accident year 2007, the ultimate loss estimates at September 30, 2009 were higher when compared to June 30, 2009.  The development in the ultimate loss selections can be attributed to indemnity and medical loss development results in certain states, both in our State Act and Longshore & Maritime business.  With each quarterly IBNR study, we monitor actual versus expected loss development closely, along with claim severity and frequency changes.  The combination of these results warranted increases totaling $2.4 million to our indemnity and medical ultimate loss estimates.  Due to the relative immaturity of accident year 2007 (age 33 months as of September 30, 2009), and the longer tail nature of the workers compensation line of business, the actual results for this accident year are still subject to volatility.  This volatility could still result in changes to the ultimate loss estimates, upward or downward, in the future periods.