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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-32.2 - EXHIBIT 32.2 - SeaBright Holdings, Inc.ex32_2.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 June 30, 2010

or

o
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 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)

SeaBright Insurance Holdings, Inc.
(Former name, former address and former fiscal year, if changed since last report)

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

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 o    No o

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 o
Accelerated filer T
Non-accelerated filer o
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):   Yes o   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 August 6, 2010
Common Stock, $0.01 Par Value
22,023,529
 


 
 

 

SeaBright Holdings, Inc.

Index to Form 10-Q

   
Page
     
Part I.
Financial Information
 
     
Item 1.
2
     
 
2
     
 
3
     
 
4
     
 
5
     
Item 2.
14
     
Item 3.
21
     
Item 4.
21
     
Part II.
Other Information
 
     
Item 1A.
21
     
Item 2.
22
     
Item 6.
22
     
23

 
- 1 -


PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

   
June 30,
2010
   
December 31,
2009
 
   
(Unaudited)
   
(Audited)
 
   
(in thousands, except share and per share amounts)
 
ASSETS
           
             
Fixed income securities available for sale, at fair value (amortized cost $645,166 in 2010 and $608,222 in 2009)
  $ 666,949     $ 626,608  
Cash and cash equivalents
    19,907       12,896  
Accrued investment income
    6,941       6,734  
Premiums receivable, net of allowance
    15,509       14,477  
Deferred premiums
    188,266       182,239  
Service income receivable
    221       317  
Reinsurance recoverables
    44,343       34,339  
Due from reinsurer
    5,783       6,707  
Receivable under adverse development cover
    3,010       3,010  
Prepaid reinsurance
    5,651       6,760  
Property and equipment, net
    5,635       5,356  
Federal income tax recoverable
    10,765       4,774  
Deferred income taxes, net
    20,866       21,861  
Deferred policy acquisition costs, net
    27,105       25,537  
Intangible assets, net
    1,391       1,431  
Goodwill
    2,794       4,321  
Other assets
    10,409       7,494  
Total assets
  $ 1,035,545     $ 964,861  
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
                 
                 
Liabilities:
               
Unpaid loss and loss adjustment expense
  $ 411,865     $ 351,496  
Unearned premiums
    180,609       175,766  
Reinsurance funds withheld and balances payable
    6,371       7,312  
Premiums payable
    7,290       4,786  
Accrued expenses and other liabilities
    63,689       54,028  
Surplus notes
    12,000       12,000  
Total liabilities
    681,824       605,388  
                 
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 – 22,024,321 shares at June 30, 2010 and 21,675,786 shares at December 31, 2009
    220       217  
Paid-in capital
    207,259       205,079  
Accumulated other comprehensive income
    15,135       12,927  
Retained earnings
    131,107       141,250  
Total stockholders’ equity
    353,721       359,473  
Total liabilities and stockholders’ equity
  $ 1,035,545     $ 964,861  

See accompanying notes to unaudited condensed consolidated financial statements.

 
- 2 -


SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2010
   
2009
   
2010
   
2009
 
   
(in thousands, except share and earnings per share information)
 
Revenue:
                       
Premiums earned
  $ 65,621     $ 60,029     $ 126,251     $ 118,033  
Claims service income
    224       243       437       489  
Other service income
    52       47       85       111  
Net investment income
    5,880       5,651       11,959       11,298  
Other-than-temporary impairment losses:
                               
Total other-than-temporary impairment losses
          (258 )           (258 )
Less portion of losses recognized in accumulated other comprehensive income
                       
Net impairment losses recognized in earnings
          (258 )           (258 )
Other net realized gains (losses) recognized in earnings
    3,851       (86 )     10,383       (75 )
Other income
    896       977       1,726       2,208  
      76,524       66,603       150,841       131,806  
Losses and expenses:
                               
Loss and loss adjustment expenses
    79,696       41,212       122,445       79,776  
Underwriting, acquisition and insurance expenses
    17,059       16,090       35,816       35,884  
Interest expense
    132       152       260       326  
Goodwill impairment
    1,527       –        1,527       –   
Other expenses
    2,402       2,642       4,892       4,714  
      100,816       60,096       164,940       120,700  
Income (loss) before taxes
    (24,292 )     6,507       (14,099 )     11,106  
                                 
Income tax expense (benefit)
    (8,762 )     2,205       (6,156 )     2,816  
Net income (loss)
  $ (15,530 )   $ 4,302     $ (7,943 )   $ 8,290  
                                 
Basic earnings (loss) per share
  $ (0.74 )   $ 0.21     $ (0.38 )   $ 0.40  
Diluted earnings (loss) per share
  $ (0.74 )   $ 0.20     $ (0.38 )   $ 0.39  
                                 
Weighted average basic shares outstanding
    20,893,983       20,724,956       20,820,281       20,670,130  
Weighted average diluted shares outstanding
    20,893,983       21,412,646       20,820,281       21,383,475  
                                 
Dividends declared per share
  $ 0.05     $     $ 0.10     $  

See accompanying notes to unaudited condensed consolidated financial statements.

 
- 3 -


SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

   
Six Months Ended June 30,
 
   
2010
   
2009
 
   
(in thousands)
 
             
Cash flows from operating activities:
           
Net income (loss)
  $ (7,943 )   $ 8,290  
Adjustments to reconcile net income (loss) to cash provided by operating activities:
               
Amortization of deferred policy acquisition costs
    22,745       22,039  
Policy acquisition costs deferred
    (24,313 )     (24,510 )
Provision for depreciation and amortization
    3,136       2,532  
Compensation cost on restricted shares of common stock
    2,268       2,144  
Compensation cost on stock options
    438       351  
Net realized (gain) loss on investments
    (10,383 )     333  
Deferred income tax benefit
    (140 )     (1,708 )
Changes in certain assets and liabilities:
               
Unpaid loss and loss adjustment expense
    60,369       30,701  
Income tax payable
    (5,992 )     (1,095 )
Reinsurance recoverables, net of reinsurance withheld
    (8,912 )     (10,362 )
Unearned premiums, net of deferred premiums and premiums receivable
    (2,216 )     6,335  
Accrued investment income
    (207 )     (144 )
Other assets and other liabilities
    4,189       (591 )
Net cash provided by operating activities
    33,039       34,315  
                 
Cash flows from investing activities:
               
Purchases of investments
    (254,446 )     (80,670 )
Sales of investments
    205,597       15,042  
Maturities and redemption of investments
    25,649       30,682  
Purchases of property and equipment
    (1,207 )     (1,713 )
Net cash used in investing activities
    (24,407 )     (36,659 )
                 
Cash flows from financing activities:
               
Proceeds from exercise of stock options
    26        
Grant of restricted shares of common stock
    4       4  
Surrender of stock in connection with restricted stock vesting
    (553 )     (473 )
Stockholder dividends paid
    (1,098 )      
Net cash used in financing activities
    (1,621 )     (469 )
                 
Net increase (decrease) in cash and cash equivalents
    7,011       (2,813 )
Cash and cash equivalents at beginning of period
    12,896       22,872  
Cash and cash equivalents at end of period
  $ 19,907     $ 20,059  
                 
Supplemental disclosures:
               
Interest paid on surplus notes
  $ 257     $ 348  
Federal income taxes paid
          5,400  
Accrued expenses for purchases of investments
    8,424       1,072  
Receivable for sales of investments
    2,936        

See accompanying notes to unaudited condensed consolidated financial statements.

 
- 4 -


SEABRIGHT 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 Holdings, Inc. (“SHI” or “SeaBright”) 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”).  On May 24, 2010, SeaBright announced that it changed its corporate name from SeaBright Insurance Holdings, Inc. to SeaBright Holdings, Inc. to better reflect the different products and services offered by its subsidiary companies.  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, 2009 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, 2009 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, 2010.

In the opinion of management, the unaudited condensed consolidated financial statements include all adjustments (including normal recurring adjustments) necessary to state fairly the financial information set forth therein. Results of operations for the three month or six month periods ended June 30, 2010 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 year’s financial statements to conform to classifications used in the current year. The condensed consolidated statements of operations for the three months and six months ended June 30, 2009 have been revised to correct an immaterial error in the elimination of intercompany revenue and expense. The corrections had no impact on income before taxes, net income or the loss, expense and combined ratios. The following table summarizes the impact of the corrections:

   
Three Months Ended June 30, 2009
   
Six Months Ended June 30, 2009
 
   
As Reported
   
Adjustment
   
As Revised
   
As Reported
   
Adjustment
   
As Revised
 
   
(in thousands)
 
Other income
  $ 1,645     $ (668 )   $ 977     $ 4,322     $ (2,114 )   $ 2,208  
Other expense
    3,310       (668 )     2,642       6,828       (2,114 )     4,714  

2.
Summary of Significant Accounting Policies

a.  Use of Estimates

The preparation of the 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 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.  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 six month periods ended June 30, 2010 and 2009:

 
- 5 -


SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2010
   
2009
   
2010
   
2009
 
   
(in thousands)
 
Basic weighted average shares outstanding
    20,894       20,725       20,820       20,670  
Weighted average dilutive shares issuable upon exercise of outstanding stock options and vesting of nonvested restricted stock
          688             713  
Diluted weighted average shares outstanding
    20,894       21,413       20,820       21,383  

The effect of including shares issuable upon the exercise of outstanding stock options and the vesting of nonvested restricted stock is antidilutive for the three month and six month periods ended June 30, 2010. Therefore, such shares have been excluded from the calculation of diluted weighted average shares outstanding. The numbers of such shares excluded for the three month and six month periods ended June 30, 2010 were approximately 843,000 and 874,000, respectively.

c.  Stockholder Dividends

On May 11, 2010, the Company’s Board of Directors declared a quarterly dividend of $0.05 per common share payable on July 15, 2010 to stockholders of record on July 1, 2010. Any future determination to pay cash dividends on the Company’s common stock will be at the discretion of its Board of Directors and will be dependent on the Company’s earnings, financial condition, operating results, capital requirements, any contractual restrictions, regulatory and other restrictions on the payment of dividends by the Company’s subsidiaries, and other factors that the Company’s Board of Directors deems relevant.

d.   Comprehensive Income

The following table summarizes the Company’s comprehensive income for the three month and six month periods ended June 30, 2010 and 2009:

   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2010
   
2009
   
2010
   
2009
 
   
(in thousands)
 
Net income (loss)
  $ (15,530 )   $ 4,302     $ (7,943 )   $ 8,290  
Reclassification adjustment for net realized (gains) losses recorded into income
    (3,851 )     344       (10,383 )     333  
Tax expense (benefit) related to reclassification adjustment gains (losses)
    1,348       (120 )     3,633       (117 )
Increase in unrealized gains/losses on investment securities available for sale
    12,262       3,051       13,780       8,994  
Tax expense related to unrealized gains (losses)
    (4,291 )     (1,068 )     (4,822 )     (3,148 )
Tax effect of change in deferred tax asset valuation allowance recorded in comprehensive income
          854             812  
Total comprehensive income (loss)
  $ (10,062 )   $ 7,363     $ (5,735 )   $ 15,164  

e.   Other Significant Accounting Policies

For a more complete discussion of the Company’s significant accounting policies, please see Note 2 to the Company’s consolidated financial statements as of and for the year ended December 31, 2009 in Part II, Item 8 of the Company’s Annual Report on Form 10-K filed with the SEC on March 16, 2010.

 
- 6 -


SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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 June 30, 2010 are as follows:

   
Cost or Amortized Cost
   
Gross Unrealized Gains
   
Gross Unrealized Losses
   
Estimated Fair Value
   
Carrying Value
 
   
(in thousands)
       
U.S. Treasury securities
  $ 21,202     $ 785     $     $ 21,987     $ 21,987  
Government sponsored agency securities
    24,135       1,258             25,393       25,393  
Corporate securities
    149,781       5,836       (62 )     155,555       155,555  
Tax-exempt municipal securities
    305,871       8,753       (293 )     314,331       314,331  
Mortgage pass-through securities
    59,515       3,449             62,964       62,964  
Collateralized mortgage obligations
    26,214       388       (52 )     26,550       26,550  
Asset-backed securities
    58,448       1,721             60,169       60,169  
Total investment securities available for sale
  $ 645,166     $ 22,190     $ (407 )   $ 666,949     $ 666,949  

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.  The Company has the ability and intent to hold impaired investments to maturity or for a period of time sufficient for recovery of their carrying amount.

Approximately $91,000 of the total unrealized losses at June 30, 2010 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 June 30, 2010. As of June 30, 2010, 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 June 30, 2010. For the three months and six months ended June 30, 2010, the Company recognized no other-than-temporary impairment losses related to debt securities.

The following table presents information about investment securities with unrealized losses at June 30, 2010:

   
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)
       
Corporate securities
  $ 8,632     $ (62 )   $     $     $ 8,632     $ (62 )
Tax-exempt municipal securities
    37,296       (249 )     5,796       (44 )     43,092       (293 )
Collateralized mortgage obligations
    1,862       (5 )     164       (47 )     2,026       (52 )
Total
  $ 47,790     $ (316 )   $ 5,960     $ (91 )   $ 53,750     $ (407 )

 
- 7 -


SEABRIGHT 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 June 30, 2010 and approximately $7.9 million of indirect exposure to sub-prime mortgages. The following table provides a breakdown of ratings on the bonds in the Company’s municipal portfolio as of June 30, 2010:

     
Insured Bonds
   
Uninsured Bonds
   
Total Municipal Portfolio Based On
 
Rating
   
Insured Ratings
   
Underlying Ratings
   
Ratings
   
Overall Ratings (1)
   
Underlying Ratings
 
     
(in thousands)
 
AAA
    $ 8,820     $ 8,820     $ 26,426     $ 35,246     $ 35,246  
AA+
      28,975       23,562       55,308       84,283       78,870  
AA
      34,889       32,083       45,656       80,545       77,739  
AA-
      45,799       42,933       25,926       71,725       68,859  
A+       16,450       26,370       7,595       24,045       33,965  
A       4,985       4,985       11,307       16,292       16,292  
A-       3,166       3,166       518       3,684       3,684  
BBB+
            1,165       3,376       3,376       4,541  
BBB
                  2,257       2,257       2,257  
Pre-refunded (2)
      12,132       12,132       10,526       22,658       22,658  
Total
    $ 155,216     $ 155,216     $ 188,895     $ 344,111     $ 344,111  
__________

 
(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 June 30, 2010, the Company had no direct investments in any bond insurer, and the following bond insurer insured more than 10% of the municipal bond investments in the Company’s portfolio:
 
         
Insurer Ratings
   
Average Underlying
 
Bond Insurer
 
Fair Value
   
S&P
   
Moody’s
   
Bond Rating
 
   
(Millions)
   
 
             
National Public Finance Guarantee Corporation
  $ 68.7       A       Baa1       AA-  
 
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 June 30, 2010, 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
  $ 32,409     $ 32,856  
Due after one year through five years
    177,678       185,500  
Due after five years through ten years
    251,227       258,257  
Due after ten years
    39,676       40,653  
Securities not due at a single maturity date
    144,176       149,683  
Total fixed income securities
  $ 645,166     $ 666,949  

The consolidated amortized cost of investment securities available for sale deposited with various regulatory authorities at June 30, 2010 was $214.3 million.

 
- 8 -


SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

4.
Premiums

Direct premiums written totaled $64.9 million and $70.7 million for the three month periods ended June 30, 2010 and 2009, respectively, and $139.5 million and $147.6 million for the six month periods then ended, respectively.

Premiums receivable consist of the following at June 30, 2010 and December 31, 2009:

   
June 30,
2010
   
December 31,
2009
 
   
(in thousands)
 
Premiums receivable
  $ 16,103     $ 15,057  
Allowance for doubtful accounts
    (594 )     (580 )
    $ 15,509     $ 14,477  

5.
Reinsurance

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. On October 1, 2009, the Company entered into reinsurance agreements with nonaffiliated reinsurers wherein it retains the first $500,000 of each loss occurrence and the next $500,000 of losses per occurrence are 50% reinsured.  This reinsurance program, which expires on September 30, 2010, provides loss coverage up to $85.0 million per loss occurrence. The Company had different reinsurance programs in place in prior years, as more fully documented in Note 8 to the Company’s consolidated financial statements as of and for the year ended December 31, 2009 in Part II, Item 8 of the Company’s Annual Report on Form 10-K filed with the SEC on March 16, 2010.

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 six month periods ended June 30, 2010 and 2009:

   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2010
   
2009
   
2010
   
2009
 
   
(in thousands)
 
Beginning balance:
                       
Unpaid loss and loss adjustment expense
  $ 361,905     $ 308,701     $ 351,496     $ 292,027  
Reinsurance recoverables
    (36,853 )     (25,669 )     (34,080 )     (18,231 )
Net balance, beginning of year
    325,052       283,032       317,416       273,796  
Incurred related to:
                               
Current period
    49,113       38,280       91,987       75,946  
Prior periods
    30,583       2,932       30,458       3,256  
Receivable under adverse development cover
                      574  
Total incurred
    79,696       41,212       122,445       79,776  
Paid related to:
                               
Current period
    (6,505 )     (10,682 )     (11,536 )     (15,970 )
Prior periods
    (30,430 )     (18,866 )     (60,512 )     (42,332 )
Total paid
    (36,935 )     (29,548 )     (72,048 )     (58,302 )
Receivable under adverse development cover
                      (574 )
Net balance, end of period
    367,813       294,696       367,813       294,696  
Reinsurance recoverables
    44,052       28,032       44,052       28,032  
Unpaid loss and loss adjustment expense
  $ 411,865     $ 322,728     $ 411,865     $ 322,728  

As a result of changes in estimates of insured events in prior periods, loss reserves for prior years increased by a net amount of $30.6 million in the three months ended June 30, 2010 and $30.5 million in the six months then ended. The net unfavorable development in the second quarter of 2010 related to the following accident years: $11.5 million in 2009, $10.1 million in 2008, $5.8 million in 2007, and $3.2 million in 2006 and prior. On a gross basis, approximately 52% of the reserve strengthening in the second quarter of 2010 related to the Company’s California book of business, driven mainly by adverse development on ultimate medical loss estimates and duration primarily in accident years 2007 through 2009. Development related to the Company’s state act business in states other than California accounted for approximately 30% of the second quarter gross reserve strengthening, driven primarily by adverse development of indemnity losses and accompanying allocated loss adjustment expenses (“ALAE”). The remaining approximately 18% of second quarter gross reserve development related to the Company’s USL&H business and was driven primarily by indemnity losses and ALAE.

 
- 9 -


SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

During the second quarter of 2010 and after considering the recent adverse development in accident years 2008 and 2009, the Company increased the net expected loss and ALAE ratio (the “ELR”) for the 2010 accident year from 61.5% to 64.5%, the quarterly impact of which was approximately $1.9 million.

The Company recorded adverse development of prior years’ loss reserves totaling $2.9 million in the three months ended June 30, 2009 and $3.8 million (excluding the receivable under the adverse development cover) in the six months then ended. Of the $2.9 million of adverse development in second quarter 2009, 88.0% related to accident year 2008 and the balance to accident year 2007.

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 June 30, 2010, SBIC had a liability for guaranty fund and other assessments of $7.5 million and a guaranty fund receivable of $1.8 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 June 30, 2010, 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 and May 2010.

As of June 30, 2010, the Company reserved 776,458 shares of common stock for issuance under the 2003 Plan, of which options to purchase 481,946 shares had been granted, and 3,065,041 shares for issuance under the 2005 Plan, of which 2,597,503 shares had been granted. In January 2006, the Compensation Committee of the Board of Directors terminated the ability to grant future stock option awards under the 2003 Plan. Therefore, the Company anticipates that all future awards will be made under the 2005 Plan.

 
- 10 -


SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

a.  Stock Options

The following table summarizes stock option activity for the six months ended June 30, 2010:

   
Shares Subject to Options
   
Weighted Average Exer- cise Price per Share
   
Weighted Average Re- maining Con- tractual Life
(years)
   
Aggregate Intrinsic Value
(in thousands)
 
Outstanding at December 31, 2009
    1,225,660     $ 11.19       6.2     $ 368  
Granted
    169,613       10.99              
Forfeited
    (12,561 )     13.24              
Exercised
    (4,000 )     6.54              
Cancelled
    (10,776 )     14.24              
Outstanding at June 30, 2010
    1,367,936       11.13       6.2        
                                 
Exercisable at June 30, 2010
    929,563       10.82       5.0        

The aggregate intrinsic values in the table above are before applicable income taxes and are based on the Company’s closing stock price of $9.48 on June 30, 2010. Proceeds from the exercise of stock options during the quarter ended June 30, 2010 totaled approximately $26,200.

b. Restricted Stock

The following table summarizes restricted stock activity for the six months ended June 30, 2010:

   
Number of Shares
   
Weighted Average Grant Date Fair Value
 
Outstanding at December 31, 2009
    936,020     $ 13.78  
Granted
    412,270       11.02  
Vested
    (213,514 )     17.93  
Forfeited
    (17,250 )     12.14  
Outstanding at June 30, 2010
    1,117,526       12.00  

As of June 30, 2010, there was $7.3 million of total unrecognized compensation cost related to restricted stock granted under the 2005 Plan. That cost is expected to be recognized over a weighted-average period of approximately 25 months.

c. Stock-Based Compensation

Total stock-based compensation expense recognized in the unaudited condensed consolidated statements of operations for the three month and six month periods ended June 30, 2010 and 2009 is shown in the following table. No compensation cost was capitalized during the periods shown.

   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2010
   
2009
   
2010
   
2009
 
   
(in thousands)
 
Stock-based compensation expense related to:
                       
Nonvested restricted stock
  $ 1,159     $ 1,059     $ 2,268     $ 2,144  
Stock options
    242       192       438       351  
Total
  $ 1,401     $ 1,251     $ 2,706     $ 2,495  
                                 
Total related tax benefit
  $ 439     $ 387     $ 845     $ 754  

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.

 
- 11 -


SEABRIGHT 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 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 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 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 June 30, 2010, the Company had no Level 3 financial assets or liabilities.

The table below presents the June 30, 2010 balances of assets and liabilities measured at fair value on a recurring basis.

   
Total
   
Level 1 (1)
   
Level 2
   
Level 3
 
   
(in thousands)
 
Securities available for sale
  $ 666,949     $ 21,987     $ 644,962     $  
__________

(1)
Consists of the Company’s investments in U.S. Treasury securities.

 
- 12 -


SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

At June 30, 2010, there were no liabilities measured at fair value on a recurring basis.

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 June 30, 2010, 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. There were no transfers between levels during the six months ended June 30, 2010.

10.
Goodwill

At June 30, 2010, the Company had the following amounts of goodwill related to previous acquisitions:

   
SBIC
   
THM
   
BWNV
   
Total
 
   
(in thousands)
 
Balance as of April 1, 2010:
                       
Goodwill
  $ 1,527     $ 1,355     $ 1,439     $ 4,321  
Accumulated impairment losses
                       
      1,527       1,355       1,439       4,321  
Goodwill acquired during the quarter
                       
Impairment losses
    (1,527 )                 (1,527 )
Balance as of June 30, 2010:
                               
Goodwill
    1,527       1,355       1,439       4,321  
Accumulated impairment losses
    (1,527 )                 (1,527 )
    $     $ 1,355     $ 1,439     $ 2,794  

The Company tests for goodwill impairment in the fourth quarter of each year. At the end of each subsequent quarter, management considers the results of the previous analysis as well as any recent developments that may constitute triggering events requiring the impairment analysis to be updated. The Company assessed the impact of the $30.6 million strengthening of the Company’s loss reserves in the second quarter of this year, the continuing negative effect of the economic slowdown on the Company’s gross premiums written, and the observed decline in the Company’s stock price and determined that a triggering event occurred for SBIC. The fair value of the reporting unit was estimated using a discounted cash flow analysis, resulting in the Company recording a $1.5 million impairment charge against the goodwill resulting from the acquisition of SBIC in September 2003. The Company did not identify any triggering events in the quarter ended June 30, 2010 that required the reevaluation of goodwill resulting from the acquisitions of THM and BWNV.

 
- 13 -


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, 2009 filed with the SEC on March 16, 2010.

The discussion under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009, 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, and include statements about our expectations for future periods with respect to payroll levels, rate changes in states where we write business, our adverse development cover with Lumbermens Mutual Casualty Company (“LMC”), stockholder dividends and our capital needs. 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;

 
changes in the U.S. economy and workforce levels;

 
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;

 
- 14 -


 
our status as an insurance holding company with no direct operations, which could adversely affect our ability to pay dividends in the future;

 
our reliance on independent insurance brokers;

 
increased assessments or other surcharges by states in which we write policies;

 
our potential exposure to losses if 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; and

 
changes in general economic conditions, including inflation and other factors.

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 2009 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.

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 or weak economic environment could result in continued high unemployment levels or further reduce payrolls, which could have a significant negative impact on our business, financial condition or results of operations.  Other negative impacts of the current economic environment include, but are not limited to, increases in claim severity and duration, which tend to drive up medical, indemnity and litigation costs. Additionally, the longer a claim remains open, the more exposed we become to the effects of medical cost inflation.  Specifically, in California, increased medical costs trends and the state’s severe economic downturn, which has made it increasingly difficult to return injured works to gainful employment, have led to increased claim durations and higher average severity.  As a result of these upward cost trends, we filed a 15.3% rate increase with the California Department of Insurance on July 26, 2010.

 
- 15 -


Results of Operations

Three Months and Six Months Ended June 30, 2010 and 2009

Gross Premiums Written. Gross premiums written consist of direct premiums written and premiums assumed from the National Council on Compensation Insurance (“NCCI”) residual market pools.  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 June 30, 2010 totaled $64.0 million, a decrease of $7.6 million, or 10.6%, from $71.6 million of gross premiums written in the same period of 2009.  Gross premiums written for the six months ended June 30, 2010 totaled $140.0 million, a decrease of $10.9 million, or 7.2%, from $150.9 million of gross premiums written in the same period of 2009. For the six months ended June 30, 2010, our “core” product lines contributed $104.1 million, or 74.4%, of the total gross premiums written compared to $129.5 million, or 85.8%, in the same period of 2009.

The decrease in our core product lines was partially offset by a net increase in our “program” business of $4.9 million and $14.7 million, respectively, in the three months and six months ended June 30, 2010. Gross premiums written in our program business in the six months ended June 30, 2010 totaled $33.6 million compared to $18.9 million in the same period of 2009. Our program business includes alternative markets and small maritime programs.

Excluding work we perform as the servicing carrier for the Washington State USL&H Compensation Act Assigned Risk Plan and business assumed from the NCCI residual market pools, the total number of customers we serviced increased from approximately 1,370 at June 30, 2009 to approximately 1,660 at June 30, 2010. The majority of the customer increase related to our program business, partially offset by a decrease in the number of core customers. By design, our program business will have a larger number of customers with a smaller average premium size than our core business. Our average premium size at June 30, 2010 was approximately $232,000 in our core business and $96,000 in our program business, compared to approximately $242,000 in our core business and $121,000 in our program business one year earlier.

Total in-force payrolls, a factor used in determining premiums charged, increased 2.9% from $7.0 billion at June 30, 2009 to $7.2 billion at June 30, 2010. California continues to be our largest market, accounting for approximately $145.5 million or 47.8% of our in-force premiums at June 30, 2010. This represents an increase of $23.8 million, or 19.6%, from approximately $121.7 million, or 40.2%, of total in-force premiums in California at June 30, 2009.

Premiums assumed from the NCCI residual markets for the three months ended June 30, 2010 decreased $1.7 million or 212.5% to ($0.9) million from $0.8 million for the same period in 2009. For the six months ended June 30, 2010, assumed premiums decreased $2.8 million, or 84.8%, to $0.5 million from $3.3 million for the same period in 2009.

Net Premiums Written.  Net premiums written totaled $60.8 million for the three months ended June 30, 2010 compared to $65.0 million in the same period in 2009, representing a decrease of $4.2 million, or 6.5%. For the six months ended June 30, 2010, net premiums written totaled $131.0 million, a decrease of $6.1 million, or 4.4%, from $137.1 million in the same period of 2009. The decrease in net premiums written for the six months ended June 30, 2010 was primarily attributable to the decrease in gross premiums written discussed above, offset in part by a decrease in ceded premiums written of $4.8 million primarily resulting from residual market business.

Net Premiums Earned.  Net premiums earned totaled $65.6 million for the three months ended June 30, 2010 compared to $60.0 million for the same period in 2009, representing an increase of $5.6 million, or 9.3%. For the six months ended June 30, 2010, net premiums earned totaled $126.3 million, an increase of $8.3 million, or 7.0%, from $118.0 million in the same period of 2009. 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 increased $5.7 million, or 8.9%, to $70.0 million for the quarter ended June 30, 2010 from $64.3 million for the same period in 2009. Our direct premiums earned for the six months ended June 30, 2010 increased $9.6 million, or 7.7%, to $134.9 million from $125.3 million for the same period in 2009.

 
- 16 -


The increases in earned premiums in the three month and six month periods of 2010 were due in part to premium increases of $3.3 million and $5.7 million, respectively, on retrospectively rated policies due to unfavorable loss results on those policies (and in particular the $30.6 million of adverse loss development recorded in the second quarter of 2010), as well as to the increase in total in-force payrolls discussed above. Earned premium on retrospectively rated policies for the three month and six month periods ended June 30, 2010 totaled $2.6 million and $2.0 million, respectively, compared to $(0.7) million and $(3.7) million, respectively, for the same periods in 2009.

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

   
Six Months Ended June 30,
 
   
2010
   
2009
 
   
Direct Premiums Earned
   
%
   
Direct Premiums Earned
   
%
 
   
($ in thousands)
 
California
  $ 62,559       46.4 %   $ 49,915       39.8 %
Louisiana
    12,262       9.1       13,081       10.4  
Illinois
    7,448       5.5       9,751       7.8  
Texas
    7,228       5.4       7,396       5.9  
Alaska
    6,855       5.1       7,167       5.7  
Total
  $ 96,352       71.5 %   $ 87,310       69.6 %

Net premiums earned are also affected by premiums ceded under reinsurance agreements and premiums we involuntarily assumed from the NCCI residual markets. Ceded premiums earned for the three months ended June 30, 2010 totaled $3.9 million compared to $5.1 million for the same period in 2009, representing a decrease of $1.2 million, or 23.5%. Ceded premiums earned for the six months ended June 30, 2010 totaled $10.3 million compared to $10.4 million for the same period in 2009, representing a decrease of $0.1 million, or 1.0%. The majority of the decrease in the second quarter related to reinsurance policies we entered into in 2008 and 2009 under which we cede 100% of NCCI assumed business for policy years 2009 and 2010. Earned premiums assumed from the NCCI residual markets for the six months ended June 30, 2010 decreased $1.5 million, or 48.4%, to $1.6 million from $3.1 million for the same period in 2009.

Net Investment Income.  Net investment income was $5.9 million for the three months ended June 30, 2010 compared to $5.7 million for the same period in 2009, representing an increase of $0.2 million, or 4.1%. For the six months ended June 30, 2010, net investment income totaled $12.0 million, an increase of $0.7 million, or 5.9%, from $11.3 million in the same period of 2009. Average invested assets for the three months ended June 30, 2010 increased $93.0 million, or 15.9%, from $586.1 million in 2009 to $679.1 million in 2010. For the six months ended June 30, 2010, average invested assets increased $89.0 million, or 15.5%, from $574.2 million in 2009 to $663.2 million in 2010. Our yield on average invested assets for the three months ended June 30, 2010 was approximately 3.5% compared to approximately 3.9% for the same period in 2009. For the six months ended June 30, 2010, our yield on average invested assets was 3.6% compared to approximately 3.9% for the same period in 2009.

Net Realized Gains.  Net realized gains totaled $3.9 million for the three months ended June 30, 2010 compared to net realized losses of $86,000 for the same period in 2009. For the six months ended June 30, 2010, net realized gains totaled $10.4 million compared to net realized losses of $75,000 in the same period of 2009. The realized gains in 2010 related primarily to the sale of investment securities to enable us to realize a portion of our capital loss carry forwards, which totaled approximately $15.3 million at December 31, 2009.

Other Income.  Other income totaled $0.9 million for the three months ended June 30, 2010 compared to $1.0 million in the same period of 2009, representing a decrease of $0.1 million or 8.3%. For the six months ended June 30, 2010, other income totaled $1.7 million, a decrease of $0.5 million, or 21.8%, from $2.2 million in the same period of 2009. 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 $79.7 million for the three months ended June 30, 2010 compared to $41.2 million for the same period in 2009, representing an increase of $38.5 million, or 93.4%. For the six months ended June 30, 2010, loss and loss adjustment expenses totaled $122.4 million, compared to $79.8 million for the same period in 2009, representing an increase of $42.7 million, or 53.5%. 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 June 30, 2010 was 121.1% compared to 68.2% for the same period in 2009. Our net loss ratio for the six months ended June 30, 2010 was 96.6% compared to 67.2% for the same period in 2009. The increase in our net loss ratio for the three months ended June 30, 2010 was primarily attributable to $30.6 million of adverse development of prior years’ net loss reserves recorded in the period compared to $2.9 million of adverse development recorded in the same period of 2009. Adverse development in the six months ended June 30, 2010 totaled $30.5 million compared to $3.8 million in the same period of 2009. Our direct loss reserves are net of reinsurance and exclude reserves associated with Kemper Employers Insurance Company (“KEIC’), whom we acquired from LMC in September 2003, 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 Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2009, we use an expected loss ratio 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 2010 is incomplete, as only six months of the year have been earned as of June 30, 2010. For the current accident year, an ELR was established for each jurisdiction and type of loss (indemnity, medical and ALAE) and was multiplied by the booked accident year earned premium to produce the ultimate loss to date. The ELR selections are reviewed quarterly with each internal reserve study. Given the short experience period for the current accident year, the ELRs are usually maintained at least through the first 12 months of the accident year and revised as the underlying data matures. However, after reviewing the year-to-date results for the 2010 accident year and considering the adverse development of accident years 2008 and 2009 booked in the second quarter, we increased the ELR for this year from 61.5% to 64.5%, resulting in $1.9 million of additional loss and ALAE in the second quarter.

For prior accident years, the ultimate loss estimates at June 30, 2010 were higher when compared to March 31, 2010 and resulted in a net increase of our loss reserves of $30.6 million in the second quarter. The $30.6 million adverse development related to the following accident years: $11.5 million in 2009, $10.1 million in 2008, $5.8 million in 2007, and $3.2 million in 2006 and prior. Please see Note 6 to the unaudited condensed consolidated financial statements in Item 1 of Part I of this Quarterly Report on Form 10-Q for further information regarding the $30.6 million of adverse development. Due to the longer tail nature of workers’ compensation claims, movements in an accident year’s ultimate loss estimate can be reasonably expected.

As of June 30, 2010, we had recorded a receivable of approximately $3.0 million for KEIC loss development under the adverse development cover we entered into with LMC on September 30, 2003, the date we acquired KEIC from LMC. We do not expect this receivable to have any material adverse effect on our future cash flows if LMC fails to perform its obligations under the adverse development cover. At June 30, 2010, we had access to approximately $3.8 million under a related collateralized reinsurance trust in the event that LMC fails to satisfy its obligations under the adverse development cover.

Underwriting, Acquisition and Insurance Expenses.  Underwriting expenses totaled $17.1 million for the three months ended June 30, 2010, compared to $16.1 million for the same period in 2009, representing an increase of $1.0 million, or 6.0%, driven mainly by increased commission expense offset by lower employee-related costs. For the six months ended June 30, 2010, underwriting expenses totaled $35.8 million, a decrease of $0.1 million, or 0.2%, from $35.9 million in the same period of 2009. Our net underwriting expense ratio, which is calculated by dividing underwriting, acquisition and insurance expenses less other service income by premiums earned, for the three months ended June 30, 2010 was 25.9%, compared to 26.7% for the same period in 2009. For the six months ended June 30, 2010, our net underwriting expense ratio was 28.3%, compared to 30.3% for the same period of 2009. The decreases in the expense ratios for the three month and six month periods ended June 30, 2010 were primarily the result of increases in net premiums earned for the periods.

Interest Expense.  Interest expense related to the surplus notes issued by our insurance subsidiary in May 2004 totaled $132,000 for the three months ended June 30, 2010, compared to $152,000 for the same period in 2009, representing a decrease of $20,000, or 13.2%. Interest expense for the six months ended June 30, 2010 totaled $260,000, compared to $326,000 for the same period in 2009, representing a decrease of $66,000, or 20.2%. The surplus notes interest rate, which is calculated at the beginning of each interest payment period using the 3-month LIBOR plus 400 basis points, decreased from 4.66% at June 30, 2009 to 4.48% at June 30, 2010.

 
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Other Expenses. Other expenses totaled $2.4 million for the three months ended June 30, 2010, compared to $2.6 million for same period in 2009, representing a decrease of $0.2 million, or 9.1%. For the six months ended June 30, 2010, other expenses totaled $4.9 million, an increase of $0.2 million, or 3.8%, from $4.7 million in the same period of 2009. Other expenses result primarily from the operations of PointSure (including BWNV) and THM, which together accounted for approximately $2.0 million and $4.3 million of expenses for the three months and six months ended June 30, 2010, respectively, compared to $2.3 million and $4.0 million for the same periods in 2009.

Income Tax Expense.  The effective tax rate for the three months ended June 30, 2010 was 36.1%, compared to 33.9% for the same period in 2009. For the six months ended June 30, 2010 our effective tax rate was 43.7% compared to 25.4% in the same period of 2009. Our effective tax rates generally vary from the statutory tax rate of 35.0% primarily as a result of tax exempt interest income. At June 30, 2010, approximately 47.1% of our investment portfolio was invested in tax-exempt municipal bonds, compared to approximately 53.0% at June 30, 2009.

Income tax expense in the quarter ended June 30, 2009 included a non-recurring, non-cash charge of approximately $976,000 to reclassify a first quarter 2009 reversal of a deferred tax asset valuation allowance which we established at December 31, 2008. This amount had previously been recorded as a reduction to income tax expense in the quarter ended March 31, 2009 and had the effect of increasing net income for that period by that amount. We subsequently concluded that the first quarter reversal should have been recorded in accumulated other comprehensive income rather than in income tax expense. The effect of this correction in the quarter ended June 30, 2009 was to increase income tax expense and to reduce net income by approximately $976,000.

 Net Income (Loss).  Net loss was $15.5 million for the three months ended June 30, 2010, compared to net income of $4.3 million for the same period in 2009, representing a decrease of $19.8 million, or 461.0%. Net loss for the six months ended June 30, 2010 totaled $7.9 million, a decrease of $16.2 million, or 195.8%, from net income of $8.3 million in the same period of 2009. The decreases in net income for the three month and six month periods ended June 30, 2010 resulted primarily from $30.6 million of adverse development of prior years’ loss reserves recognized in the second quarter of 2010, offset by increases in premiums earned and gains realized upon the sale of investment securities.

Liquidity and Capital Resources

Our principal sources of funds are underwriting operations, investment income and proceeds from sales and maturities of investments. Our primary uses of funds are to pay claims and operating expenses, to purchase investments and to pay declared common stock dividends.

Our investment portfolio is structured so that investments mature periodically over time in reasonable relation to current expectations of future claim payments. Since we have a limited claims history, we have derived our expected future claim payments from industry and predecessor trends and included a provision for uncertainties. Our investment portfolio as of June 30, 2010 has an effective duration of 4.80 years with individual maturities extending out to 29 years. Currently, we make claim payments from positive cash flow from operations and invest excess cash in securities with appropriate maturity dates to balance against anticipated future claim payments. As these securities mature, we intend to invest any excess funds in investments with appropriate durations to match against expected future claim payments.

At June 30, 2010, our investment portfolio consisted of investment grade fixed income securities with fair values subject to fluctuations in interest rates, as well as other factors such as credit. All of the securities in our investment portfolio are accounted for as “available for sale” securities. While we have structured our investment portfolio to provide an appropriate matching of maturities with anticipated claim payments, if we decide or are required in the future to sell securities in a rising interest rate environment, we would expect to incur losses from such sales.

Our ability to adequately provide funds to pay claims comes from our disciplined underwriting and pricing standards and the purchase of reinsurance to protect us against severe claims and catastrophic events. Effective October 1, 2008 and as renewed on October 1, 2009, our reinsurance program provides for retention of the first $500,000 of each loss occurrence and the next $500,000 of losses per occurrence are 50% reinsured up to $85.0 million, subject to various deductibles and exclusions. Our reinsurance program that was effective October 1, 2007 to October 1, 2008 provides us with reinsurance protection for each loss occurrence in excess of $1.0 million, up to $75.0 million, subject to various deductibles and exclusions. Given industry and predecessor trends, we believe we are sufficiently capitalized to cover our retained losses.

 
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SeaBright is a holding company with minimal unconsolidated revenue. As SeaBright pays stockholder dividends and has other capital needs in the future, we anticipate that it will be necessary for our insurance subsidiary to pay dividends to SeaBright. Our insurance subsidiary is required by law to maintain a certain minimum level of surplus on a statutory basis. The payment of such dividends will be regulated as described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of Part II of our Annual Report on Form 10-K for the year ended December 31, 2009.

Our unaudited condensed consolidated net cash provided by operating activities for the six months ended June 30, 2010 was $33.0 million, compared to our cash flow from operations of $34.3 million for the same period in 2009. The decrease is mainly attributable to an increase in paid losses (net of reinsurance collected), partially offset by a decrease in federal income taxes paid.

Net cash used in investing activities was $24.4 million in the six months ended June 30, 2010, compared to $36.7 million of net cash used during the same period in 2009. The significant increases in the purchases and sales of investment securities were driven by the $10.4 million of realized gains discussed previously.

For the six months ended June 30, 2010, financing activities used a total of $1.6 million due to stockholder dividend payments and cash used due to the surrender of stock to cover tax withholding obligations associated with the vesting of restricted stock, compared to $0.5 million of cash used in the same period in 2009 due to the surrender of stock to cover tax withholding obligations associated with the vesting of restricted stock.

As of June 30, 2010, SBIC’s statutory surplus totaled $298.9 million (unaudited), compared to $282.6 million (unaudited) as of June 30, 2009.

Contractual Obligations and Commitments

During the six months ended June 30, 2010, there were no material changes to our contractual obligations and commitments.

Off-Balance Sheet Arrangements

As of June 30, 2010, we had no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Critical Accounting Policies, Estimates and Judgments

It is important to understand our accounting policies in order to understand our financial statements. Management considers some of these policies to be critical to the presentation of our financial results, since they require management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the financial reporting date and throughout the period being reported upon. Some of the estimates result from judgments that can be subjective and complex, and consequently, actual results reflected in future periods might differ from these estimates.

The most critical accounting policies involve the reporting of 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, deferred policy acquisition costs, income taxes, the valuation of goodwill, the impairment of investment securities, earned but unbilled premiums and retrospective premiums. These critical accounting policies are described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of Part II of our Annual Report on Form 10-K for the year ended December 31, 2009.

 
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Item 3.
Quantitative and Qualitative Disclosures About Market Risk

Credit Risk

Credit risk is the potential economic loss principally arising from adverse changes in the financial condition of a specific debt issuer. We address this risk by investing primarily in fixed-income securities which are rated “A” or higher by Standard & Poor’s or another major rating agency. We also independently, and through our outside investment manager, monitor the financial condition of all of the issuers of fixed-income securities in the portfolio. To limit our exposure to risk, we employ stringent diversification rules that limit the credit exposure to any single issuer or business sector.

Interest Rate Risk

We had fixed-income investments with a fair value of $666.9 million at June 30, 2010 that are subject to interest rate risk compared with $626.6 million at December 31, 2009. We manage the exposure to interest rate risk through a disciplined asset/liability matching and capital management process. In the management of this risk, the characteristics of duration, credit and variability of cash flows are critical elements. These risks are assessed regularly and balanced within the context of the liability and capital position.

Since December 31, 2009, there have been no material changes in the quantitative or qualitative aspects of our market risk profile. For additional information regarding our exposure to certain market risks, see Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” in our Annual Report on Form 10-K for the year ended December 31, 2009, filed with the SEC on March 16, 2010.

Item 4.
Controls and Procedures

Disclosure Controls and Procedures

Under the supervision and with the participation of management, including our Chief Executive Officer and our Chief Financial Officer, we have carried out an evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information we are required to disclose in reports that are filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms specified by the SEC and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our second fiscal quarter of 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item  1A.
Risk Factors

During the quarter ended June 30, 2010, there were no material changes to the risk factors disclosed in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2009, filed with the SEC on March 16, 2010.

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

The following table sets forth information in connection with purchases made by, or on behalf of, us or any affiliated purchaser, of shares of our common stock during the three months ended June 30, 2010:

   
(a)
Total Number of Shares (or Units) Purchased
   
(b)
Average Price Paid per Share (or Unit)
   
(c)
Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs
   
(d)
Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs
 
Month # 1 (April 1, 2010 through April 30, 2010)
                       
Month # 2 (May 1, 2010 through May 31, 2010)
    2,378     $ 11.16              
Month # 3 (June 1, 2010 through June 30, 2010)
                       

We did not repurchase any of our common stock on the open market as part of a stock repurchase program during the six months ended June 30, 2010; however, our employees surrendered 50,485 shares of our common stock to satisfy their tax withholding obligations in connection with the vesting of restricted stock awards issued under our 2005 Plan.

Item 6.
Exhibits

The list of exhibits in the Exhibit Index to this quarterly report is incorporated herein by reference.

 
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SIGNATURES

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

 
SEABRIGHT HOLDINGS, INC.
 
       
       
Date: August 9, 2010
     
       
 
By:
/s/ John G. Pasqualetto
 
   
John G. Pasqualetto
 
   
Chairman, President and Chief Executive Officer
 
   
(Principal Executive Officer)
 
       
 
By:
/s/ Scott H. Maw
 
   
Scott H. Maw
 
   
Senior Vice President – Chief Financial Officer and Assistant Secretary
 
   
(Principal Financial Officer)
 

 
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EXHIBIT INDEX

The list of exhibits in the Exhibit Index to this quarterly report on Form 10-Q is incorporated herein by reference. Exhibits 31.1 and 31.2 are being filed as part of this quarterly report on Form 10-Q. Exhibits 32.1 and 32.2 are being furnished with this quarterly report on Form 10-Q.

Exhibit
   
Number
 
Description
3.1
 
Amended and Restated Certificate of Incorporation of the Company (incorporated by refence to the Company’s Registration Statement on Form S-8 (file No. 333-123319), filed on March 15, 2005).
     
3.2
 
Amendment to the Company’s Amended and Restated Certificate of Incorporation (incorporated by reference to the Company’s Current Report on Form 8-K (file No. 001-34204), filed on May 24, 2010).
     
10.1
 
SeaBright Holdings, Inc. Amended and Restated 2005 Long-Term Equity Incentive Plan (incorporated by reference to the Company’s Current Report on Form 8-K (file No. 001-34204), filed on May 24, 2010).
     
10.2
 
SeaBright Holdings, Inc. 2010 Bonus Plan (incorporated by reference to the Company’s Current Report on Form 8-K (file No. 001-34204), filed on May 24, 2010).
     
 
Rule 13a-14(a) Certification (Chief Executive Officer)
     
 
Rule 13a-14(a) Certification (Chief Financial Officer)
     
 
Section 1350 Certification (Chief Executive Officer)
     
 
Section 1350 Certification (Chief Financial Officer)