SeaBright Holdings, Inc. - FORM 10-Q

Attached files

file	filename
EX-32.1 - EXHIBIT 32.1 - SeaBright Holdings, Inc.	ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - SeaBright Holdings, Inc.	ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - SeaBright Holdings, Inc.	ex31-1.htm
EXCEL - IDEA: XBRL DOCUMENT - SeaBright Holdings, Inc.	Financial_Report.xls
EX-32.2 - EXHIBIT 32.2 - SeaBright Holdings, Inc.	ex32-2.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

[X]	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 2011

[ ]	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)

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer [ ] Accelerated filer [X] 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 [X]

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 5, 2011
Common Stock, $0.01 Par Value		[22,378,394]

SeaBright Holdings, Inc.

Index to Form 10-Q

Page

Part I.	Financial Information

Item 1.	Financial Statements (unaudited)	2

	Condensed Consolidated Balance Sheets as of June 30, 2011 and December 31, 2010	2

	Condensed Consolidated Statements of Operations for the Three Months and Six Months Ended June 30, 2011 and 2010	3

	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2011 and 2010	4

	Notes to Unaudited Condensed Consolidated Financial Statements	5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	22

Item 4.	Controls and Procedures	23

Part II.	Other Information

Item 1A.	Risk Factors	23

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	24

Item 6.	Exhibits	24

Signatures		25

Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

	June 30, 2011		December 31, 2010
	(Unaudited)		(Audited)
	(in thousands, except share and per share amounts)
ASSETS

Fixed income securities available for sale, at fair value (amortized cost $653,989 in 2011 and $665,761 in 2010)	$	670,375	$	672,968
Cash and cash equivalents		29,210		15,958
Premiums receivable, net		20,655		15,023
Deferred premiums, net		169,483		168,842
Reinsurance recoverables		81,042		56,746
Federal income tax recoverable		12,743		11,749
Deferred income taxes, net		24,313		23,458
Deferred policy acquisition costs, net		25,762		25,574
Goodwill		2,794		2,794
Other assets		34,141		33,450
Total assets	$	1,070,518	$	1,026,562

LIABILITIES AND STOCKHOLDERS’ EQUITY

Liabilities:
Unpaid loss and loss adjustment expense	$	490,929	$	440,919
Unearned premiums		156,499		155,786
Reinsurance funds withheld and balances payable		6,396		6,739
Premiums payable		7,573		8,645
Accrued expenses and other liabilities		56,184		51,456
Surplus notes		12,000		12,000
Total liabilities		729,581		675,545

Contingencies (Note 7)

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 – 22,408,739 shares at June 30, 2011 and 22,025,450 shares at December 31, 2010		224		220
Paid-in capital		211,751		209,941
Accumulated other comprehensive income		11,493		5,591
Retained earnings		117,469		135,265
Total stockholders’ equity		340,937		351,017
Total liabilities and stockholders’ equity	$	1,070,518	$	1,026,562

See accompanying notes to unaudited condensed consolidated financial statements.

-2-

Table of Contents

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010
	(in thousands, except share and loss per share information)
Revenue:
Premiums earned	$	62,088		$	65,621		$	118,818		$	126,251
Claims service income		303			276			636			522
Net investment income		5,297			5,880			10,672			11,959
Net realized gains		109			3,851			407			10,383
Other income		1,230			1,086			2,294			2,290
Total revenue		69,027			76,714			132,827			151,405
Losses and expenses:
Loss and loss adjustment expenses		72,657			80,547			115,923			124,124
Underwriting, acquisition and insurance expenses		19,328			17,059			37,742			35,816
Interest expense		129			132			259			260
Goodwill impairment		–			1,527			–			1,527
Other expenses		2,077			1,741			4,047			3,777
Total losses and expenses		94,191			101,006			157,971			165,504
Loss before taxes		(25,164	)		(24,292	)		(25,144	)		(14,099	)

Income tax benefit		(9,352	)		(8,762	)		(9,580	)		(6,156	)
Net loss	$	(15,812	)	$	(15,530	)	$	(15,564	)	$	(7,943	)

Basic and diluted loss per share	$	(0.75	)	$	(0.74	)	$	(0.74	)	$	(0.38	)

Dividends declared per share	$	0.05		$	0.05		$	0.10		$	0.10

Weighted average basic and diluted shares outstanding		21,174,768			20,893,983			21,063,407			20,820,281

See accompanying notes to unaudited condensed consolidated financial statements.

-3-

Table of Contents

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Six Months Ended June 30,
	2011			2010
	(in thousands)
Cash flows from operating activities:
Net loss	$	(15,564	)	$	(7,943	)
Adjustments to reconcile net loss to cash provided by operating activities:
Amortization of deferred policy acquisition costs		25,025			22,745
Policy acquisition costs deferred		(25,213	)		(24,313	)
Provision for depreciation and amortization		4,226			3,136
Compensation cost on restricted shares of common stock		2,421			2,268
Compensation cost on stock options		350			438
Net realized gains on investments		(407	)		(10,383	)
Deferred income tax benefit		(4,133	)		(140	)
Changes in certain assets and liabilities:
Unpaid loss and loss adjustment expense		50,010			60,431
Income taxes payable		(994	)		(5,992	)
Reinsurance recoverables, net of reinsurance withheld		(24,814	)		(8,912	)
Unearned premiums, net of deferred premiums and premiums receivable		(5,559	)		(2,216	)
Other assets and other liabilities		2,028			3,920
Net cash provided by operating activities		7,376			33,039

Cash flows from investing activities:
Purchases of investments		(80,559	)		(254,446	)
Proceeds from sales of investments		61,276			205,597
Maturities and redemption of investments		29,258			25,649
Purchases of property and equipment		(926	)		(1,207	)
Net cash provided by (used in) investing activities		9,049			(24,407	)

Cash flows from financing activities:
Proceeds from exercise of stock options		–			26
Grant of restricted shares of common stock		5			4
Surrender of stock in connection with restricted stock vesting		(962	)		(553	)
Stockholder dividends paid		(2,216	)		(1,098	)
Net cash used in financing activities		(3,173	)		(1,621	)

Net increase in cash and cash equivalents		13,252			7,011
Cash and cash equivalents at beginning of period		15,958			12,896
Cash and cash equivalents at end of period	$	29,210		$	19,907

Supplemental disclosures:
Interest paid on surplus notes	$	259		$	257
Payable for purchases of investments		2,165			8,424
Receivable for sales of investments		1,000			2,936

See accompanying notes to unaudited condensed consolidated financial statements.

-4-

Table of Contents

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. (“SeaBright”) and its wholly owned subsidiaries, SeaBright Insurance Company (“SBIC”), PointSure Insurance Services, Inc. (“PointSure”), and Paladin Managed Care Services, Inc. (“PMCS”) (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, 2010 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, 2010 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 14, 2011.

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 months and six months ended June 30, 2011 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.

2.	Summary of Significant Accounting Policies

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.

Earnings Per Share

There was no difference between basic and diluted weighted average shares outstanding used in calculating earnings per share for the three month and six month periods ended June 30, 2011 and 2010 since the effect of including shares issuable upon the exercise of outstanding stock options and the vesting of non-vested restricted stock was anti-dilutive for all periods presented. Therefore, such shares have been excluded from the calculation of diluted weighted average shares outstanding. The approximate numbers of such shares excluded were as follows:

	Three Months Ended June 30,				Six Months Ended June 30,
	2011		2010		2011		2010
	(in thousands)
Weighted average shares issuable upon exercise of outstanding stock options and vesting of nonvested restricted stock		553		843		653		874

-5-

Table of Contents

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Stockholder Dividends

On May 10, 2011, the Company’s Board of Directors declared a quarterly dividend of $0.05 per common share. The dividend was paid on July15, 2011 to stockholders of record on July 1, 2011. 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, regulatory or other restrictions on the payment of dividends by the Company’s subsidiaries; and other factors that the Company’s Board of Directors deems relevant.

Comprehensive Loss

The following table summarizes the Company’s comprehensive loss for the three month and six month periods ended June 30, 2011 and 2010:

	Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010
	(in thousands)
Net loss	$	(15,812	)	$	(15,530	)	$	(15,564	)	$	(7,943	)
Reclassification adjustment for net realized gains recorded into income		(109	)		(3,851	)		(407	)		(10,383	)
Tax benefit related to reclassification adjustment gains		38			1,348			145			3,633
Increase in net unrealized gains on investment securities available for sale		10,905			12,262			9,586			13,780
Tax expense related to unrealized gains		(3,892	)		(4,291	)		(3,422	)		(4,822	)
Total comprehensive loss	$	(8,870	)	$	(10,062	)	$	(9,662	)	$	(5,735	)

Recent Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, to provide largely identical guidance about fair value measurement and disclosure requirements. The new standards do not extend the use of fair value but, rather, provide guidance about how fair value should be applied where it already is required or permitted under International Financial Reporting Standards (“IFRS”) or U.S. GAAP. The new guidance is effective for interim and annual reporting periods beginning after December 15, 2011. Early adoption is not permitted. The adoption of ASU 2011-04 is not expected to have a material effect on the Company’s consolidated financial condition and results of operations.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, to increase the prominence of other comprehensive income in the financial statements. An entity will have the option to present the components of net income and comprehensive income in either one or two consecutive financial statements. The new guidance is effective for interim and annual reporting periods beginning after December 15, 2011. However, early adoption is permitted. The amendments in this ASU should be applied retrospectively. The adoption of ASU 2011-05 is not expected to have a material effect on the Company’s consolidated financial condition and results of operations.

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, 2010 in Part II, Item 8 of the Company’s Annual Report on Form 10-K filed with the SEC on March 14, 2011.

-6-

Table of Contents

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 of investment securities available-for-sale at June 30, 2011, and December 31, 2010 were as follows:

	Cost or Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
	(in thousands)
June 30, 2011:
U.S. Treasury securities	$	25,990	$	796	$	(60	)	$	26,726
Government sponsored agency securities		17,263		960		–			18,223
Corporate securities		162,088		4,561		(795	)		165,854
Tax-exempt municipal securities		292,483		8,050		(881	)		299,652
Mortgage pass-through securities		75,804		2,723		(500	)		78,027
Collateralized mortgage obligations		14,891		230		(35	)		15,086
Asset-backed securities		65,470		1,414		(77	)		66,807
Total investment securities available for sale	$	653,989	$	18,734	$	(2,348	)	$	670,375

December 31, 2010:
U.S. Treasury securities	$	26,514	$	635	$	(172	)	$	26,977
Government sponsored agency securities		23,159		943		(31	)		24,071
Corporate securities		154,652		3,532		(1,915	)		156,269
Tax-exempt municipal securities		309,935		5,555		(4,778	)		310,712
Mortgage pass-through securities		73,501		2,548		(745	)		75,304
Collateralized mortgage obligations		17,260		233		(28	)		17,465
Asset-backed securities		60,740		1,577		(147	)		62,170
Total investment securities available for sale	$	665,761	$	15,023	$	(7,816	)	$	672,968

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. For the three months and six months ended June 30, 2011, the Company recognized no other-than-temporary impairment losses related to investments in debt securities.

The following table presents information about investment securities with unrealized losses at June 30, 2011:

	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:
US Treasury securities	$	3,443	$	(60	)	$	–	$	–		$	3,443	$	(60	)
Corporate securities		46,790		(795	)		–		–			46,790		(795	)
Tax-exempt municipal securities		77,060		(881	)		–		–			77,060		(881	)
Mortgage pass-through securities (1)		23,779		(500	)		–		–			23,779		(500	)
Collateralized mortgage obligations		–		–			151		(35	)		151		(35	)
Asset backed securities		6,150		(76	)		609		(1	)		6,759		(77	)
Total	$	157,222	$	(2,312	)	$	760	$	(36	)	$	157,982	$	(2,348	)

__________

(1) Includes adjustable rate mortgage securities.

-7-

Table of Contents

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, 2011 and approximately $10.0 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, 2011:

	Insured Bonds				Uninsured Bonds		Total Municipal Portfolio Based On
Rating	Insured Ratings		Underlying Ratings		Ratings		Overall Ratings (1)		Underlying Ratings
	(in thousands)

AAA	$	4,693	$	4,693	$	27,616	$	32,309	$	32,309
AA+		18,383		16,648		51,958		70,341		68,606
AA		24,024		21,832		55,530		79,554		77,362
AA-		24,530		24,199		42,122		66,652		66,321
A+		12,774		15,872		8,350		21,124		24,222
A		4,221		4,221		20,340		24,561		24,561
A-		1,051		2,211		3,483		4,534		5,694
BBB+		–		–		2,581		2,581		2,581
BBB		–		–		2,894		2,894		2,894
Pre-refunded (2)		6,119		6,119		8,133		14,252		14,252
Total	$	95,795	$	95,795	$	223,007	$	318,802	$	318,802

__________

(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, 2011, 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	$	44.3	BBB	Baa1	AA/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, 2011, 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.

	Cost or Amortized Cost		Estimated Fair Value
	(in thousands)
Maturity
Due in one year or less	$	28,100	$	28,516
Due after one year through five years		196,957		203,818
Due after five years through ten years		239,756		245,110
Due after ten years		33,011		33,010
Securities not due at a single maturity date		156,165		159,921
Total fixed income securities	$	653,989	$	670,375

The consolidated amortized cost of investment securities available for sale deposited with various regulatory authorities at June 30, 2011 was $224.1 million.

-8-

Table of Contents

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Premiums

Direct premiums written totaled $67.5 million and $64.9 million for the three month periods ended June 30, 2011 and 2010, respectively, and $135.8 million and $139.5 million for the six month periods then ended, respectively.

Premiums receivable consist of the following at June 30, 2011 and December 31, 2010:

	June 30, 2011		December 31, 2010
	(in thousands)
Current:
Premiums receivable	$	21,376	$	15,673
Allowance for doubtful accounts	(721)		(650)
Premiums receivable, net.	$	20,655	$	15,023

	June 30, 2011		December 31, 2010
	(in thousands)
Deferred:
Premiums receivable	$	169,743	$	169,128
Allowance for doubtful accounts	(260)		(286)
Premiums receivable, net.	$	169,483	$	168,842

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, 2010, the Company entered into reinsurance agreements with nonaffiliated reinsurers wherein it retains the first $0.25 million of each loss occurrence. The next $0.25 million of losses per occurrence (excess of the first $0.25 million of losses per occurrence retained by the Company) are 100% reinsured, subject to an annual aggregate deductible. This reinsurance program, which expires on September 30, 2011, provides loss coverage up to $100.0 million per loss occurrence, subject to various additional limitations and exclusions as more fully described in the treaties. The ceding rate increased approximately 141.0% as a result of the new reinsurance agreement, which contributed to the increase in the Company’s reinsurance recoverable from $56.7 million at December 31, 2010 to $81.0 million at June 30, 2011. The Company had different reinsurance programs in place in prior years, as set forth in Note 8 to the Company’s consolidated financial statements as of and for the year ended December 31, 2010 in Part II, Item 8 of the Company’s Annual Report on Form 10-K filed with the SEC on March 14, 2011.

-9-

Table of Contents

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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, 2011 and 2010:

	Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010
	(in thousands)
Beginning balance:
Unpaid loss and loss adjustment expense	$	446,977		$	362,334		$	440,919		$	351,891
Reinsurance recoverables		(63,564	)		(36,853	)		(56,350	)		(34,080	)
Net balance, beginning of period		383,413			325,481			384,569			317,811
Incurred related to:
Current period		45,536			49,964			87,567			93,666
Prior periods		27,121			30,583			28,356			30,458
Total incurred		72,657			80,547			115,923			124,124
Paid related to:
Current period		(9,306	)		(7,328	)		(13,383	)		(13,153	)
Prior periods		(35,928	)		(30,430	)		(76,273	)		(60,512	)
Total paid		(45,234	)		(37,758	)		(89,656	)		(73,665	)
Net balance, end of period		410,836			368,270			410,836			368,270
Reinsurance recoverable		80,093			44,052			80,093			44,052
Unpaid loss and loss adjustment expense	$	490,929		$	412,322		$	490,929		$	412,322

As a result of changes in estimates of insured events in prior periods, the Company experienced adverse loss development and, as a result, increased its loss reserves for prior years by a net amount of $27.1 million in the three months ended June 30, 2011 and $28.4 million in the six months ended June 30, 2011. The net adverse development in the second quarter of 2011 related to the following accident years: $1.4 million in 2010, $8.3 million in 2009, $8.8 million in 2008, $6.6 million in 2007, and $2.0 million in 2006 and prior years.

On a gross basis, approximately 39.0% of the reserve strengthening in the second quarter of 2011 related to the Company’s California book of business, driven mainly by adverse development on medical and indemnity losses primarily in accident years 2007 through 2009. Development related to the Company’s state act business in states other than California accounted for approximately 47.0% of the second quarter gross reserve strengthening, driven primarily by adverse development of medical and indemnity losses primarily in accident years 2007 through 2010. The remaining second quarter gross reserve development related to the Company’s USL&H business and was driven primarily by indemnity losses.

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, 2011, SBIC had a liability for guaranty fund and other assessments of $7.3 million and a guaranty fund receivable of $3.3 million. These amounts represent management’s best estimates 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.

-10-

Table of Contents

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

8.	Share-Based Payment Arrangements

At June 30, 2011, 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 2007 and May 2010.

As of June 30, 2011, the Company reserved 776,458 shares of common stock for issuance under the 2003 Plan, of which options to purchase 479,946 shares had been granted, and 3,505,550 shares for issuance under the 2005 Plan, of which 3,128,315 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.

a. Stock Options

The following table summarizes stock option activity for the six months ended June 30, 2011:

	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, 2010		1,354,442		$	11.09		5.7	$	1,002
Granted		162,538			9.96		–		–
Forfeited		(2,124	)		11.90		–		–
Exercised		–			–		–		–
Cancelled		(2,526	)		12.97		–		–
Outstanding at June 30, 2011		1,512,330			10.97		5.7		1,307

Exercisable at June 30, 2011		1,086,545			11.09		5.7		1,305

The aggregate intrinsic values in the table above are before applicable income taxes and are based on the Company’s closing stock price of $9.90 on June 30, 2011. There were no proceeds from or exercises of stock options during the quarter ended June 30, 2011.

b. Restricted Stock

The following table summarizes restricted stock activity for the six months ended June 30, 2011:

				Weighted
				Average
	Number of			Grant Date
	Shares			Fair Value
Outstanding at December 31, 2010		1,105,125		$	11.84
Granted		477,925			10.00
Vested		(364,199	)		14.07
Forfeited		–			–
Outstanding at June 30, 2011		1,218,851			10.45

As of June 30, 2011, there was $7.6 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 2.2 years.

-11-

Table of Contents

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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, 2011 and 2010 is shown in the following table. No stock-based compensation cost was capitalized during the periods shown.

	Three Months Ended June 30,				Six Months Ended June 30,
	2011		2010		2011		2010
	(in thousands)
Stock-based compensation expense related to:
Nonvested restricted stock	$	1,053	$	1,159	$	2,421	$	2,268
Stock options		168		242		351		438
Total	$	1,221	$	1,401	$	2,772	$	2,706

Total related tax benefit	$	388	$	439	$	888	$	845

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.

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 Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, “Fair Value Measurements and Disclosures”. The estimated fair values for available-for-sale securities are generally based on quoted market 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.

-12-

Table of Contents

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

•

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, 2011, the Company had no Level 3 financial assets or liabilities.

The table below presents the June 30, 2011 balances of assets and liabilities measured at fair value on a recurring basis.

June 30, 2011:

	Total		Level 1		Level 2		Level 3
	(in thousands)
U.S. Treasury securities	$	26,726	$	26,726	$	—	$	—
Government sponsored agency securities		18,223		—		18,223		—
Corporate securities		165,854		—		165,854		—
Tax-exempt municipal securities		299,652		—		299,652		—
Mortgage pass-through securities		78,027		—		78,027		—
Collateralized mortgage obligations		15,086		—		15,086		—
Asset-backed securities		66,807		—		66,807		—
Total	$	670,375	$	26,726	$	643,649	$	—

December 31, 2010:

	Total		Level 1		Level 2		Level 3
	(in thousands)
U.S. Treasury securities	$	26,977	$	26,977	$	—	$	—
Government sponsored agency securities		24,071		—		24,071		—
Corporate securities		156,269		—		156,269		—
Tax-exempt municipal securities		310,712		—		310,712		—
Mortgage pass-through securities		75,304		—		75,304		—
Collateralized mortgage obligations		17,465		—		17,465		—
Asset-backed securities		62,170		—		62,170		—
Total	$	672,968	$	26,977	$	645,991	$	—

At June 30, 2011, 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, 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, 2011, 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 three months and six months ended June 30, 2011.

The Company obtains fair value inputs for securities in its investment portfolio from independent, nationally recognized 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.

-13-

Table of Contents

SEABRIGHT HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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.

The Company holds a limited amount ($14.2 million at June 30, 2011) of privately placed corporate bonds and estimates the fair value of these bonds using an internal matrix that is based in part on market information regarding interest rates, credit spreads and liquidity. The pricing matrix begins with current U.S. Treasury rates and uses credit spreads received from third-party sources to estimate fair value. The Company includes the fair value estimates of these corporate bonds in Level 2, since all significant inputs are market observable. As some of these securities are issued by public companies, the Company compares the estimates of fair value to the fair values of these companies’ publicly traded debt to test the validity of the internal pricing matrix.

-14-

Table of Contents

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, 2010 filed with the SEC on March 14, 2011.

The discussion under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2010 and in this Quarterly Report on Form 10-Q, 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, including the length of the economic recovery;

•

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;

•

uncertainty about the effect of rules and regulations to be promulgated under the Dodd-Frank Wall Street Reform and Consumer Protection Act on us and the economy and the financial services sector in particular;

•

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;

-15-

Table of Contents

•

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;

•

our potential exposure to losses if LMC were to be placed into receivership;

•

the effects of mergers, acquisitions and divestitures 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 2010 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, the District of Columbia and Guam, to write workers’ compensation and other lines of insurance. Traditional underwriters 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 have been impacted by changes in the U.S. economy. The significant downturn in the U.S. economy from 2008 through 2010 led to lower reported payrolls, which has had a negative impact on our gross premiums written. When our customers reduce their workforce levels, the level of workers' compensation insurance coverage they require, and, as a result the premiums that we charge, are reduced, and if our customers cease operations, they may cancel or choose not to renew their policies. The economic downturn and high levels of unemployment have the effect of increasing claims and claim severity and duration, which drives up our medical, indemnity and litigation costs. The economic downturn has also diminished opportunities for injured workers to return to transitional, modified duty positions during their recoveries, which has lengthened the periods of their recoveries and increased our medical, indemnity and litigation costs, particularly in California. The longer a claim remains open, the more exposed we become to the effects of medical cost inflation. All of these factors have had, and could continue to have, a significant negative impact on our claims costs.

-16-

Table of Contents

If we fail to accurately assess our future claims costs, our loss reserves may be inadequate to cover our actual losses. As discussed under “Management's Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies, Estimates and Judgments – Unpaid Loss and Loss Adjustment Expenses” in our 2010 Annual Report on Form 10-K, there are many variables that can impact the adequacy of our loss and loss adjustment expense liabilities and we continually refine our loss reserve estimates. In response to the factors described in the preceding paragraph, we strengthened our loss reserves for prior accident years by $28.4 million in the six months ended June 30, 2011, and $30.5 million in the six months ended June 30, 2010. We may ultimately conclude that our current estimate of loss reserves is inadequate, if the negative claim trends experienced over the last two years described above continue or worsen. Future adverse development could require us to increase our loss reserves, which could have a material adverse effect on our earnings and financial position in the periods in which such increases are made.

It is uncertain if economic conditions will deteriorate further, or when economic conditions will show significant improvement. If the recovery from the recent economic recession continues to be slow, or the recovery fails to positively impact employment levels, or if we experience another recession, it could further reduce payrolls and increase our claims costs, which could have a significant negative impact on our business, financial condition or results of operations.

Results of Operations

Three Months and Six Months Ended June 30, 2011 and 2010

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, 2011 totaled $67.8 million, an increase of $3.8 million, or 5.9%, from $64.0 million of gross premiums written in the same period of 2010. Gross premiums written for the six months ended June 30, 2011 totaled $137.3 million, a decrease of $2.7 million, or 1.9%, from $140.0 million of gross premiums written in the same period of 2010.

Our “Program Business” contributed $17.2 million or 25.4% of gross premiums written in the three months ended June 30, 2011, compared to $14.5 million or 22.7% of gross premiums written for the same period in 2010. Our Program Business includes alternative markets, small maritime programs and small energy programs. Gross premiums written from our “core” product lines remained nearly flat as compared to the same period in 2010.

For the six months ended June 30, 2011, our core product lines contributed $95.0 million or 69.2% of gross premiums written in the period compared to $104.1 million or 74.4% of gross premiums written in the same period in 2010. The decrease in core product lines was partially offset by an increase of $8.5 million in our Program Business, which contributed $42.1 million or 30.7% of gross premiums written in the period compared to $33.6 million or 24.0% of gross premiums written in the same period in 2010. We also had an increase of $1.0 million in premiums assumed from the NCCI residual market pools during the six months ended June 30, 2011, as compared to the same period in 2010.

Excluding work we perform as the servicing carrier for the Washington State USL&H Assigned Risk Plan and excluding business assumed from the NCCI residual market pools, the total number of customers we serviced decreased from over 1,660 at June 30, 2010 to nearly 1,580 at June 30, 2011. The majority of the customer decrease was in our core business, which was offset by an increase of approximately 170 customers our Program Business. 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, 2011 was approximately $249,000 in our core business and $105,000 in our Program Business, compared to approximately $232,000 in our core business and $96,000 in our Program Business one year earlier.

Total in-force payrolls, a factor used in determining premiums charged, decreased 5.6% from $7.2 billion at June 30, 2010 to $6.8 billion at June 30, 2011. California continues to be our largest market, accounting for approximately $142.7 million or 50.4% of our in-force premiums at June 30, 2011. This represents a decrease of $2.8 million, or 1.9%, from approximately $145.5 million, or 47.8% of total in-force premiums in California at June 30, 2010.

-17-

Table of Contents

Premiums assumed from the NCCI residual markets for the three months ended June 30, 2011 increased $1.2 million, or 131.9%, to $0.3 million from $(0.9) million for the same period in 2010. For the six months ended June 30, 2011, assumed premiums increased $1.0 million, or 200.0%, to $1.5 million from $0.5 million for the same period in 2010. The majority of the increases for the three months and six months ended June 30, 2011 were the result of increases in our actuarial NCCI reapportionment estimate.

Net Premiums Written. Net premiums written totaled $58.0 million for the three months ended June 30, 2011 compared to $60.8 million in the same period in 2010, representing a decrease of $2.8 million, or 4.6%. For the six months ended June 30, 2011, net premiums written totaled $117.6 million, a decrease of $13.4 million, or 10.2%, from $131.0 million in the same period of 2010. The decrease in net premiums written for the six months ended June 30, 2011 was primarily attributable to an increase in ceded premiums written of $10.7 million, mainly as a result of a higher ceding rate in our excess of loss reinsurance program that renewed in October 2010. Our ceding rate increased approximately 141.0% as a result of our lowering the attachment point from $0.5 million to $0.25 million and increasing maximum coverage from $85.0 million to $100.0 million. A smaller portion of the decrease in net premiums written resulted from the decrease in gross premiums written.

Net Premiums Earned. Net premiums earned totaled $62.1 million for the three months ended June 30, 2011, compared to $65.6 million for the same period in 2010, representing a decrease of $3.5 million, or 5.4%. For the six months ended June 30, 2011, net premiums earned totaled $118.8 million, a decrease of $7.4 million, or 5.9%, from $126.3 million in the same period of 2010. 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 $1.5 million, or 2.1%, to $71.5 million for the three months ended June 30, 2011 from $70.0 million for the same period in 2010. Our direct premiums earned for the six months ended June 30, 2011 increased $1.6 million, or 1.2%, to $136.5 million from $134.9 million for the same period in 2010.

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

	Six Months Ended June 30,
	2011					2010
	Direct Premiums Earned		%			Direct Premiums Earned		%
	($ in thousands)
California	$	67,364		49.4	%	$	62,559		46.4	%
Louisiana		12,524		9.2			12,262		9.1
Texas		7,894		5.8			7,228		5.4
Alaska		7,849		5.8			6,855		5.1
Washington		5,888		4.3			5,435		4.0
Total	$	101,519		74.5	%	$	94,339		70.0	%

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, 2011 totaled $9.8 million compared to $3.9 million for the same period in 2010, representing an increase of $5.9 million, or 151.3%. Ceded premiums earned for the six months ended June 30, 2011 totaled $19.3 million compared to $10.3 million for the same period in 2010, representing an increase of $9.0 million, or 87.4%. The majority of the increase in ceded premiums in the three months and six months ended June 30, 2011 was the result of higher ceding rates under our October 2010 reinsurance program. Earned premiums assumed from the NCCI residual markets for the six months ended June 30, 2011 totaled $1.6 million, which was nearly flat compared to the same period in 2010.

Net Investment Income. Net investment income was $5.3 million for the three months ended June 30, 2011, compared to $5.9 million for the same period in 2010, representing a decrease of $0.6 million, or 9.9%. Net investment income was $10.7 million for the six months ended June 30, 2011, compared to $12.0 million for the same period in 2010, representing a decrease of $1.3 million, or 10.8%. Average invested assets for the three months ended June 30, 2011 increased $16.3 million, or 2.4%, from $679.1 million in 2010 to $695.4 million in 2011. For the six months ended June 30, 2011, average invested assets increased $31.1 million, or 4.7%, from $663.2 million in 2010 to $694.3 million in 2011. Our yield on average invested assets for the three months ended June 30, 2011 was approximately 3.0% compared to approximately 3.5% for the same period in 2010. For the six months ended June 30, 2011, our yield on average invested assets was 3.1% compared to approximately 3.6% for the same period in 2010.

-18-

Table of Contents

Net Realized Gains. Net realized gains totaled $0.1 million for the three months ended June 30, 2011, compared to $3.9 million for the same period in 2010. For the six months ended June 30, 2011, net realized gains totaled $0.4 million compared to $10.4 million in the same period of 2010. The realized gains in 2010 related primarily to the sale of investment securities to enable us to realize a portion of our tax capital loss carry forwards, which totaled approximately $15.0 million at December 31, 2009. Those capital loss carry forwards were fully realized in 2010.

Other Income. Other income totaled $1.2 million for the three months ended June 30, 2011, compared to $1.1 million for the same period in 2010, representing an increase of $0.1 million, or 13.3%. For the six months ended June 30, 2011, other income totaled $2.3 million, nearly flat compared to the same period in 2010. Other income is derived primarily from the operations of PointSure, our wholesale broker and third party administrator, and PMCS, our provider of medical bill review, utilization review, nurse case management and related services.

Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses totaled $72.7 million for the three months ended June 30, 2011, compared to $80.5 million for the same period in 2010, representing a decrease of $7.9 million, or 9.8%. For the six months ended June 30, 2011, loss and loss adjustment expenses totaled $115.9 million, compared to $124.1 million for the same period in 2010, representing a decrease of $8.2 million, or 6.6%. 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, 2011 was 116.5% compared to 122.3% for the same period in 2010. Our net loss ratio for the six months ended June 30, 2011 was 97.0% compared to 97.9% for the same period in 2010. The decrease in our net loss ratio for the three months ended June 30, 2011 was primarily attributable to a reduction in net adverse development of prior years’ reserves recorded in the period, from $30.6 million in 2010 to $27.1 million in 2011. Net adverse development of prior years’ reserves in the six months ended June 30, 2011 totaled $28.4 million compared to $30.5 million in the same period of 2010. A reduction in the current accident year net expected loss and allocated loss adjustment expense (“ALAE”) ratio (“ELR”) from 64.5% in 2010 to 62.5% in 2011 also contributed to the reduction in the net loss ratio.

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, 2010, we use an 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 2011 is incomplete, as only six months of the year have been earned as of June 30, 2011. An ELR was established for each jurisdiction and type of loss (indemnity, medical, ALAE) and was multiplied by the booked accident year earned premium to produce the ultimate losses 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 thereafter as the underlying data matures. The net ELR used in the first six months of 2011was 62.5%. The net ELR used in the first quarter of 2010 was 61.5%, but after reviewing year to date results of accident year 2010, and considering the adverse development of accident years 2008 and 2009, we increased the accident year 2010 ELR to 64.5% in the second quarter of 2010. The 2011 accident year ELR takes into consideration the development of recent accident years, as well as the provisions of the excess-of-loss reinsurance treaty that we entered into on October 1, 2010.

For prior accident years, the ultimate loss estimates as of June 30, 2011 were higher when compared to March 31, 2011 and as a result of this adverse loss development, we increased our loss reserves by a net amount of $27.1 million in the three months June 30, 2011. Adverse development of prior year direct loss reserves totaled $28.5 million and related to the following accident years: $2.4 million in 2010, $8.4 million in 2009, $8.8 million in 2008, $6.7 million in 2007, and $2.2 million in 2006 and prior. This adverse development was partially offset by $1.4 million of net favorable development of other amounts such as ULAE, loss based assessments and losses assumed from the NCCI pools. In the three months ended June 30, 2010, we increased our loss reserves by a net amount of $30.6 million. Adverse development of prior year direct loss reserves totaled $30.1 million and related to the following accident years: $11.3 million in 2009, $10.0 million in 2008, $5.6 million in 2007, $2.1 million in 2006, $1.1 million in 2005 and prior. We also recognized $0.5 million of net adverse development from ULAE reserves.

-19-

Table of Contents

As of June 30, 2011, we had recorded a receivable of approximately $3.0 million for loss development under the adverse development cover we entered into with LMC since 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, 2011, 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. In July 2011, we complied with LMC’s request to withdraw approximately $659,000 of excess funds on deposit in the trust account, resulting in a trust account balance of approximately $3.1 million immediately following the withdrawal.

Underwriting, Acquisition and Insurance Expenses. Underwriting expenses totaled $19.3 million for the three months ended June 30, 2011, compared to $17.1 million for the same period in 2010, representing an increase of $2.3 million, or 13.3%. For the six months ended June 30, 2011, underwriting expenses totaled $37.7 million, an increase of $1.9 million, or 5.4%, from $35.8 million in the same period of 2010. The increases in expenses for the three months and six months ended June 30, 2011, as compared to the same period in 2010, was primarily the result of increases in commissions expense and taxes, licenses and fees expense. Our net underwriting expense ratio, which is calculated by dividing underwriting, acquisition and insurance expenses by premiums earned, for the three months ended June 30, 2011 was 31.1%, compared to 26.0% for the same period in 2010. For the six months ended June 30, 2011, our net underwriting expense ratio was 31.8%, compared to 28.4% in the same period of 2010.

The increases in the expense ratios for the three months and six month periods ended June 30, 2011 were primarily the result of decreased premiums earned as compared to the same periods in 2010.

Interest Expense. Interest expense related to the surplus notes issued by our insurance subsidiary in May 2004 totaled $129,000 for the three months ended June 30, 2011, compared to $132,000 for the same period in 2010, representing a decrease of $3,000 or 2.3%. Interest expense was flat year over year for the six months ended June 30, 2011 as compared to the same period in 2010. 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 4.48% at June 30, 2010 to 4.26% at June 30, 2011.

Other Expenses. For the three months ended June 30, 2011, other expenses totaled $2.1 million compared to $1.7 million for same period in 2010. For the six months ended June 30, 2011, other expenses totaled $4.0 million compared to $3.8 million in the same period of 2010. Other expenses result primarily from the operations of PointSure and PMCS, which together accounted for approximately $1.7 million and $3.4 million of expenses for the three months and six months ended June 30, 2011, respectively, compared to $1.4 million and $3.2 million for the same periods in 2010.

Income Tax Benefit. The effective tax rate for the three months ended June 30, 2011 was 37.2%, compared to 36.1% for the same period in 2010. The effective tax rate for the six months ended June 30, 2011 was 38.1% compared to 43.7% in the same period of 2010. 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, 2011, approximately 44.1% of our investment portfolio was invested in tax-exempt municipal bonds, compared to approximately 47.1% at June 30, 2010.

Net Loss. Net loss was $15.8 million for the three months ended June 30, 2011, compared to a net loss of $15.5 million for the same period in 2010, representing an increase of $0.3 million, or 1.8%. Net loss for the six months ended June 30, 2011 totaled $15.6 million, an increase of $7.6 million, or 95.9%, from $7.9 million in the same period of 2010. The increases in net loss for the three month and six month periods ended June 30, 2011 resulted primarily from decreases in net realized gains and premiums earned, offset by lower loss and loss adjustment expenses.

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, 2011 has an effective duration of 4.6 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.

-20-

Table of Contents

At June 30, 2011, 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, 2010, our reinsurance program provides for retention of the first $0.25 million of each loss occurrence. The next $0.25 million of losses per occurrence (excess of the first $0.25 million of losses retained by us) are 100% reinsured, subject to an annual aggregate deductible. This reinsurance program, which expires on September 30, 2011, provides loss coverage up to $100.0 million per loss occurrence. Given industry and predecessor trends, we believe we are sufficiently capitalized to cover our retained losses.

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 additional 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, 2010.

Our unaudited condensed consolidated net cash provided by operating activities for the six months ended June 30, 2011 was $7.4 million, compared to our cash flow from operations of $33.0 million for the same period in 2010. The decrease was mainly attributable to an increase in paid losses, net of reinsurance, and a decrease in premium collections.

Net cash used in investing activities was $9.0 million in the six months ended June 30, 2011, compared to $24.4 million during the same period in 2010. The decrease was primarily driven by lower net purchases of investments as a result of lower cash provided by operations.

For the six months ended June 30, 2011, cash used in financing activities totaled $3.2 million, compared to $1.6 million in the same period in 2010. The increase was primarily due to stockholder dividend payments, which began in the second quarter of 2010, and the surrender of stock to cover tax withholding obligations associated with the vesting of restricted stock.

As of June 30, 2011, SBIC’s statutory surplus totaled $286.4 million (unaudited), compared to $298.9 million (unaudited) as of June 30, 2010.

Contractual Obligations and Commitments

During the six months ended June 30, 2011, there were no material changes to our contractual obligations and commitments.

Off-Balance Sheet Arrangements

As of June 30, 2011, 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.

-21-

Table of Contents

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, 2010.

Regulation

On July 21, 2010, the President signed into law the Dodd Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which has significant implications for the insurance industry. In addition to imposing a number of new compliance obligations on publicly traded companies, the Dodd-Frank Act established the Financial Services Oversight Council (“FSOC”), which is authorized to recommend that certain systemically significant non-bank financial companies, including insurance companies, be regulated by the Board of Governors of the Federal Reserve. The Dodd-Frank Act also created within the United States Department of the Treasury a new Federal Insurance Office (“FIO”) and authorizes the federal preemption of certain state insurance laws. The FSOC and the FIO are authorized to study, monitor and report to Congress on the U.S. insurance industry and the significance of global reinsurance to the U.S. insurance market. Many sections of the Dodd-Frank Act will become effective over time, and certain provisions of the Dodd-Frank Act require the implementation of regulations that have not yet been adopted. The potential impact of the Dodd-Frank Act on the U.S. insurance industry is not clear. However, our business could be affected by changes to the U.S. system of insurance regulation or our designation or the designation of insurers or reinsurers with which we do business as systemically significant non-bank financial companies.

Recent Accounting Pronouncements

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, to provide largely identical guidance about fair value measurement and disclosure requirements. The new standards do not extend the use of fair value but, rather, provide guidance about how fair value should be applied where it already is required or permitted under IFRS or U.S. GAAP. The new guidance is effective for interim and annual reporting periods beginning after December 15, 2011. Early adoption is not permitted. The adoption of ASU 2011-04 is not expected to have a material effect on our consolidated financial condition and results of operations.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, to increase the prominence of other comprehensive income in the financial statements. An entity will have the option to present the components of net income and comprehensive income in either one or two consecutive financial statements. The new guidance is effective for interim and annual reporting periods beginning after December 15, 2011. However, early adoption is permitted. The amendments in this ASU should be applied retrospectively. The adoption of ASU 2011-05 is not expected to have a material effect on our consolidated financial condition and results of operations.

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 $670.4 million at June 30, 2011 that are subject to interest rate risk compared with $673.0 million at December 31, 2010. 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.

-22-

Table of Contents

Since December 31, 2010, 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, 2010, filed with the SEC on March 14, 2011.

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 Principal Accounting Officer (acting principal financial officer), we 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 Principal Accounting Officer (acting principal 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 Principal Accounting Officer (acting principal financial officer), as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no 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 2011 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

The disclosure set forth below updates specific risk factors previously disclosed in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2010. Other than as described below, there were no material changes to the risk factors set forth in such report.

Under the heading “Item 1A. Risk Factors – Risks Related to Our Business – Our loss reserves are based on estimates and may be inadequate to cover our actual losses” in our Annual Report on Form 10-K filed with the SEC on March 14, 2011, we included a discussion about the potential adverse impact to our business of failing to establish adequate loss reserves in our financial statements. In the six months ended June 30, 2011, we increased loss reserves for prior accident years by a net amount of approximately $28.4 million. See the discussion in Part I, Item 1, Note 6, “Unpaid Loss and Loss Adjustment Expenses” and under the heading “Results of Operations – Three Months and Six Months Ended June 30, 2011 and 2010 – Loss and Loss Adjustment Expenses” in Part I, Item 2 of this quarterly report.

Under the heading "A downgrade in the A.M. Best rating of our insurance subsidiary could reduce the amount of business we are able to write" in our Annual Report on Form 10-K filed with the SEC on March 14, 2011, we included a discussion about the potential negative impact on our results of operations and our financial position of any reduction in our A.M. Best rating below its current level of "A-". We have kept A.M. Best informed of the actions we have taken or are considering taking in response to the challenging economic and market conditions under which have been operating, including the $27.1 million strengthening of loss reserves in second quarter 2011. Most recently, we met with A.M. Best in late July 2011. After reviewing the information we provided them, they plan to review our current rating and outlook and expect to announce the results of their review in the next 30 days or so. We do not know what, if any, action A.M. Best might take with respect to our current rating or the potential impact any such rating change would have on our results of operations and financial position.

Under the heading “Item 1A. Risk Factors – Risks Related to Our Business – We could be adversely affected by the loss of one or more principal employees or by an inability to attract or retain staff” in our Annual Report on Form 10-K filed with the SEC on March 14, 2011, we included a discussion about the potential adverse impact to our business of losing a member of our senior management team, including our Chief Financial Officer. Scott H. Maw, our Senior Vice President, Chief Financial Officer and Assistant Secretary, resigned from all offices of the Company held by him, effective August 5, 2011. We are unable to predict how long it will take to identify a new Chief Financial Officer. In the meantime, we have appointed M. Philip Romney, our Principal Accounting Officer, to serve as acting principal financial officer commencing August 8, 2011 until a new Chief Financial Officer is appointed.

-23-

Table of Contents

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, 2011:

(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, 2011 through April 30, 2011)

12,880

10.21

–

Month # 2 (May 1, 2011 through May 31, 2011)

–

Month # 3 (June 1, 2011 through June 30, 2011)

–

We did not repurchase any of our common stock on the open market as part of a stock repurchase program during the three months ended June 30, 2011; however, our employees surrendered 94,636 shares of our common stock to satisfy their tax withholding obligation 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.

-24-

Table of Contents

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 8, 2011	By:	/s/ John G. Pasqualetto
		John G. Pasqualetto
		Chairman, President and Chief Executive Officer
		(Principal Executive Officer)


	By:	/s/ M. Philip Romney
		Vice President – Finance, Principal Accounting Officer and Assistant Secretary
		(Chief Accounting Officer)

-25-

Table of Contents

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, 32.2 and 101 are being furnished with this quarterly report on Form 10-Q.

Exhibit

Number

Description

31.1	Rule 13a-14(a) Certification (Chief Executive Officer)

31.2	Rule 13a-14(a) Certification (Chief Financial Officer)

32.1	Section 1350 Certification (Chief Executive Officer)

32.2	Section 1350 Certification (Chief Financial Officer)

101	Interactive Data Files

Attached files

SeaBright Holdings, Inc. Reports

Also read