0001104659-05-050341.txt : 20051026 0001104659-05-050341.hdr.sgml : 20051026 20051026170843 ACCESSION NUMBER: 0001104659-05-050341 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20050930 FILED AS OF DATE: 20051026 DATE AS OF CHANGE: 20051026 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ZENITH NATIONAL INSURANCE CORP CENTRAL INDEX KEY: 0000109261 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 952702776 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-09627 FILM NUMBER: 051157711 BUSINESS ADDRESS: STREET 1: 21255 CALIFA ST CITY: WOODLAND HILLS STATE: CA ZIP: 91367 BUSINESS PHONE: 8187131000 10-Q 1 a05-18468_110q.htm 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2005

o TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 1-9627

ZENITH NATIONAL INSURANCE CORP.
[Exact name of registrant as specified in its charter]

Delaware	95-2702776
[State or other jurisdiction of incorporation or organization]	[I.R.S. Employer Identification No.]
21255 Califa Street, Woodland Hills, California	91367-5021
[Address of principal executive offices]	[Zip Code]

(818) 713-1000
[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 o

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

Yes x

No o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12-b-2 of the Exchange Act).

Yes o

No x

At October 25, 2005, there were 36,387,000 shares of Zenith National Insurance Corp. common stock outstanding, net of 7,695,000 shares of treasury stock.

Zenith National Insurance Corp. and Subsidiaries
Form 10-Q
For the Quarter Ended September 30, 2005

Table of Contents

			Page
Part I—Financial Information
	Item 1. Financial Statements:
		Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004	3
		Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2005 and 2004	4
		Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2005 and 2004	5
		Consolidated Statements of Stockholders’ Equity for the Three and Nine Months Ended September 30, 2005 and 2004	6
		Notes to Consolidated Financial Statements	7
	Item 2.	Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations	21
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	43
	Item 4.	Controls and Procedures	44
Part II—Other Information
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		45
	Item 6. Exhibits		46
Signatures			47

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

	September 30,				December 31,
(Dollars and shares in thousands)	2005				2004
Assets:
Investments:
Fixed maturity investments:
At amortized cost (fair value $120,737 in 2005 and $140,828 in 2004)		$	120,410			$	138,260
At fair value (amortized cost $1,540,016 in 2005 and $1,091,453 in 2004)		1,540,393				1,110,775
Equity securities, at fair value (cost $73,481 in 2005 and $62,962 in 2004)		77,034				106,062
Mortgage loans (at unpaid principal balance)						12,645
Short-term investments (at cost or amortized cost, which approximates fair value)		366,337				492,126
Investment in Advent Capital (Holdings) PLC (see Note 6)						28,066
Other investments		9,763				12,080
Total investments		2,113,937				1,900,014
Cash		6,574				10,322
Accrued investment income		16,869				15,312
Premiums receivable, less bad debt allowance of $136 in 2005 and $192 in 2004		75,394				58,161
Receivable from reinsurers and state trust funds for paid and unpaid losses		257,249				293,572
Deferred policy acquisition costs		21,173				18,664
Deferred tax asset		72,397				29,152
Current income tax receivable		5,669
Goodwill		20,985				20,985
Other assets		86,073				68,473
Total assets		$	2,676,320			$	2,414,655
Liabilities:
Policy liabilities:
Unpaid losses and loss adjustment expenses		$	1,667,534			$	1,482,319
Unearned premiums		167,993				142,219
Policyholders’ dividends accrued		18,556				6,001
Convertible senior notes payable, less unamortized discount of $1,059 in 2005 and $3,447 in 2004		42,741				121,548
Redeemable securities, less unamortized discount of $169 in 2005 and $175 in 2004		58,831				58,825
Current income tax payable						8,269
Other liabilities		90,825				93,327
Total liabilities		2,046,480				1,912,508
Commitments and contingencies (see Note 8)
Stockholders’ equity:
Preferred stock, $1 par, 1,000 shares authorized; none issued or outstanding in 2005 and 2004
Common stock, $1 par, 50,000 shares authorized; issued 42,258 (including 11,520 shares issued on October 11, 2005 as a 3-for-2 stock split) in 2005 and 26,510 in 2004; outstanding 34,563 in 2005 and 19,371 in 2004 (see Note 1)		42,258				26,510
Additional paid-in capital		417,668				318,850
Retained earnings		339,263				254,682
Unearned compensation		(5,252		)		(4,588		)
Accumulated other comprehensive income		2,555				43,583
		796,492				639,037
Treasury stock, at cost (7,695 shares in 2005 and 7,139 shares in 2004)		(166,652		)		(136,890		)
Total stockholders’ equity		629,840				502,147
Total liabilities and stockholders’ equity		$	2,676,320			$	2,414,655

The accompanying notes are an integral part of these Financial Statements.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(Dollars in thousands, except per share data)	2005			2004			2005			2004
Revenues:
Premiums earned	$	301,302		$	239,716		$	883,799		$	696,346
Net investment income	20,550			14,909			56,732			43,825
Realized gains on investments	2,043			6,690			21,265			12,362
Total revenues	323,895			261,315			961,796			752,533
Expenses:
Loss and loss adjustment expenses incurred	201,492			171,184			548,429			472,533
Policy acquisition costs	42,998			28,997			128,258			87,200
Underwriting and other operating expenses	33,065			26,070			94,780			77,140
Payment regarding conversion of Convertible Notes (see Note 5)	50						4,710
Policyholders’ dividends	12,874			1,152			16,166			3,653
Interest expense	1,997			3,295			7,323			9,762
Total expenses	292,476			230,698			799,666			650,288
Income from continuing operations before tax and equity in earnings of investee	31,419			30,617			162,130			102,245
Income tax expense	9,672			7,737			55,477			32,231
Income from continuing operations after tax and before equity in earnings of investee	21,747			22,880			106,653			70,014
Equity in earnings of investee, net of income tax expense				1,234			794			4,000
Income from continuing operations	21,747			24,114			107,447			74,014
Gain on sale of discontinued real estate segment, net of income tax expense of $675 in 2005 and $692 in 2004 (see Note 9)	1,253			1,286			1,253			1,286
Net income	$	23,000		$	25,400		$	108,700		$	75,300
Net income per common share (2004 restated, see Notes 1 and 3):
Basic:
Continuing operations	$	0.63		$	0.84		$	3.30		$	2.58
Discontinued operations	0.04			0.04			0.04			0.04
Net income	$	0.67		$	0.88		$	3.34		$	2.62
Diluted:
Continuing operations	$	0.60		$	0.69		$	2.96		$	2.12
Discontinued operations	0.03			0.03			0.03			0.04
Net income	$	0.63		$	0.72		$	2.99		$	2.16
Disclosure regarding comprehensive income:
Net income	$	23,000		$	25,400		$	108,700		$	75,300
Other comprehensive income (loss), net of tax:
Net change in unrealized appreciation on investments	(16,735		)	18,545			(38,019		)	8,809
Net change in foreign currency translation adjustment				(128		)	(3,009		)	135
Comprehensive income	$	6,265		$	43,817		$	67,672		$	84,244

The accompanying notes are an integral part of these Financial Statements.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

	Nine Months Ended
	September 30,
(Dollars in thousands)	2005			2004
Cash flows from operating activities:
Premiums collected	$	925,523		$	858,436
Investment income received	50,417			46,366
Loss and loss adjustment expenses paid	(333,460		)	(304,371		)
Underwriting and other operating expenses paid	(264,141		)	(278,765		)
Interest paid	(10,060		)	(12,869		)
Income taxes paid	(80,680		)	(56,575		)
Net cash provided by operating activities	287,599			252,222
Cash flows from investing activities:
Purchases of investments:
Fixed maturity securities held-to-maturity	(6,323		)	(45,030		)
Fixed maturity securities available-for-sale	(1,597,075		)	(908,199		)
Equity securities available-for-sale	(59,704		)	(68,165		)
Other investments	(862		)	(9,138		)
Proceeds from maturities and redemptions of investments:
Fixed maturity securities held-to-maturity	23,861			20,582
Fixed maturity securities available-for-sale	35,725			38,209
Other investments	17,444			40,375
Proceeds from sales of investments:
Fixed maturity securities available-for-sale	1,108,621			740,311
Equity securities available-for-sale	95,803			66,172
Other investments	347			4,604
Net decrease (increase) in short-term investments	132,152			(107,945		)
Capital expenditures and other, net	(8,759		)	(6,965		)
Net cash used in investing activities	(258,770		)	(235,189		)
Cash flows from financing activities:
Repurchase of redeemable securities				(7,600		)
Cash paid regarding conversion of convertible notes (see Note 5)	(4,710		)
Cash dividends paid to common stockholders	(20,452		)	(15,492		)
Proceeds from exercise of stock options	3,471			4,978
Purchase of treasury shares	(10,886		)
Net cash used in financing activities	(32,577		)	(18,114		)
Net decrease in cash	(3,748		)	(1,081		)
Cash at beginning of period	10,322			8,006
Cash at end of period	$	6,574		$	6,925
Reconciliation of net income to net cash flows provided by operating activities:
Net income	$	108,700		$	75,300
Adjustments to reconcile net income to net cash flows provided by operating activities:
Net depreciation, amortization and accretion	2,038			10,498
Realized gains on investments	(21,265		)	(12,362		)
Cash paid regarding conversion of convertible notes (see Note 5)	4,710
Equity in earnings of investee	(794		)	(4,000		)
Gain on sale of discontinued real estate segment	(1,253		)	(1,286		)
(Increase) decrease in:
Accrued investment income	(1,557		)	(1,697		)
Premiums receivable	(19,134		)	(1,081		)
Receivable from reinsurers and state trust funds for paid and unpaid losses	31,968			(40,121		)
Deferred policy acquisition costs	(2,509		)	(4,264		)
Increase (decrease) in:
Unpaid losses and loss adjustment expenses	185,215			204,111
Unearned premiums	25,774			56,330
Net income taxes payable	(25,203		)	(24,344		)
Accrued expenses	(1,706		)	(4,856		)
Other	2,615			(6		)
Net cash provided by operating activities	$	287,599		$	252,222

The accompanying notes are an integral part of these Financial Statements.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(UNAUDITED)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(Dollars in thousands)	2005			2004			2005			2004
Preferred stock, $1 par:
Beginning of period	none			none			none			none
End of period	none			none			none			none
Common stock, $1 par:
Beginning of period	$	30,501		$	26,417		$	26,510		$	25,928
Exercise of stock options	185			2			943			418
Conversion of convertible senior notes	34						3,248
3-for-2 stock split (see Note 1)	11,520						11,520
Restricted stock awards granted	22			6			41			79
Restricted stock awards forfeited	(4		)				(4		)
End of period	42,258			26,425			42,258			26,425
Additional paid-in capital:
Beginning of period	420,301			315,380			318,850			300,448
Exercise of stock options	4,198			43			21,404			9,308
Tax benefit on options exercised	2,650			12			9,886			2,414
Recognition of stock-based compensation on stock options	15			15			45			45
Conversion of convertible senior notes	808						76,591			5
3-for-2 stock split (see Note 1)	(11,520		)				(11,520		)
Restricted stock awards granted	1,393			257			2,589			3,487
Restricted stock awards forfeited	(177		)				(177		)
End of period	417,668			315,707			417,668			315,707
Retained earnings:
Beginning of period	325,358			196,353			254,682			157,191
Net income	23,000			25,400			108,700			75,300
Cash dividends declared to common stockholders	(9,095		)	(5,383		)	(24,119		)	(16,121		)
End of period	339,263			216,370			339,263			216,370
Unearned compensation:
Beginning of period	(4,653		)	(3,116		)	(4,588		)
Restricted stock awards granted	(1,393		)	(257		)	(2,589		)	(3,487		)
Amortization to compensation expense	794			312			1,925			426
End of period	(5,252		)	(3,061		)	(5,252		)	(3,061		)
Accumulated other comprehensive income:
Beginning of period	19,290			22,348			43,583			31,821
Net change in unrealized appreciation on investments, net of deferred tax expense and reclassification adjustment	(16,735		)	18,545			(38,019		)	8,809
Change in foreign currency translation adjustment, net of deferred tax expense				(128		)	(3,009		)	135
End of period	2,555			40,765			2,555			40,765
Treasury stock:
Beginning of period	(159,092		)	(136,890		)	(136,890		)	(132,142		)
Acquisition of treasury shares	(7,560		)				(29,762		)	(4,748		)
End of period	(166,652		)	(136,890		)	(166,652		)	(136,890		)
Total stockholders’ equity	$	629,840		$	459,316		$	629,840		$	459,316
Cash dividends declared per common share	$	0.25		$	0.19		$	0.69		$	0.56

The accompanying notes are an integral part of these Financial Statements.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Note 1. Basis of Presentation

Zenith National Insurance Corp. (“Zenith National”) is a holding company engaged, through its wholly-owned subsidiaries (primarily Zenith Insurance Company (“Zenith Insurance”)), in the workers’ compensation insurance business, nationally, and the assumed reinsurance business. Unless otherwise indicated, all references to “Zenith,” “we,” “us,” “our,” the “Company” or similar terms refer to Zenith National together with its subsidiaries. The accompanying unaudited, consolidated financial statements of Zenith National and subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal, recurring adjustments) necessary for a fair presentation of the financial position and results of operations of Zenith for the periods presented have been included. The results of operations for an interim period are not necessarily indicative of the results for an entire year. For further information, refer to the financial statements and notes thereto included in the Zenith National Insurance Corp. Annual Report on Form 10-K for the year ended December 31, 2004. Zenith has elected to round to the nearest thousand dollars, except for per share data, in reporting amounts in these statements.

3-for-2 Stock Split. On September 7, 2005, Zenith National’s Board of Directors declared a 3-for-2 stock split which was paid in the form of a 50% stock dividend. The additional shares of Zenith National’s common stock were distributed on October 11, 2005 to shareholders of record as of September 19, 2005. The 3-for-2 stock split was recorded in the third quarter of 2005 as an increase to common stock and a decrease to additional paid-in capital. Issued and outstanding shares in the consolidated balance sheets for prior periods were not restated. Dividends and earnings per share amounts in the current and prior periods reflect the 3-for-2 stock split.

Note 2. Stock-Based Compensation

Restricted Stock Awards. In May 2005, Zenith National’s stockholders approved the Amended and Restated 2004 Restricted Stock Plan (the “Restricted Stock Plan”). The Restricted Stock Plan was amended to include non-employee Directors in addition to employees as eligible recipients. In May 2005, non-employee Directors were granted 12,000 shares of restricted stock that vest in equal amounts of one-third a year over three years from the date of grant. Of the shares of stock granted to employees, 50% vest two years from the grant date. The remaining 50% of the shares vest four years from the grant date.

Employee Stock Options. Effective in the fourth quarter of 2002, Zenith began to expense the cost of employee stock options using the fair value based method of recording stock options in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” and accounted for the change in accounting principle using the prospective method in accordance with SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” Under the prospective method, all employee stock options granted since January 2002 are being expensed over the stock option vesting period based on the fair value at the date the options were granted. Prior to the fourth quarter of 2002, Zenith applied the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), in accounting for stock options issued prior

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 2. Stock-Based Compensation (Continued)

to January 2002. Under the intrinsic value method of APB No. 25, Zenith was not required to recognize compensation expense for stock option grants.

The following table sets forth the effect of all stock-based compensation included in net income and the pro forma effect of all stock-based compensation if the fair value of stock options accounted for under the intrinsic value method of APB No. 25 were included in net income for the periods presented:

	Three Months Ended September 30,						Nine Months Ended September 30,
(Dollars and shares in thousands, except per share data)	2005			2004			2005			2004
Net income as reported	$	23,000		$	25,400		$	108,700		$	75,300
Stock-based compensation expense included in reported net income, net of income tax benefit	458			230			1,283			385
Total stock-based compensation expense determined under fair value method for all awards, net of income tax benefit	(458		)	(257		)	(1,303		)	(498		)
Pro forma net income	$	23,000		$	25,373		$	108,680		$	75,187
Net income per share—basic:
Net income per share as reported	$	0.67		$	0.88		$	3.34		$	2.62
Net income per share—pro forma	0.67			0.88			3.34			2.62
Net income per share—diluted:
Net income per share as reported	$	0.63		$	0.72		$	2.99		$	2.16
Net income per share—pro forma	0.63			0.72			2.99			2.15

Net income per share amounts have been adjusted to reflect the 3-for-2 stock split declared on September 7, 2005.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 3. Earnings and Dividends Per Share

The following table sets forth the computation of basic and diluted net income per common share:

		Three Months Ended September 30,				Nine Months Ended September 30,
(Dollars and shares in thousands, except per share data)		2005		2004		2005		2004
(A)	Income from continuing operations	$	21,747	$	24,114	$	107,447	$	74,014
(B)	Gain on sale of discontinued real estate segment	1,253		1,286		1,253		1,286
(C)	Net income	$23,000		$25,400		$108,700		$75,300
(D)	Interest expense on the Convertible Notes, net of tax	447		1,268		2,174		3,800
(E)	Weighted average shares outstanding	34,266		28,811		32,519		28,700
	Common shares issuable under employee stock option plan (treasury stock method)	98		474		161		450
	Common shares issuable under restricted stock plan (treasury stock method)	107		10		80		4
	Common shares issuable upon conversion of the Convertible Notes	2,627		7,500		4,269		7,500
(F)	Weighted average shares outstanding—diluted	37,098		36,795		37,029		36,654
	Net income per common share—
	Basic:
(A)/(E)	Continuing operations	$	0.63	$	0.84	$	3.30	$	2.58
(B)/(E)	Gain on sale of discontinued real estate segment	0.04		0.04		0.04		0.04
(C)/(E)	Net income	$	0.67	$	0.88	$	3.34	$	2.62
	Diluted:
((A)+(D))/(F)	Continuing operations	$	0.60	$	0.69	$	2.96	$	2.12
(B)/(F)	Gain on sale of discontinued real estate segment	0.03		0.03		0.03		0.04
((C)+(D))/(F)	Net income	$	0.63	$	0.72	$	2.99	$	2.16
	Cash dividends declared per common share	$	0.25	$	0.19	$	0.69	$	0.56

Weighted average shares outstanding and shares issuable under the employee stock option plan, restricted stock plan and upon conversion of the 5.75% Convertible Senior Notes due 2023 (the “Convertible Notes”) have been adjusted to reflect the 3-for-2 stock split. Basic weighted average shares outstanding for the three and nine months ended September 30, 2005 includes shares issued in 2005 in connection with the conversions of $81.2 million aggregate principal amount of our Convertible Notes.

Diluted weighted average shares outstanding include the impact of all additional shares that would be issuable in connection with conversion of all of the Convertible Notes. This represents an additional 2.6 million and 4.3 million shares for the three and nine months ended September 30, 2005, respectively, and an additional 7.5 million shares for the three and nine months ended September 30, 2004. After tax interest expense associated with the Convertible Notes of $0.4 million and $2.2 million for the three and nine

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 3. Earnings and Dividends Per Share (Continued)

months ended September 30, 2005, respectively, and $1.3 million and $3.8 million for the three and nine months ended September 30, 2004, respectively, was added back to net income in computing diluted earnings per share.

Note 4. Income Tax

Income tax expense was reduced in the three and nine months ended September 30, 2005 by the reduction of $1.0 million for a provision for prior years’ taxes and by $2.6 million for a provision for prior years’ taxes in the three and nine months ended September 30, 2004.

Note 5. Outstanding Debt

In the nine months ended September 30, 2005, outstanding debt was reduced because holders of the Convertible Notes converted $81.2 million aggregate principal amount into 3.2 million shares of Zenith National’s common stock. Zenith entered into privately negotiated transactions with these holders of the Convertible Notes pursuant to which the holders converted their Convertible Notes in accordance with the Indenture governing the Convertible Notes (“the Indenture”) and received a total of $4.7 million in cash as an incentive for such conversion. All of the shares of Zenith National’s common stock were issued in reliance upon the exemption from registration provided in Section 3(a)(9) of the Securities Act of 1933, as amended. No commission or other remuneration was paid or given directly or indirectly for soliciting these transactions. The cash incentive paid in connection with the foregoing conversions is included in the results of the Parent segment.

In October 2005, a further $30.2 million aggregate principal amount of the Convertible Notes were converted into 1.8 million shares of Zenith National’s common stock including the 3-for-2 stock split shares. No cash incentive was paid in connection with such conversions.

At September 30, 2005, the aggregate maturities for all of Zenith’s long-term borrowings for each of the five years after December 31, 2004 are as follows:

(Dollars in thousands)	Convertible Notes			Redeemable Securities			Total
Maturing in:
2005		$	43,800				$	43,800
2006
2007
2008
2009
Thereafter					$	59,000	59,000
Total		$	43,800		$	59,000	$	102,800

The maturity of the outstanding Convertible Notes is presented as being due in 2005 because the holders of the Convertible Notes currently have the right to convert their notes into our common stock during the fourth quarter of 2005 as a result of the triggering of the contingent conversion condition relative to Zenith National’s common stock price at the end of the third quarter of 2005. If any holder

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 5. Outstanding Debt (Continued)

requires Zenith National to repurchase its Convertible Notes, Zenith National may choose to pay the repurchase price in cash or shares of its common stock or a combination thereof. Whether the notes will be convertible after December 31, 2005 will depend upon the occurrence of events specified in the Indenture, including the sale price of Zenith National’s common stock. If the Convertible Notes are not converted or redeemed, their scheduled maturity is March 2023.

Prior to the 3-for-2 stock split, the terms of conversion were such that each $1,000 principal amount of the Convertible Notes was convertible at each holder’s option into 40 shares of Zenith National’s common stock (subject to adjustment as provided in the Indenture) only if: (i) during any fiscal quarter the sale price of the common stock for at least 20 trading days in the 30 trading-day period ending on the last trading day of the immediately preceding fiscal quarter exceeds 120% of the conversion price on that 30th trading day; (ii) after the 30th day following the initial issuance of the Convertible Notes, the credit rating assigned to the Convertible Notes by Standard & Poor’s Rating Services falls below BB- or is suspended or withdrawn; (iii) Zenith has called the Convertible Notes for redemption; or (iv) certain corporate events have occurred. After the 3-for-2 stock split, the conversion terms were adjusted to reflect a conversion rate of 59.988 shares for each $1,000 principal amount of Convertible Notes, which is equivalent to a conversion price of $16.67 per share of Zenith National’s common stock and the maximum number of shares that could be required to be issued upon conversion of all outstanding Convertible Notes at September 30, 2005 was approximately 2.6 million.

In March 2004, Zenith National repurchased $8.0 million aggregate liquidation amount of the outstanding 8.55% Capital Securities of Zenith National Insurance Capital Trust I, all of the voting securities of which are owned by Zenith National (“Redeemable Securities”), which resulted in a gain of $0.3 million before tax ($0.2 million after tax). The gain was recorded as a reduction of interest expense in the first quarter of 2004. Zenith National used its available cash balances to fund this purchase.

At September 30, 2005, Zenith National had an unsecured line of credit in the amount of $30.0 million which expires on October 31, 2007. Zenith National did not renew a one year revolving line of credit in the amount of $20.0 million which expired on August 1, 2005 because Zenith National’s current cash, investments and other sources of liquidity are sufficient for any foreseeable requirements at this time. There were no amounts drawn under these lines of credit in 2005 or 2004.

Note 6. Investment in Advent Capital (Holdings) PLC (“Advent Capital”)

Zenith owns 22.1 million shares of Advent Capital common stock. On June 3, 2005, Advent Capital sold 114.3 million shares of its common stock in a public offering at the United States dollar equivalent of $0.64 per share. On the same date, Advent Capital common stock was listed for trading on the Alternative Investments Market of the London Stock Exchange (“AIM”). Prior to Advent Capital’s listing on the AIM, there was no public market for such shares. Prior to the public offering, Zenith owned approximately 20.9% of the outstanding shares of Advent Capital and recorded its investment in Advent Capital under the equity method of accounting. Under the equity method, we recognized our share of the earnings or losses of Advent Capital on a one-quarter lag to allow sufficient time for Advent Capital to prepare its financial statements. After the sale of additional shares of common stock by Advent Capital, Zenith owns 10.0% of the outstanding shares of Advent Capital, accounts for its investment in Advent Capital under the cost method and reports this investment in the Consolidated Balance Sheet at fair value.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 6. Investment in Advent Capital (Holdings) PLC (“Advent Capital”) (Continued)

To reflect the new, publicly traded price of Advent Capital, Zenith reduced the carrying value of this investment to its fair value resulting in a charge of $9.5 million before tax ($6.2 million after tax) in the second quarter of 2005 as a reduction of realized gains on investments. The charge resulted from the difference between the fair value of our investment in Advent Capital, based upon the offering price for Advent Capital’s common stock, and the carrying value of the investment under the equity method as of the date of the public offering. The carrying value under the equity method as of the date of the public offering included our share of Advent Capital’s loss for the first quarter of 2005, the most recent period for which such financial information was available. We were unable to estimate our share of Advent Capital’s earnings or losses for the period between the end of the first quarter of 2005 and the date of the public offering. However, the amount of any such share would have no impact on our consolidated net income in the second quarter of 2005 because the charge required to reduce our investment in Advent Capital to its fair value would have increased or decreased by the amount of any such share of earnings or losses recorded under the equity method of accounting.

At September 30, 2005, our investment in Advent Capital is included in equity securities classified as “available for sale.” The fair value of the investment is the publicly traded price for Advent Capital’s common stock obtained from the AIM and reflected in United States dollars. Changes in the fair value of the investment since the date of the public offering are recorded as a component of other comprehensive income. We do not presently intend to sell any of our shares of Advent Capital common stock.

In each of the second quarters of 2005 and 2004, we received a dividend payment from Advent Capital of $1.1 million.

Note 7. Segment Information

Our business is comprised of the following segments: workers’ compensation; reinsurance; investments; and parent. Our real estate segment was discontinued in 2002. Segments are designated based on the types of products and services provided. Workers’ compensation represents insurance coverage for the statutorily prescribed benefits that employers are required to provide to their employees injured in the course of employment. Reinsurance principally consists of assumed reinsurance of property losses from worldwide catastrophes and large property risks. Income from operations of the investments segment includes investment income and realized gains and losses on investments and we do not allocate investment income to the results of our workers’ compensation and reinsurance segments. Income (loss) from the workers’ compensation and reinsurance segments is determined solely by deducting net loss and loss adjustment expenses incurred and underwriting and other operating expenses incurred from net premiums earned. The loss from operations of the parent segment includes interest expense and the general operating expenses of Zenith National, a holding company which owns, directly or indirectly, all of the capital stock of its insurance subsidiaries and other investment securities.

In September 2005, Zenith National’s Board of Directors announced that we will exit the reinsurance business. Zenith will not renew existing assumed reinsurance contracts and has ceased writing any new contracts. We will service our obligations under our existing assumed reinsurance contracts and will receive earned premiums and be subject to continuing exposure to losses until our in-force assumed reinsurance contracts expire. The results of the reinsurance segment will continue to be included in the results of continuing operations.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 7. Segment Information (Continued)

The combined ratio, expressed as a percentage, is a key measurement of profitability traditionally used in the property-casualty insurance industry. The combined ratio is the sum of the loss and loss adjustment expense ratio and the underwriting and other operating expense ratio. The loss and loss adjustment expense ratio is the percentage of net incurred loss and loss adjustment expenses to net premiums earned. The underwriting and other operating expense ratio is the percentage of underwriting and other operating expenses to net premiums earned. The key operating goal for our insurance segments is to achieve a combined ratio of 100% or lower and to achieve a workers’ compensation combined ratio that is at least three percentage points lower than the combined ratio of the national workers’ compensation industry.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 7. Segment Information (Continued)

Segment information is set forth below:

(Dollars in thousands)	Workers’ Compensation				Reinsurance				Real Estate(1)			Investments			Parent			Total
Three Months Ended September 30, 2005
Revenues:
Premiums earned		$	277,410			$	23,892											$	301,302
Net investment income													$	20,550				20,550
Realized gains on investments													2,043					2,043
Total revenues		277,410				23,892							22,593					323,895
Interest expense															$	(1,997	)	(1,997		)
Income (loss) from continuing operations before tax		62,681				(49,951		)					22,593		(3,904		)	31,419
Income tax expense (benefit)		21,162				(17,483		)					7,421		(1,428		)	9,672
Income (loss) from continuing operations		41,519				(32,468		)					15,172		(2,476		)	21,747
Gain on sale of discontinued real estate segment, net of tax expense of $675										$	1,253							1,253
Net income (loss)		$	41,519			$	(32,468	)		$	1,253		$	15,172	$	(2,476	)	$	23,000
Combined ratios		77.4		%		309.1		%
Nine Months Ended September 30, 2005
Revenues:
Premiums earned		$	836,469			$	47,330											$	883,799
Net investment income													$	56,732				56,732
Realized gains on investments													21,265					21,265
Total revenues		836,469				47,330							77,997					961,796
Interest expense															$	(7,323	)	(7,323		)
Income (loss) from continuing operations before tax and equity in earnings of investee		146,706				(45,002		)					77,997		(17,571		)	162,130
Income tax expense (benefit)		51,162				(15,751		)					25,939		(5,873		)	55,477
Income (loss) from continuing operations after tax and before equity in earnings of investee		95,544				(29,251		)					52,058		(11,698		)	106,653
Equity in earnings of investee, net of tax expense of $428													794					794
Income (loss) from continuing operations		95,544				(29,251		)					52,852		(11,698		)	107,447
Gain on sale of discontinued real estate segment, net of tax expense of $675										$	1,253							1,253
Net income (loss)		$	95,544			$	(29,251	)		$	1,253		$	52,852	$	(11,698	)	$	108,700
Combined ratios		82.5		%		195.1		%
As of September 30, 2005
Total assets		$	476,761			$	58,548						$	2,136,004	$	5,007		$	2,676,320

(1) Discontinued in 2002.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 7. Segment Information (Continued)

	Workers’								Real
(Dollars in thousands)	Compensation				Reinsurance				Estate(1)			Investments			Parent			Total
Three Months Ended September 30, 2004
Revenues:
Premiums earned		$	227,728			$	11,988											$	239,716
Net investment income													$	14,909				14,909
Realized gains on investments													6,690					6,690
Total revenues		227,728				11,988							21,599					261,315
Interest expense															$	(3,295	)	(3,295		)
Income (loss) from continuing operations before tax and equity in earnings of investee		29,504				(15,776		)					21,599		(4,710		)	30,617
Income tax expense (benefit)(2)		10,608				(5,521		)					7,050		(4,400		)	7,737
Income (loss) from continuing operations after tax and before equity in earnings of investee		18,896				(10,255		)					14,549		(310		)	22,880
Equity in earnings of investee, net of tax expense of $664													1,234					1,234
Income (loss) from continuing operations		18,896				(10,255		)					15,783		(310		)	24,114
Gain on sale of discontinued real estate segment, net of tax expense of $692										$	1,286							1,286
Net income (loss)		$	18,896			$	(10,255	)		$	1,286		$	15,783	$	(310	)	$	25,400
Combined ratios		87.0		%		231.6		%
Nine Months Ended September 30, 2004
Revenues:
Premiums earned		$	662,160			$	34,186											$	696,346
Net investment income													$	43,825				43,825
Realized gains on investments													12,362					12,362
Total revenues		662,160				34,186							56,187					752,533
Interest expense															$	(9,762	)	(9,762		)
Income (loss) from continuing operations before tax and equity in earnings of investee		71,442				(11,284		)					56,187		(14,100		)	102,245
Income tax expense (benefit)(2)		25,735				(3,949		)					18,132		(7,687		)	32,231
Income (loss) from continuing operations after tax and before equity in earnings of investee		45,707				(7,335		)					38,055		(6,413		)	70,014
Equity in earnings of investee, net of tax expense of $2,154													4,000					4,000
Income (loss) from continuing operations		45,707				(7,335		)					42,055		(6,413		)	74,014
Gain on sale of discontinued real estate segment, net of tax expense of $692										$	1,286							1,286
Net income (loss)		$	45,707			$	(7,335	)		$	1,286		$	42,055	$	(6,413	)	$	75,300
Combined ratios		89.2		%		133.0		%
As of September 30, 2004
Total assets		$	497,429			$	32,675						$	1,786,847	$	10,868		$	2,327,819

(1) Discontinued in 2002.

(2) Parent segment includes $2.6 million in reduced income tax expense for a reduction of an estimated tax liability for prior years.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 7. Segment Information (Continued)

The following table is a reconciliation of our segment results to the accompanying Consolidated Statements of Operations:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(Dollars in thousands)	2005			2004			2005			2004
Income before tax from investments segment:
Net investment income	$	20,550		$	14,909		$	56,732		$	43,825
Realized gains on investments	2,043			6,690			21,265			12,362
	22,593			21,599			77,997			56,187
Income (loss) before tax from:
Workers’ compensation segment	62,681			29,504			146,706			71,442
Reinsurance segment	(49,951		)	(15,776		)	(45,002		)	(11,284		)
Parent segment	(3,904		)	(4,710		)	(17,571		)	(14,100		)
Income from continuing operations before tax and before equity in earnings of investee	31,419			30,617			162,130			102,245
Income tax expense	9,672			7,737			55,477			32,231
Income from continuing operations after tax and before equity in earnings of investee	21,747			22,880			106,653			70,014
Equity in earnings of investee, after tax				1,234			794			4,000
Income from continuing operations	21,747			24,114			107,447			74,014
Gain on sale of discontinued real estate segment, after tax	1,253			1,286			1,253			1,286
Net income	$	23,000		$	25,400		$	108,700		$	75,300

Note 8. Commitments and Contingencies

Contingencies Surrounding Reinsurance Receivable from Reliance Insurance Company

At September 30, 2005 and December 31, 2004, Reliance Insurance Company (“Reliance”) owed Zenith Insurance $6.0 million of reinsurance recoverable on paid and unpaid losses in connection with the reinsurance arrangements assumed by Zenith Insurance in its 1996 acquisition of the Associated General Commerce Self-Insurers’ Trust Fund.

On October 3, 2001, the Commonwealth Court of Pennsylvania approved an Order of Liquidation for Reliance, which was experiencing cash flow problems caused by slow reinsurance recoveries. At that time, an estimated balance sheet of Reliance was made available as of December 31, 2000, from which we estimated that we could expect to recover no more than 50% of our receivable. This established a range of outcomes for the amount impaired between $3.0 million and $6.0 million (i.e., we expect to recover an amount between 50% and nothing). We have no information with which to establish an estimate within that range as better than any other and, therefore, in 2001, we recorded an impairment provision of $3.0 million for our receivable from Reliance. The impairment provision was $3.0 million at September 30, 2005 and December 31, 2004. The eventual outcome of this matter will be determined by the ultimate amount of Reliance’s liabilities and whether Reliance has sufficient assets or can obtain recoveries and

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 8. Commitments and Contingencies (Continued)

investment income in an amount sufficient to pay its liabilities. We will revise our impairment provision, if necessary, upon receipt of relevant information.

Contingencies Surrounding State Guarantee Fund Assessments

State guarantee funds (“Guarantee Funds”) exist to ensure that policyholders (holders of direct insurance policies but not of reinsurance policies) receive payment of their claims if insurance companies become insolvent. The Guarantee Funds are funded primarily by statutorily prescribed assessments they bill to other insurance companies doing business in their states. Various mechanisms exist in some of these states for assessed insurance companies to recover these assessments. Upon the insolvency of an insurance company, the Guarantee Funds become primarily liable for the payment of the insolvent company’s liabilities to policyholders. The declaration of an insolvency establishes the presumption that assessments by the Guarantee Funds are probable. Zenith Insurance writes workers’ compensation insurance in many states in which unpaid workers’ compensation liabilities are the responsibility of the Guarantee Funds and has received, and expects to continue to receive, Guarantee Fund assessments, some of which may be based on certain of the premiums it has already earned at September 30, 2005.

Zenith recorded an estimated $8.6 million (net of expected recoveries of $2.5 million recoverable before the end of 2006) for its expected liability at September 30, 2005 for Guarantee Fund assessments. Recoveries are attributable to premium tax credits in various states. The amount of the recovery we have recorded is limited to credits applicable to, and recoverable from, premiums earned through September 30, 2005. The estimated expense for Guarantee Fund assessments was $1.6 million and $4.8 million in the three and nine months ended September 30, 2005, respectively, compared to $1.4 million and $3.9 million in the three and nine months ended September 30, 2004, respectively. Our estimated liability is based on information currently available and could change based on additional information or reinterpretation of existing information concerning the actions of the Guarantee Funds. Zenith expects that it will continue to accrue and receive Guarantee Fund assessments; and the ultimate impact of such assessments will depend upon the amount and timing of the assessments and of any recoveries to which Zenith is entitled.

Contingencies Surrounding Recoverability of Special Disability Trust Fund Receivable

The Florida Special Disability Trust Fund (“SDTF”) was established to reimburse insurance companies and employers for the cost of certain workers’ compensation claims. The SDTF promotes the re-hiring of injured workers by providing a reimbursement for certain qualifying claims made by a previously injured worker subsequent to their re-hiring. These claims are sometimes referred to as “second injuries.” We are able to submit such second injury claims to the SDTF and, if the claims are accepted, we are reimbursed for part of the cost of the claim. The SDTF stopped accepting new second injury claims dated after January 1, 1998. At September 30, 2005, approximately 550 of our Florida claims have been accepted, for which we have recorded a recoverable of $6.2 million, net of amounts due to reinsurers. We bill the SDTF and receive reimbursements as we make payments on accepted claims. The SDTF is funded by currently assessing a fee of 4.52% of workers’ compensation premiums written in Florida, and we accrue the assessment as a liability when we write Florida business. If the legislature in Florida were to decide to cease or suspend the assessment, and thereby the funding of the SDTF, any recoverable that we may have at that time which is related to un-reimbursed claims might be at risk. However, we have no current

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 8. Commitments and Contingencies (Continued)

information to indicate that the SDTF assessment in Florida will not continue. We continue to collect recoveries for second injury claims from the SDTF and although the SDTF is currently about 48 months behind schedule in reimbursing claims, we expect to fully recover the remaining amount receivable.

Litigation

The U.S. Equal Employment Opportunity Commission (“EEOC”), on behalf of a job applicant and other similarly situated individuals, has filed a class action lawsuit against Zenith for allegations of employment and racial discrimination. The case was filed September 30, 2005. The EEOC alleges that Zenith discriminated against certain job applicants by failing to hire them because of their race. Zenith has retained legal counsel and service has been effected with counsel. Plaintiff seeks unspecified compensatory and punitive damages, according to proof at trial. The burden of proof rests with plaintiff to establish the validity of the claim, as well as the appropriateness and certification of the alleged class. Because the case is at such an early stage, and damages are not specified, Zenith is unable to quantify potential damages at this time. It is Zenith’s position that the claims are without merit and Zenith will vigorously defend its position. The ultimate outcome of this matter is not expected to have a material impact on Zenith’s consolidated financial condition, results of operations or cash flows.

Zenith National and its subsidiaries are defendants in various other litigation. In the opinion of management, after consultation with legal counsel, such litigation is either without merit or the ultimate liability, if any, is not expected to have a material adverse effect on the consolidated financial condition, results of operations or cash flows of Zenith.

Note 9. Discontinued Operations—Gain on Sale of Real Estate Segment

On October 8, 2002, Zenith closed the sale of its home-building business and related real estate assets in Las Vegas, Nevada to Meritage Corporation (“Meritage”). The business had been operated by Zenith National’s indirect wholly-owned subsidiary, Zenith of Nevada, Inc. (formerly, Perma-Bilt, a Nevada corporation (“Perma-Bilt”)). In the transaction, Meritage, through its wholly-owned subsidiary, MTH-Homes Nevada, Inc. (“MTH Nevada”), acquired substantially all of Perma-Bilt’s assets, subject to the related liabilities, pursuant to a Master Transaction Agreement, dated as of October 7, 2002, and related asset and real property acquisition agreements (the “Agreement”).

Zenith received gross proceeds of $65.0 million in connection with the sale, including $28.4 million in repayment of intercompany loans to Zenith National from Perma-Bilt, and recorded a gain on the sale in the fourth quarter of 2002 of $6.3 million after tax.

In addition to the consideration received in October 2002, the Agreement entitles Zenith to receive 10% of MTH Nevada’s pre-tax net income, subject to certain adjustments, for each of the twelve-month periods ending September 30, 2003, September 30, 2004 and September 30, 2005. We recorded additional gains on this sale of $1.9 million before tax ($1.3 million after tax) and $2.0 million before tax ($1.3 million after tax) in the third quarter of 2005 and 2004, respectively. These gains represent our share of MTH Nevada’s profits for the twelve months ended September 30, 2005 and 2004, respectively, under the earn-out provision of the sale. 2005 was the last such payment under the earn-out provision.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 10. Exercise of Stock Options Using Previously Acquired Shares

A Zenith employee exercised his option to purchase from Zenith National a total of 799,000 shares of Zenith National’s common stock in 2005 and 201,000 shares in 2004 at an exercise price of $23.63 per share (all shares and the exercise price are pre 3-for-2 stock split) using previously owned shares to pay the purchase price and, in 2005, to pay the withholding taxes due.

The following table sets forth these transactions:

	September			February		March
(Dollars and shares in thousands, except per share data)	2005			2005		2004
Shares of common stock purchased		179		620		201
Exercise price per share		$	23.63	$	23.63	$	23.63
Aggregate exercise price		$	4,219	$	14,657	$	4,748
Number of shares tendered by employee in lieu of cash payment of:
Aggregate exercise price		66		288		121
Employee’s income tax withholdings		52		150
Value of shares tendered by employee in lieu of cash payment of:
Aggregate exercise price		$	4,219	$	14,657	$	4,748
Employee’s income tax withholdings		$	3,341	$	7,545

These exercises of stock options had no net effect on cash or stockholders’ equity in 2005 or 2004 because the increase in treasury stock for the shares tendered was offset by an increase in common stock and an increase in additional paid-in capital for the shares issued. The shares tendered by the employee in lieu of cash payment of his income tax withholding increased treasury stock and decreased cash.

Note 11. Recently Issued Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”). This statement requires companies to measure the cost of employee services received in exchange for an award of equity instruments by estimating the fair value of the award which is then recognized as an expense over the vesting period of the award. Starting in the fourth quarter of 2002, we have been expensing the fair value of all stock options granted since January 1, 2002 under the prospective method. Zenith will adopt SFAS No. 123(R) using the modified prospective method. Under this method, all employee stock option grants outstanding at the date of adoption will be expensed over the stock option vesting period based on the fair value at the date the options were granted. SFAS No. 123(R) is effective as of the beginning of the first annual reporting period that begins after June 15, 2005. The adoption of SFAS No. 123(R) is not expected to have a material impact on our results of operations or financial condition. There will be no material change in the accounting for Zenith’s Restricted Stock Plan or Employee Stock Purchase Plan based upon the adoption of SFAS No. 123(R).

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS No. 154”). This Statement replaces APB Opinion No. 20, “Accounting Changes,” and SFAS No. 3, “Reporting Accounting Changes

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 11. Recently Issued Accounting Pronouncements (Continued)

in Interim Financial Statements,” and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement also provides guidance on the accounting for and reporting of accounting changes and error corrections. It requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. This Statement also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. It also addresses the reporting of a correction of an error by restating the previously issued financial statements. SFAS No. 154 is effective as of the beginning of the first annual reporting period that begins after December 15, 2005. We believe that SFAS No. 154 will not have a material effect on our financial condition or results of operations.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

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

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements if accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed. Forward-looking statements include those related to the plans and objectives of management for future operations, future economic performance, or projections of revenues, income, earnings per share, capital expenditures, dividends, capital structure, or other financial items. Statements containing words such as expect, anticipate, believe, estimate, or similar words that are used in this Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (“MD&A”), in other parts of this report or in other written or oral information conveyed by or on behalf of Zenith, are intended to identify forward-looking statements. The Company undertakes no obligation to update such forward-looking statements, which are subject to a number of risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, the following: (1) competition; (2) adverse state and federal legislation and regulation; (3) changes in interest rates causing fluctuations of investment income and fair values of investments; (4) changes in the frequency and severity of claims and catastrophes; (5) adequacy of loss reserves; (6) changing environment for controlling medical, legal and rehabilitation costs, as well as fraud and abuse; (7) losses associated with any terrorist attacks that impact our workers’ compensation business segment in excess of our reinsurance protection; (8) losses caused by nuclear, biological, chemical or radiological events whether or not there is any applicable reinsurance protection; and (9) other risks detailed herein and from time to time in Zenith’s reports and filings with the Securities and Exchange Commission.

Overview

1) Revenues. Our revenues are comprised of the net premiums earned from our workers’ compensation and reinsurance segments and the net investment income and realized gains from our investments segment. Total revenues increased in the three and nine months ended September 30, 2005 compared to the corresponding periods of 2004 principally because our workers’ compensation premium revenues increased in the three and nine months ended September 30, 2005. In the three and nine months ended September 30, 2005, there is a favorable impact on our workers’ compensation net premiums earned because we no longer cede 10% of our workers’ compensation earned premiums under a quota share reinsurance agreement which reduced net premiums earned in the corresponding periods of 2004. Our workers’ compensation premiums are discussed further below under “Results of Operations—Workers’ Compensation Segment” on pages 24 through 26.

2) Income from workers’ compensation and reinsurance segments. The results of our workers’ compensation and reinsurance segments may fluctuate from time to time.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

a) Workers’ compensation. Income in the three and nine months ended September 30, 2005 increased compared to the corresponding periods in 2004 as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
(Dollars in thousands)	2005		2004		2005		2004
Income before tax from workers’ compensation segment	$	62,681	$	29,504	$	146,706	$	71,442

b) Reinsurance. Results for the three and nine months ended September 30, 2005 were reduced by estimated catastrophe losses of $55.7 million, or $36.2 million after tax ($0.98 per share). Results for the three and nine months ended September 30, 2004 were reduced by estimated catastrophe losses of $18.5 million, or $12.0 million after tax ($0.33 per share).

In September 2005, we announced that we will exit the assumed reinsurance business.

3) Loss reserves. At September 30, 2005, we re-allocated our workers’ compensation loss reserves by accident year compared to the allocation at December 31, 2004 to better reflect the facts and trends based on our current knowledge. In this regard, we recognized $8.1 million and $13.0 million of favorable development on prior year loss reserves during the three and nine months ended September 30, 2005, respectively.

4) Investments segment. We increased our investment portfolio by $213.9 million in the nine months ended September 30, 2005 as a result of favorable net cash flow from operations. We expect favorable net cash flow from operations to continue in 2005. Investment income in the three and nine months ended September 30, 2005 was higher than the corresponding periods in 2004 because of the increase in the investment portfolio and higher short-term interest rates in 2005. At September 30, 2005, $1,118.4 million of the investment portfolio was in fixed maturities of two years or less compared to $901.3 million at December 31, 2004.

Realized gains from investments in the first nine months of 2005 were higher than the comparable period in 2004 due to net capital gains, partially offset by a $9.5 million before tax charge in the second quarter related to our investment in the common stock of Advent Capital (Holdings) PLC (“Advent Capital”).

5) Outstanding debt. In the first nine months of 2005, we reduced our outstanding debt because $81.2 million principal amount of our 5.75% Convertible Senior Notes due 2023 (“Convertible Notes”) was converted into Zenith National’s common stock, par value $1.00 per share (“Zenith National’s common stock”). As a result of these conversions, the ratio of outstanding debt (the remaining balance of the Convertible Notes plus the balance of our redeemable securities) was 14% of the sum of all outstanding debt and stockholders’ equity at September 30, 2005, compared to 27% at December 31, 2004. We do not expect to incur any additional debt in the foreseeable future. An additional $30.2 million aggregate principal amount of the Convertible Notes was converted into shares of Zenith National’s common stock in October 2005.

6) Stockholders’ equity. Our stockholders’ equity increased from $502.1 million ($17.28 per share) at December 31, 2004 to $629.8 million ($18.22 per share) at September 30, 2005. These per share amounts reflect the 3-for-2 stock split declared by Zenith National’s Board of Directors on September 7, 2005.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

Results of Operations

Summary Results by Segment

The comparative components of net income for the three and nine months ended September 30, 2005 and 2004 are set forth in the following table. These components of net income are consistent with the results of our business segments set forth in Note 7 to the Consolidated Financial Statements.

	Three Months Ended September 30,						Nine Months Ended September 30,
(Dollars in thousands)	2005			2004			2005			2004
Income before tax from investments segment:
Net investment income	$	20,550		$	14,909		$	56,732		$	43,825
Realized gains on investments	2,043			6,690			21,265			12,362
	22,593			21,599			77,997			56,187
Income (loss) before tax from:
Workers’ compensation segment	62,681			29,504			146,706			71,442
Reinsurance segment	(49,951		)	(15,776		)	(45,002		)	(11,284		)
Parent segment	(3,904		)	(4,710		)	(17,571		)	(14,100		)
Income from continuing operations before tax and before equity in earnings of investee	31,419			30,617			162,130			102,245
Income tax expense	9,672			7,737			55,477			32,231
Income from continuing operations after tax and before equity in earnings of investee	21,747			22,880			106,653			70,014
Equity in earnings of investee after tax				1,234			794			4,000
Income from continuing operations	21,747			24,114			107,447			74,014
Gain on sale of discontinued real estate segment, after tax	1,253			1,286			1,253			1,286
Net income	$	23,000		$	25,400		$	108,700		$	75,300

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

Net premiums earned and the combined ratios of the workers’ compensation and reinsurance segments for the three and nine months ended September 30, 2005 and 2004 are set forth below:

	Three Months Ended September 30,						Nine Months Ended September 30,
(Dollars in thousands)	2005			2004			2005			2004
Net premiums earned:
Workers’ compensation:
California	$	191,105		$	157,181		$	574,638		$	456,172
Outside California	86,305			70,547			261,831			205,988
Total workers’ compensation	277,410			227,728			836,469			662,160
Reinsurance	23,892			11,988			47,330			34,186
Total	$	301,302		$	239,716		$	883,799		$	696,346
Combined loss and expense ratios:
Workers’ compensation:
Loss and loss adjustment expense:
Current accident year	49.8		%	61.7		%	56.8		%	62.8		%
Prior accident years	(2.9		)%	2.2		%	(1.6		)%	3.0		%
Total loss and loss adjustment expense	46.9		%	63.9		%	55.2		%	65.8		%
Underwriting and other operating expense(1)	30.5		%	23.1		%	27.3		%	23.4		%
Combined ratio	77.4		%	87.0		%	82.5		%	89.2		%
Reinsurance:
Loss and loss adjustment expense	298.6		%	214.1		%	182.5		%	107.9		%
Underwriting and other operating expense	10.5		%	17.5		%	12.6		%	25.1		%
Combined ratio	309.1		%	231.6		%	195.1		%	133.0		%

(1) Reflects an increase of $11.0 million in accrued policyholder dividends in the three and nine months ended September 30, 2005.

Workers’ Compensation Segment

The combined ratio of our workers’ compensation segment improved in the three and nine months ended September 30, 2005 compared to the corresponding periods in 2004 because of a lower estimated loss and loss adjustment expense ratio in the three and nine months ended September 30, 2005 compared to the estimated loss and loss adjustment expense ratio in the corresponding periods in 2004. The lower estimated loss and loss adjustment expense ratio in the three months ended September 30, 2005 includes a lower estimated current accident year loss ratio than the estimate we made for the first six months of 2005 and favorable development of prior years’ loss reserves. Lower loss ratio estimates in the third quarter caused us to re-evaluate our estimate for accrued policyholder dividends. The increase in policyholder dividends caused an increase in the underwriting and other expense ratio in the three and nine months

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

ended September 30, 2005. The lower estimated loss and loss adjustment expense ratio in 2005 is primarily due to a continuation of favorable trends in claim inflation and lower than expected claim frequency compared to premiums. Our assumptions underlying our loss cost estimates are discussed further under “Loss Reserves” on pages 29 to 33.

In the nine months ended September 30, 2005, we increased our in-force workers’ compensation premiums. Premiums in-force and number of policies in-force in California and outside of California were as follows (premiums in-force is a measure of the amount of premiums billed or to be billed on all un-expired policies at the date shown):

	California				Outside of California
(Dollars in millions)	Premiums in-force			Policies in-force	Premiums in-force			Policies in-force
September 30, 2005		$	746.8	28,000		$	329.3	16,900
December 31, 2004		731.3		27,200		311.0		16,200
September 30, 2004		702.3		26,700		304.1		15,900
December 31, 2003		587.9		25,900		277.8		15,600

We believe that the insureds’ payroll is our best indicator of exposure. We estimate that the underlying payroll associated with our policies in-force increased during the same periods as follows:

	Annual Increase in Insured Payroll
Policies in-force at September 30,	California Only			Total Company
2005		18	%		14	%
2004		21			16

In California, the state in which the largest amount of our workers’ compensation premium is earned, we set our own rates based upon actuarial analysis of current and anticipated cost trends. In Florida, the state in which the second largest amount of our workers’ compensation premiums is earned, rates for workers’ compensation insurance are set by the Florida Department of Insurance. Percentage changes in average rates in these two states during 2005 and 2004 were as follows (rate decreases are shown in parentheses):

Effective date of change	California			Florida
July 1, 2005		(12.0	)%		0.0	%
January 1, 2005		(1.6	)		(4.0	)
July 1, 2004		(10.0	)		0.0
January 1, 2004		0.0			0.0

Average rates do not necessarily indicate charged rates since underwriters are given authority to debit or credit rates based upon individual risk characteristics. According to published California industry data, Zenith’s major competitors also reduced rates July 1, 2005 in a range from 12% to 25%.

Net premiums earned in the three and nine months ended September 30, 2004 are net of $25.1 million and $72.8 million, respectively, of ceded premiums earned in connection with a 10% quota share ceded reinsurance agreement. This quota share ceded reinsurance agreement was terminated effective

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

December 31, 2004. The underwriting and other operating expense ratio for the workers’ compensation segment is higher in the three and nine months ended September 30, 2005 compared to the corresponding periods in 2004 by approximately two percentage points due to the absence in 2005 of ceding commissions received in 2004 on the terminated 10% quota share ceded reinsurance agreement.

In California, the Workers’ Compensation Insurance Rating Bureau (“WCIRB”) recommends advisory pure premium rates for California workers’ compensation insurance and the California Department of Insurance adopts and publishes advisory pure premium rates. Pure premium rates are rates that would cover expected loss costs but do not contain an element to cover operating expenses or profit. On September 9, 2005, the WCIRB’s governing committee announced that it had approved for filing an amendment to its July 28, 2005 filing. The amendment recommends an average 15.9% decrease in advisory pure premium rates to be effective on policies incepting on or after January 1, 2006. The recommended decrease was based on an analysis of loss and loss adjustment expense data as of June 30, 2005. Notwithstanding this process, our California rates continue to be based upon our actuarial analysis of current and anticipated cost trends, and we have not made a determination as to rates for January 1, 2006.

Reinsurance Segment

In assumed reinsurance, we provide coverage that protects other insurance and reinsurance companies from the accumulation of large losses from major loss events, known as “catastrophes.” Results of the reinsurance segment will fluctuate and are favorable in the absence of catastrophes and may be unfavorable in periods when they occur. Results of the reinsurance segment for the three and nine months ended September 30, 2005 were reduced by estimated catastrophe losses of $55.7 million, or $36.2 million after tax ($0.98 per share) net of additional premiums earned from original and reinstatement premiums. Results of the reinsurance segment for the three and nine months ended September 30, 2004 were reduced by estimated catastrophe losses, net of additional premiums earned from original and reinstatement premiums, of $18.5 million, or $12.0 million after tax ($0.33 per share).

Our estimated loss from Hurricane Katrina is $27.3 million after the benefit of reinstatement premiums and after tax compared to the previously announced loss of $21.0 million after tax and reinstatement premiums. The charge to earnings in the third quarter is higher than our estimated loss from Hurricane Katrina by $8.0 million after tax since part of the reinstatement premiums will be substantially earned in the fourth quarter of 2005. The loss after tax and reinstatement premiums related to Hurricane Katrina is recognized as follows:

(Dollars in thousands)
Q3 2005	$	(35,300	)	Loss, net of reinstatement premiums earned in Q3 2005
Q4 2005	8,000			Reinstatement premiums unearned at September 30, 2005 to be substantially earned in Q4 2005
Total	$	(27,300	)	Loss, net of reinstatement premiums

Estimating catastrophe losses in the reinsurance business is highly dependent upon the nature and timing of the event and our ability to obtain timely and accurate information with which to estimate our liability to pay losses. Estimated catastrophe losses in 2005 are attributable principally to losses arising from Hurricane Katrina. We estimated our loss from Hurricane Katrina by estimating the probable impact

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

to each of our assumed reinsurance contracts based on currently available information, including reports from companies that we reinsure. About 70% of our loss from Hurricane Katrina relates to our excess of loss contracts and represents the maximum loss payable for 92% of our excess of loss assumed reinsurance contracts that provide coverage for catastrophe losses occurring in the United States. The remainder of our Hurricane Katrina loss estimate is attributable to losses from our assumed quota share reinsurance contracts and is based on estimates from the companies that we reinsure. Based on our current information, our estimated loss from Hurricane Rita is $1.3 million before tax and is included in our catastrophe losses in the third quarter of 2005.

Estimates of the impact of catastrophes on the reinsurance segment are based on the information that is currently available and such estimates could change based on new information that becomes available or based upon any reinterpretation of existing information.

In September 2005, Zenith National’s Board of Directors announced that we will exit the reinsurance business. Zenith will not renew existing assumed reinsurance contracts and has ceased writing any new contracts. We will service our obligations under our existing assumed reinsurance contracts and will receive earned premiums and be subject to continuing exposure to losses until our in-force assumed reinsurance contracts expire. The results of the Reinsurance segment will continue to be included in the results of continuing operations.

Investments Segment

Investment income and net realized gains are discussed in the “Investments” section following.

Parent Segment

The parent segment loss reflects the holding company activities of Zenith National. Parent segment losses before tax for the three and nine months ended September 30, 2005 and 2004 were as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
(Dollars in thousands)	2005			2004			2005		2004
Interest expense		$	1,997		$	3,295	$	7,323	$	9,762
Parent expenses		1,907			1,415		10,248		4,338
Loss from operations		$	3,904		$	4,710	$	17,571	$	14,100

Parent expenses in the nine months ended September 30, 2005 include $4.7 million related to the conversion of the Convertible Notes in April and July 2005 (see Note 5 to the Consolidated Financial Statements).

Interest expense on the Convertible Notes after tax is added back to net income in the computation of diluted earnings per share (see Note 3 to the Consolidated Financial Statements).

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

Equity Investee—Advent Capital

Zenith’s share of Advent Capital net income included in our Consolidated Statements of Operations was as follows:

	Three Months Ended September 30,					Nine Months Ended September 30,
(Dollars in thousands)	2005		2004			2005			2004
Zenith’s share of Advent Capital’s net income, after tax		none		$	1,234		$	794		$	4,000

Our share of Advent Capital net income for the nine months ended September 30, 2005 includes losses of $1.5 million after tax for our share of adverse loss development for the 2004 Florida hurricanes recognized by Advent Capital.

Zenith owns 22.1 million shares of Advent Capital common stock. On June 3, 2005, Advent Capital sold 114.3 million shares of its common stock in a public offering at the United States dollar equivalent of $0.64 per share. On the same date, Advent Capital common stock was listed for trading on the Alternative Investments Market of the London Stock Exchange (“AIM”). Prior to Advent Capital’s listing on the AIM, there was no public market for such shares. Prior to the public offering, Zenith owned approximately 20.9% of the outstanding shares of Advent Capital and recorded its investment in Advent Capital under the equity method of accounting. Under the equity method, we recognized our share of the earnings or losses of Advent Capital on a one-quarter lag to allow sufficient time for Advent Capital to prepare its financial statements. After the sale of additional shares of common stock by Advent Capital, Zenith owns 10.0% of the outstanding shares of Advent Capital and accounts for its investment in Advent Capital under the cost method and reports this investment in the Consolidated Balance Sheet at fair value.

To reflect the new, publicly traded price of Advent Capital, Zenith reduced the carrying value of this investment to its fair value resulting in a charge of $9.5 million before tax ($6.2 million after tax) in the second quarter of 2005 as a reduction of realized gains on investments. The charge resulted from the difference between the fair value of our investment in Advent Capital, based upon the offering price for Advent Capital’s common stock, and the carrying value of the investment under the equity method as of the date of the public offering. The carrying value under the equity method as of the date of the public offering includes our share of Advent Capital’s loss for the first quarter of 2005, the most recent period for which such financial information was available. We were unable to estimate our share of Advent Capital’s earnings or losses for the period between the end of the first quarter of 2005 and the date of the public offering. However, the amount of any such share would have no impact on our consolidated net income in the second quarter of 2005 because the charge required to reduce our investment in Advent Capital to its fair value would have increased or decreased by the amount of any such share of earnings or losses recorded under the equity method of accounting.

At September, 30, 2005, our investment in Advent Capital is included in equity securities classified as “available for sale.” The fair value of the investment is the publicly traded price for Advent Capital’s common stock obtained from the AIM reflected in U.S. dollars. Changes in the fair value of the investment since the date of the public offering are recorded as a component of other comprehensive income. We do not presently intend to sell any of our shares of Advent Capital common stock.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

In each of the second quarters of 2005 and 2004, Zenith received a dividend payment from Advent Capital of $1.1 million.

Discontinued Real Estate Segment

Loss Reserves

Accounting for the workers’ compensation and reinsurance segments requires us to estimate the liability for the expected ultimate cost of unpaid losses and loss adjustment expenses (“loss reserves”) as of the balance sheet date. Loss reserves are estimates and are inherently uncertain; they do not and cannot represent an exact measure of liability. Accordingly, our loss reserves may prove to be inadequate to cover our actual losses or they may prove to exceed the ultimate amount of our actual losses. The amount by which estimated losses, measured subsequently by the reference to payments and additional estimates, differ from those originally reported for a period is known as “development.” Development is unfavorable when losses ultimately settle for more than the levels at which they were reserved or subsequent estimates indicate a basis for reserve increases on open claims. Development is favorable when losses ultimately settle for less than the amount reserved or subsequent estimates indicate a basis for reducing loss reserves on open claims. Favorable or unfavorable developments of loss reserves are reflected in our Consolidated Statements of Operations in the period the changes are made.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

Actuarial techniques and methods are utilized to establish the most reasonably accurate estimate of loss reserves and we perform a comprehensive review of our loss reserves at the end of every quarter. Our loss reserves were as follows:

(Dollars in millions)	September 30, 2005			December 31, 2004
Workers’ compensation segment:
Unpaid loss and loss adjustment expenses		$	1,487		$	1,344
Less: Receivable from reinsurers and state trust funds for unpaid losses		239			270
Unpaid loss and loss adjustment expenses, net of reinsurance		$	1,248		$	1,074
Reinsurance segment:
Unpaid losses and loss adjustment expenses		$	181		$	138
Less: Receivable from reinsurers for unpaid losses
Unpaid losses and loss adjustment expenses, net of reinsurance		$	181		$	138
Total:
Unpaid loss and loss adjustment expenses		$	1,668		$	1,482
Less: Receivable from reinsurers and state trust funds for unpaid losses		239			270
Unpaid loss and loss adjustment expenses, net of reinsurance		$	1,429		$	1,212

When losses are reported to us, we establish, individually, estimates of the ultimate cost of the claims, known as “case reserves.” These case reserves are continually monitored and revised in response to new information and for amounts paid. Our actuaries use this information about reported claims in some of their estimation techniques. In estimating our total loss reserves, we make provision for two types of loss development. At the end of any calendar period, there are a number of claims that have not yet been reported but will arise out of accidents that have already occurred. These are referred to in the insurance industry as IBNR claims. In addition to this provision for later reported claims, we also have to estimate the extent to which the case reserves on known claims may also develop. These types of reserves are referred to in the insurance industry as bulk reserves. Our actuarial estimation techniques for estimating our loss reserves make provision for both IBNR and bulk reserves in total, but not separately. We are required to file exhibits with state insurance departments which reflect the amount which is the sum of our IBNR and bulk reserves.

At September 30, 2005 and December 31, 2004, IBNR and bulk reserves included in unpaid loss and loss adjustment expenses, net of reinsurance, were as follows:

(Dollars in millions)	September 30, 2005			December 31, 2004
Workers’ compensation		$	374		$	267
Reinsurance		83			41
Total IBNR and bulk reserves		$	457		$	308

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

The principal uncertainty in our workers’ compensation loss reserve estimates at this time is caused by the trend of increasing severity in the years prior to 2002 compared to the severity trend in more recent years. Severity is the average cost of a claim. The increasing severity trend, or inflation rate, is attributable to changes in medical costs (payments to providers to treat injured workers) and indemnity payments (payments to injured workers for lost wages) per claim. We have observed a favorable change in the inflationary trend in the amounts we have paid for claims in recent accident years compared to payments for 2001 and prior, but there is uncertainty as to whether the recent lower inflation data will be sustained over the long-term.

Our actuaries produce a point estimate using the results of various methods of estimation. However, these various methods do not produce separate point estimates. The point estimate is prepared as follows: our actuaries prepare reserve estimates based upon paid loss patterns, incurred loss patterns and claim count methods for all accident years. The actuarial point estimate is based on a selection of the results of these various methods depending upon both the age of the accident year and the geographic state of the injury. For more mature accident years, all of the methods produce very similar loss estimates and our actuarial point selections are based upon incurred methods. For the more recent accident years, with respect to a substantial portion of our actuarial estimate, the estimate is based on both the paid loss patterns and assumed rates of claim inflation. Since the number of claims is relatively certain, the inflation assumption is the key assumption in establishing loss reserve estimates for these recent accident years. Management establishes loss reserve estimates in the financial statements that provide for fluctuating rates of inflation dependent on the most current data. The loss reserve estimates recorded in the financial statements were higher than the actuarial point estimates by approximately $64 million and $41 million at September 30, 2005 and June 30, 2005, respectively. We believe that these differences are not significant in the context of the amounts being estimated.

When we estimate our loss reserves, we do so in the aggregate for all years, and then allocate them to each accident year. This allows us to look at the year-over-year change in claim severity, or inflation - our most important concept for understanding adequate loss reserve estimates. By allocating loss reserves to individual accident years, we produce an implied rate of inflation for each year. Any changes in our assumptions about inflation rates will cause a change in our loss reserve estimates, although our view of the adequacy of the total loss reserve estimate may be unchanged if the effect of the change in the inflation assumptions has the effect of reallocating the loss reserve estimate among accident years.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

At September 30, 2005, the workers’ compensation accident year paid loss inflation rates in our paid loss data and the assumptions of accident year inflation rates in our estimates of ultimate losses and loss reserves were as follows:

	Estimated
(Dollars in	Ultimate			Average Paid Loss per Claim Annual														Assumed Inflation in Ultimate Loss
thousands)	Losses(A)			Inflation Evaluated After (number of months)														Estimate
Accident																		Sept. 30,			June 30,			March 31,			Dec. 31,
year				21		33		45		57		69		81		93		2005			2005			2005			2004
1998		$	218,472	8	%	10	%	9	%	9	%	11	%	12	%	13	%		14	%		15	%		15	%		13	%
1999		220,234		16		14		14		15		15		16					16			16			16			16
2000		242,742		9		11		13		13		14							15			15			15			15
2001		316,289		16		16		15		15									17			17			17			18
2002		333,734		2		3		4											8			8			8			6
2003		362,864		3		(1	)												8			10			10			16
2004		412,873		(10	)														7			9			9			13
2005		392,726																	6			6			7

(A) Estimated ultimate losses for an accident year represent the estimated aggregate amount we expect to pay for all claims reported for that year for losses and allocated loss adjustment expenses. Loss reserves are the liability for the unpaid portion of ultimate losses, computed by subtracting the amount paid from the ultimate loss estimate as of the balance sheet date.

Our inflation assumptions at September 30, 2005 were more favorable than at June 30, 2005 due to a reduction in average paid inflation in the third quarter. The 2004 and 2003 accident year paid inflation declined two percentage points in each year in the third quarter and we made corresponding changes in the estimated inflation rate in the reserves. As a result, favorable development of $19.7 million was reflected in the third quarter for the 2004 and 2003 accident years of which $11.6 million was reallocated to increase reserves for old accident years.

The net decrease in loss reserves during the three and nine months ended September 30, 2005 for accident years 2004 and prior was $8.1 million and $13.0 million, respectively. The total favorable development of $13.0 million in the nine months ended September 30, 2005 was 1.2% of our estimated workers’ compensation net loss reserves at December 31, 2004. As a percentage of workers’ compensation net premiums earned in the first nine months of 2005, the favorable development of our workers’ compensation loss reserves was 1.6%.

In the prior year, our inflation assumptions at September 30, 2004 resulted in a reallocation of loss reserve estimates by accident year primarily from 2004 and 2003 to older accident years prior to 1998. The net increase in workers’ compensation loss reserves for the nine months ended September 30, 2004 was approximately $20.0 million. The adverse development of $20.0 million in the first nine months of 2004 was 2.3% of estimated workers’ compensation net loss reserves at December 31, 2003. As a percentage of workers’ compensation net premiums earned in the first nine months of 2004, the adverse development of our workers’ compensation loss reserves was 3.0%.

Different assumptions about the inflation rates would change our workers’ compensation loss reserve estimates. A change in the assumed inflation rate for any particular accident year would change our estimate of ultimate losses for that accident year by an amount equal to the change in the inflation rate multiplied by the estimated ultimate loss for that year. Such a change in the inflation rate for a particular accident year would also change the estimated ultimate loss for each subsequent accident year. For example, if the average annual inflation rate for each of the accident years 2001 through 2005 were

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

decreased by one percentage point in each year, our loss reserve estimates at September 30, 2005 would decrease by about $51.1 million as illustrated in the table that follows:

(Dollars in thousands)	Assumption Currently Used							Revised Assumption
				(a)		(b)					(c)	*[(c)/(a)](b)**
	Assumed			Cumulative		Estimated		Assumed			Cumulative	Estimated
	Inflation			Inflation		Ultimate		Inflation			Inflation	Ultimate
Accident Year	Rate			Factor		Losses		Rate			Factor	Losses
2001		17	%		1.170	$	316,289		16	%	1.160	$	313,586
2002		8	%		1.264	333,734			7	%	1.241	327,661
2003		8	%		1.365	362,864			7	%	1.328	353,028
2004		7	%		1.460	412,873			6	%	1.408	398,168
2005		6	%		1.548	392,726			5	%	1.478	374,967
						$	1,818,486					$	1,767,410
											Decrease	$	51,076

The reform legislation of 2003 and 2004 in California introduced, among other changes, guidelines for medical treatment, medical networks, an objective permanent disability rating schedule, the elimination of the vocational rehabilitation benefit and the requirement to apportion disabilities between occupational and non-occupational disabilities. These changes have resulted in short-term cost savings and may reduce the long-term trend of increasing costs of California claims and the ultimate inflation rate.

The WCIRB recently published its most current estimate of California workers’ compensation loss experience. Their analysis contains some specific anticipated savings from the reforms and also relies significantly on the most current paid loss trends. Based upon these assumptions, they estimate that an indemnity claim in 2004 will cost 8% less than in the pre-reform year of 2002. They believe that the 2004 accident year loss reserves for the California workers’ compensation industry may be excessive by about $3.1 billion but they have also concluded that the aggregate of loss reserves for all accident years are deficient by $2.0 billion.

We believe our loss reserve estimates are adequate. However, the actual ultimate inflation rate will not be known with any certainty for several years. We assume that general healthcare inflation trends will continue and will impact our long term claim costs and reserves. We will evaluate our best estimate of inflation rates and reserves every quarter to reflect the most current data.

Claims involving permanent disability comprise 20% of the number of claims in California but contribute nearly 90% of our total California costs. As of September 30, 2005, we have settled only 29% of our 2003 permanent disability cases and 9% of our 2004 permanent disability cases. This sample is too small for us to conclude at this time that the recent decline in the short-term inflation rate will offset the long-term inflation in workers’ compensation health care costs which have historically exceeded general health care costs. As a result, we have established current claim reserves based on our best estimate that inflation rates will be higher than predicted by the WCIRB and higher than observed thus far for 2002 - 2005, but lower than the actual inflation rates observed during 1998 - 2001.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

Investments

The investment portfolio increased during the first nine months of 2005 principally as a result of favorable net cash flow from operations.

Investment income in the three and nine months ended September 30, 2005 was higher than the corresponding periods in 2004 because of the increase in the investment portfolio and higher short-term interest rates in 2005. The average annual yields on the investment portfolio in the three and nine months ended September 30, 2005 and 2004 were as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2005			2004			2005			2004
Before tax(1)		4.0	%		3.6	%		3.8	%		3.7	%
After tax		2.6	%		2.4	%		2.5	%		2.4	%

(1) Reflects the pre-tax equivalent yield on tax-exempt securities.

Realized gains from investments in the nine months ended September 30, 2005 were higher than the comparable period in 2004 due to net capital gains partially offset by a $9.5 million before tax charge in the second quarter related to our investment in the common stock of Advent Capital.

At September 30, 2005, our investment portfolio was comprised of 78% fixed maturity securities, 17% short-term investments, 4% equity securities and less than 1% other investments. At December 31, 2004, our investment portfolio was comprised of 66% fixed maturity securities, 26% short-term investments, 6% equity securities and 2% other investments including mortgage loans and our investment in Advent Capital. Fixed maturity securities include primarily corporate bonds, U.S. Treasury Notes, municipal bonds and mortgage-backed securities issued by the Government National Mortgage Association. Of the fixed maturity portfolio, including short-term investments, 95% were rated investment grade at September 30, 2005 and December 31, 2004. The average maturity of the fixed maturity portfolio, including short-term investments, was 4.2 years and 4.6 years at September 30, 2005 and December 31, 2004, respectively.

At September 30, 2005 and December 31, 2004, 94% and 92%, respectively, of the investments in fixed maturity securities and short-term investments were classified as available-for-sale securities. Stockholders’ equity will fluctuate with changes in the fair values of available-for-sale securities. Stockholders’ equity decreased by $12.3 million after deferred tax from December 31, 2004 to September 30, 2005 as a result of changes in the fair values of fixed maturity investments classified as available-for-sale.

The unrealized net gain on held-to-maturity and available-for-sale fixed maturity investments were as follows:

	Held-to-Maturity			Available-for-Sale
(Dollars in thousands)	Before Tax			Before Tax			After Tax
September 30, 2005		$	327		$	377	$	245
December 31, 2004		2,568			19,322		12,559

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

We monitor our portfolio continuously and actively manage our investments to preserve principal values whenever possible. When, in the opinion of management, a decline in the fair value of an investment is considered to be other-than-temporary, such investment is written-down to its fair value. The amount written-down is recorded in earnings as a realized loss on investments. The determination of other-than-temporary includes, in addition to other relevant factors, a presumption that if the market value is below cost by a significant amount for a period of time, a write-down is necessary.

For the three and nine months ended September 30, 2005 and 2004, write-downs reduced realized gains on investments as follows:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(Dollars in thousands)	2005			2004			2005			2004
Write-downs		$	0		$	0		$	9,547		$	68

The write-down in 2005 was attributable to our investment in Advent Capital (see Note 6 to the Consolidated Financial Statements and the foregoing discussion under “Equity Investee—Advent Capital”). The write-down in 2004 was attributable to the impairment of an investment with a cost basis of $0.1 million before the write-down. We continuously assess the prospects for individual securities as part of ongoing portfolio management, including the identification of other-than-temporary declines in fair values. This process includes reviewing the amount and length of time of unrealized losses on investments, historical and projected company financial performance, company-specific news and other developments, the outlook for industry sectors, credit ratings and macro-economic changes, including government policy initiatives. We believe that we have appropriately identified other-than-temporary declines in fair value in the three and nine months ended September 30, 2005 and 2004, and that our remaining unrealized losses at September 30, 2005 are not other-than-temporary. We base this conclusion on our current understanding of the issuers of these securities, as described above, and because we have established a presumption that an unrealized loss of a significant amount for a specific period of time is other-than-temporary. We have consistently applied this presumption for thirteen years. We also have the ability and intent to hold securities with unrealized losses for a sufficient amount of time for them to recover their values or reach maturity.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

Investments that we currently own could be subject to default by the issuer or could suffer declines in value that become other-than-temporary. The table below sets forth information about unrealized gains and losses in our investment portfolio at September 30, 2005:

	Securities with
(Dollars in thousands)	Unrealized losses			Unrealized gains
Fixed maturity securities:
Fair value	$	1,195,648			$	465,482
Amortized cost	1,208,207				452,219
Unrealized (loss) gain	(12,559		)		13,263
Fair value as a percentage of amortized cost	99.0		%		102.9		%
Number of security positions held	135				163
Concentration of unrealized (losses) or gains by type or industry:
U.S. Treasury Notes	$	(3,943	)		$	12
Hotels	(1,138		)
Municipal bonds	(1,912		)		406
Insurance companies	(727		)		4,234
Personal goods	(540		)		631
Pharmaceuticals	(538		)		210
Machinery	(435		)		921
Petroleum refining	(431		)		558
Financial institutions	(379		)		336
Food & beverage	(333		)		583
Utilities	(245		)		20
Communications	(226		)		644
Other	(1,712		)		4,708
Total	$	(12,559	)		$	13,263
Investment grade:
Fair value	$	1,137,437			$	427,273
Amortized cost	1,148,739				417,092
Fair value as a percentage of amortized cost	99.0		%		102.4		%
Non-investment grade:
Fair value	$	58,211			$	38,209
Amortized cost	59,468				35,127
Fair value as a percentage of amortized cost	97.9		%		108.8		%
Equity securities:
Fair value	$	48,625			$	28,409
Cost	54,904				18,577
Unrealized (loss) gain	(6,279		)		9,832
Fair value as a percentage of cost	88.6		%		152.9		%
Number of security positions held	10				17

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

The table below sets forth the fair value of fixed maturity securities at September 30, 2005, based on their expected maturities:

	Securities with
(Dollars in thousands)	Unrealized losses		Unrealized gains
1 year or less	$	14,036		$	33,638
After 1 year through 5 years	787,368			142,821
After 5 years through 10 years	384,227			182,656
After 10 years	10,017			106,367
	$	1,195,648		$	465,482

The table below sets forth information about fixed maturity securities and equity securities with unrealized losses at September 30, 2005:

(Dollars in thousands)	Fair value		Unrealized loss				Fair value as a percentage of cost basis
Fixed maturity securities with unrealized losses:
Individually exceeding $0.1 million at September 30, 2005 and for:
Less than 3 months (17 issues)	$	255,282		$	(2,999	)		98.8	%
3-6 months (1 issue)	113,742			(949		)		99.2	%
6-12 months (9 issues)	246,318			(3,283		)		98.7	%
Greater than 12 months (8 issues)	31,761			(1,488		)		95.5	%
Less than $0.1 million at September 30, 2005 (100 issues)	548,545			(3,840		)		99.3	%
Total	$	1,195,648		$	(12,559	)		99.0	%
Equity securities with unrealized losses:
Individually exceeding $0.1 million at September 30, 2005 and for:
Less than 3 months (3 issues)	$	15,344		$	(3,007	)		83.6	%
3-6 months (3 issues)	7,238			(1,012		)		87.7	%
6-12 months (1 issue)	24,270			(2,135		)		91.9	%
Less than $0.1 million at September 30, 2005 (3 issues)	1,773			(125		)		93.4	%
Total	$	48,625		$	(6,279	)		88.6	%

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

The following is a summary of securities sold at a loss in the three and nine months ended September 30, 2005:

(Dollars in thousands)	Three Months Ended September 30, 2005				Nine Months Ended September 30, 2005
Fixed maturity securities:
Realized losses on sales		$	(1,556	)		$	(5,339	)
Fair value at the date of sale		1,010,807				1,323,951
Number of securities sold		10				21
Losses realized on securities with an unrealized loss preceding the sale for:
Less than 3 months		$	(596	)		$	(1,182	)
3-6 months		(960		)		(2,839		)
6-12 months						(631		)
Greater than 12 months						(687		)
Equity securities:
Realized losses on sales		$	(28	)		$	(1,507	)
Fair value at the date of sale		261				11,572
Number of securities sold		3				11
Losses realized on securities with an unrealized loss preceding the sale for:
Less than 3 months		$	(27	)		$	(483	)
3-6 months		(1		)		(296		)
6-12 months						(728		)

At September 30, 2005, there were no investments in fixed maturity securities or equity securities with individually material unrealized losses. Those securities which we are holding in our portfolio with an unrealized loss were compatible with our current view of appropriate asset allocation and issuer prospects. Any future changes in those assumptions could result in sales at a loss or write-downs of securities.

Terrorism Exposure and the Terrorism Risk Insurance Act of 2002

On July 5, 2005, we received a determination from the U.S. Treasury Department (“Treasury”) that our deductible under the Terrorism Risk Insurance Act of 2002 (the “Act”), which is intended to provide insurers reinsurance protection for losses arising out of certain terrorist acts, is $155.2 million. Prior to the determination, our deductible was approximately $351.1 million. An explanation of the reinsurance protection that may be afforded us by the Act and of the determination by Treasury follows.

Under our workers’ compensation policies, we are required to provide workers’ compensation benefits for losses arising from acts of terrorism.

In November 2002, the Act became effective for the period from November 26, 2002 until December 31, 2005. It is unclear at this time whether or not the Act or a modified version of it will be

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

extended beyond December 31, 2005. The Act may provide us with reinsurance protection for losses arising out of terrorist acts under certain circumstances and subject to certain limitations. The Treasury Secretary must certify an act for it to constitute an act of terrorism. The definition of terrorism excludes domestic acts of terrorism or acts of terrorism committed in the course of a war declared by U.S. Congress. Losses arising from an act of terrorism must exceed $5.0 million to qualify for reimbursement. If an event is certified, the U.S. Federal Government will reimburse losses not to exceed $100.0 billion in any year. Each insurance company is responsible for a deductible based on a percentage of its direct earned premiums in the previous calendar year. For losses in excess of the deductible, the U.S. Federal Government will reimburse 90% of the insurer’s loss, up to the insurer’s proportionate share of the $100.0 billion.

The Act contemplates that affiliated insurers will be treated collectively as one entity by Treasury for purposes of calculating direct earned premiums and, therefore, an insurer’s deductible. Prior to July 2004, companies controlled by Fairfax Financial Holdings Limited (“Fairfax”), a Toronto based financial services holding company, owned approximately 41% of our outstanding common stock. The 41% did not include shares issuable upon conversion of our Convertible Notes held by affiliates of Fairfax. Because of Fairfax’s ownership, we were required (based on an earlier Treasury determination) to combine the U.S. direct earned premiums of the insurers controlled by Fairfax (the “Fairfax direct earned premiums”) with our direct earned premiums to calculate our deductible under the Act. Including the Fairfax direct earned premiums with ours, our deductible for 2005 would have been approximately $351.1 million. However, as a result of the sale of 3.1 million shares of our common stock by subsidiaries of Fairfax in July 2004, Fairfax’s percentage ownership of our outstanding common stock (not including shares issuable upon conversion of the Convertible Notes held by affiliates of Fairfax) declined to 24%. We then sought another determination from Treasury whether the Fairfax direct earned premiums would continue to be required to be combined with our direct earned premiums in calculating our deductible under the Act. After we requested the determination, Fairfax’s percentage ownership of our outstanding common stock (not including shares issuable upon conversion of the Convertible Notes held by affiliates of Fairfax) declined further due to our issuance of additional shares of common stock, and, as of June 28, 2005, it was approximately 20.6%. On July 5, 2005, Treasury determined that the Fairfax direct earned premiums are no longer required to be combined with our direct earned premiums, and accordingly, our deductible in 2005 is $155.2 million. At September 30, 2005, Fairfax had reduced its ownership of our common stock to 11.9% and no longer owns any of our Convertible Notes.

In our workers’ compensation business, we monitor the geographical concentrations of insured employees to help mitigate the risk of loss from terrorist acts. Also, small businesses constitute a large proportion of our policies, and we avoid risks in high profile locations. For 2005 we have purchased reinsurance for acts of terrorism. The limit for domestic acts of terrorism is $150.0 million, in excess of a $1.0 million retention; and, the limit for foreign acts of terrorism is $75.0 million, in excess of a $1.0 million retention. Both of these coverages exclude nuclear, biological and chemical attacks for losses in excess of $10.0 million.

In our reinsurance business, any terrorism exposure we have assumed is subject to our underwriting guidelines not to write business that could expose us to losses from a single event of greater than about $25 million after deducting the benefit of applicable premium and reinstatement premium income and income tax.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

Notwithstanding the protection provided by the reinsurance we have purchased and any protection provided by the Act, the risk of severe losses to us from acts of terrorism has not been eliminated because events may not be covered by, or may exceed the capacity of, our reinsurance protection. The impact of any terrorist act is unpredictable, and the ultimate impact on us will depend upon the nature, extent, location and timing of such an act. Any such impact on us could have a material adverse affect on our business and financial condition.

Liquidity and Capital Resources

Zenith’s insurance subsidiaries generally create liquidity because insurance premiums are collected prior to disbursements for claims which may take place many years after the collection of premiums. Collected premiums may be invested, prior to their use in such disbursements, and investment income provides additional cash receipts. In periods in which disbursements for claims and benefits, current policy acquisition costs and current operating and other expenses exceed operating cash receipts, cash flow is negative. Such negative cash flow is offset by cash flow from investments, principally from short-term investments and maturities of longer-term investments. The exact timing of the payment of claims cannot be predicted with certainty. The insurance subsidiaries maintain portfolios of invested assets with varying maturities and a substantial amount of short-term investments to provide adequate cash for the payment of claims. At September 30, 2005 and December 31, 2004, short-term investments and fixed maturity investments maturing within two years owned by the insurance subsidiaries amounted to $1,065.3 million and $870.6 million, respectively. These securities, in conjunction with our positive net cash flow from operations, provide adequate sources of liquidity for the expected payment of our loss reserves in the near future. We do not expect to sell securities or use our credit facilities to pay our policy liabilities as they come due. The current trend of favorable net cash flow from operations is attributable to our workers’ compensation segment, and the trend of favorable net cash flow from operations is expected to continue through 2005.

Zenith National requires cash to pay any dividends declared to its stockholders, make interest and principal payments on its outstanding debt obligations, fund its operating expenses, and, from time to time, to make capital contributions to Zenith Insurance. Such cash requirements are generally funded in the long-run by dividends received from Zenith Insurance and financing or refinancing activities by Zenith National. Cash, short-term investments and other marketable investments in Zenith National were $56.6 million and $63.9 million at September 30, 2005 and December 31, 2004, respectively. The decrease is due to the payment of dividends to stockholders, interest payments on outstanding debt and the acquisition of treasury shares in connection with two stock option exercises, partially offset by receipt of a dividend of $20.0 million from Zenith Insurance in the second quarter of 2005. Zenith National’s available invested assets and other sources of liquidity are currently expected to be sufficient to meet its requirements for liquidity in the short and long-term.

Zenith National’s insurance subsidiaries are subject to insurance regulations which restrict their ability to distribute dividends. In 2005, Zenith Insurance will be able to pay up to $91.5 million of dividends to Zenith National without prior approval of the California Department of Insurance, including the dividend of $20.0 million paid to Zenith National in the second quarter of 2005. No dividends were paid to Zenith National in the first nine months of 2004. The restrictions on the payment of dividends have not had, and under current regulations are not expected to have, a material adverse impact on the ability of Zenith Insurance to pay dividends.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

Zenith’s Convertible Notes are convertible at each holder’s option into shares of Zenith National’s common stock under certain circumstances including if the price of Zenith National’s common stock reaches specified thresholds. Each holder of the Convertible Notes has the right to convert his Convertible Notes into Zenith National’s common stock at a conversion rate of 59.988 shares (post 3-for-2 stock split) per $1,000 principal amount of Convertible Notes during the period beginning on October 1, 2005 and ending on December 31, 2005. Whether the Convertible Notes will be convertible after December 31, 2005 will depend upon the occurrence of the events specified in the Indenture governing the Convertible Notes, including the sale price of Zenith National’s common stock. At September 30, 2005, the maximum number of shares that could be required to be issued upon conversion of all outstanding Convertible Notes is approximately 2.6 million (post 3-for-2 stock split).

In the nine months ended September 30, 2005, holders of the Convertible Notes converted $81.2 million aggregate principal amount into 3.2 million shares (pre 3-for-2 stock split) of Zenith National’s common stock (see Note 5 to the Consolidated Financial Statements). In October 2005, a further $30.2 million aggregate principal amount of the Convertible Notes were converted into 1.8 million shares of Zenith National’s common stock (including the 3-for-2 stock split shares).

In March 2004, Zenith National paid $7.6 million to repurchase $8.0 million aggregate liquidation amount of the outstanding Redeemable Securities. Zenith National used its available cash balances to fund this purchase.

At September 30, 2005, Zenith National had an unsecured line of credit in the amount of $30.0 million which expires on October 31, 2007. Zenith National did not renew another one year revolving line of credit in the amount of $20.0 million which expired on August 1, 2005 because Zenith National’s current cash, investments and other sources of liquidity are sufficient for any foreseeable requirements at this time. There were no amounts drawn under these lines of credit in 2005 or 2004.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires both the use of estimates and judgment relative to the application of appropriate accounting policies. Zenith’s accounting policies are described in the Notes to Consolidated Financial Statements in Zenith’s Annual Report on Form 10-K for the year ended December 31, 2004 (“2004 Form 10-K”). We believe that certain matters related to accounting policies and estimates in the areas of loss reserve estimation, investment write-downs, deferred policy acquisition costs and deferred income taxes are particularly important to an understanding of Zenith’s Consolidated Financial Statements. These matters are discussed under “Critical Accounting Policies and Estimates” in the Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations in Zenith’s 2004 Form 10-K.

Contractual Obligations and Contingent Liabilities

All of Zenith’s outstanding financing obligations are included in the Consolidated Financial Statements and the accompanying Notes. There are no liquidity or financing arrangements with unconsolidated entities or any off-balance sheet arrangements. Zenith National’s available invested assets and other sources of liquidity are currently expected to be sufficient to meet its requirements for liquidity in the short and long-term.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations (Continued)

The table below sets forth the amounts of Zenith’s contractual obligations, including interest payable, at September 30, 2005:

	Payments due by period
(Dollars in thousands)	Less than 1 year		1-3 years		3-5 years		More than 5 years		Total
Convertible notes	$	43,800							$	43,800
Redeemable securities	5,045		$	10,090	$	10,090	$	149,798	175,023
Operating lease commitments	7,531		13,249		5,975		1,023		27,778
Loss reserves	382,689		424,382		201,572		658,891		1,667,534
Total	$	439,065	$	447,721	$	217,637	$	809,712	$	1,914,135

Our loss reserves do not have contractual maturity dates and the exact timing of the payment of claims cannot be predicted with certainty. However, based upon historical payment patterns, we have included in the preceding table an estimate of when we expect our loss reserves (without the benefit of any reinsurance recoveries) to be paid. We maintain a portfolio of investments with varying maturities and a substantial amount of short-term investments to provide adequate cash for the payment of claims. We do not expect to have to sell securities or use our credit facilities to pay claims.

Our contractual obligations under the outstanding Redeemable Securities are comprised of $116.0 million of interest payments over the next 23 years and $59.0 million of principal payable in 2028. Our contractual obligations under the outstanding Convertible Notes are comprised of $43.8 million of principal that may be due in the fourth quarter of 2005 because the holders of the Convertible Notes currently have the right to convert their notes into our common stock during the fourth quarter of 2005 as a result of the triggering of the contingent conversion condition relative to Zenith National’s common stock price at the end of the third quarter of 2005. In October 2005, holders of the Convertible Notes converted $30.2 million aggregate principal amount of the Convertible Notes in accordance with the Indenture governing the Convertible Notes. Upon such conversion, the holders received a total of 1.8 million shares of Zenith National’s common stock (including the 3-for-2 stock split shares) in accordance with the terms of the Indenture.

If the remaining Convertible Notes are not converted or redeemed prior to the scheduled maturity in 2023, the total interest obligation over the remaining term would be $13.7 million. In addition, Zenith may be required to pay contingent interest during any nine-month period commencing with the nine-month period beginning September 30, 2008 if the average market price of a Convertible Note for the five trading days ending on the second trading day immediately preceding the relevant nine-month period equals 120% or more of the principal amount of the Convertible Notes.

Zenith’s commitments and contingencies are discussed in Note 8 to the Consolidated Financial Statements. Accrued guarantee fund assessments would be payable within approximately one year, if they are ultimately assessed. We cannot currently predict the timing or the outcome of the contingencies surrounding reinsurance recoverable from Reliance Insurance Company or the contingencies surrounding recoveries from the Florida Special Disability Trust Fund.

In addition to the foregoing commitments and contingencies, we have issued letters of credit in the amount of $8.0 million in favor of a Lloyd’s of London syndicate that we reinsure to secure losses payable to the syndicate and a $5.0 million guarantee in connection with a construction loan to our Sarasota real estate joint venture.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The fair value of the fixed maturity investment portfolio is exposed to interest rate risk—the risk of loss in fair value resulting from changes in prevailing market rates of interest for similar financial instruments. However, Zenith has the ability to hold fixed maturity investments to maturity. Zenith relies on the experience and judgment of senior management to monitor and mitigate the effects of market risk. Zenith does not utilize financial instrument hedges or derivative financial instruments to manage risks, nor does it enter into any swap, forward or option contracts, but will attempt to mitigate its exposure through active portfolio management. The allocation among various types of securities is adjusted from time to time based on market conditions, credit conditions, tax policy, fluctuations in interest rates and other factors. In addition, Zenith places the majority of its investments in high-quality, liquid securities and limits the amount of credit exposure to any one issuer.

The table below provides information about Zenith’s financial instruments for which fair values are subject to changes in interest rates. For fixed maturity investments, the table presents fair values of investments held and weighted average interest rates on such investments by expected maturity dates. Such investments include corporate bonds, municipal bonds, government bonds, redeemable preferred stock, and mortgage-backed securities. For Zenith’s debt obligations, the table presents principal cash flows by expected maturity dates (including interest).

	Expected Maturity Date
(Dollars in thousands)	2005			2006			2007			2008			2009			Thereafter				Total
As of September 30, 2005
Investments:
Held-to-maturity and available-for-sale securities:
Fixed rate	$	16,012		$	148,027		$	604,254		$	70,320		$	89,435			$	733,082		$	1,661,130
Weighted average interest rate	4.3		%	4.3		%	4.2		%	4.7		%	4.5		%		5.2		%	4.6		%
Short-term investments	$	366,337																		$	366,337
Debt and interest obligations of Zenith:
Convertible notes payable(1)	43,800																			43,800
Redeemable securities				$	5,045		$	5,045		$	5,045		$	5,045			$	154,843		175,023
As of December 31, 2004
Investments:
Held-to-maturity and available-for-sale securities:
Fixed rate	$	162,800		$	246,370		$	89,326		$	79,488		$	85,544			$	588,075		$	1,251,603
Weighted average interest rate	2.8		%	3.1		%	3.5		%	3.9		%	3.8		%		5.0		%	4.1		%
Short-term investments	$	492,126																		$	492,126
Debt and interest obligations of Zenith:
Convertible notes payable(1)	128,589																			128,589
Redeemable securities	5,045			$	5,045		$	5,045		$	5,045		$	5,045			$	154,843		180,068

(1) The Convertible Notes are shown with an expected maturity date in 2005 because the holders have the right to convert their notes into our common stock during the fourth quarter of 2005 and had the same right in the first quarter of 2005 (see discussion of the Convertible Notes under “Liquidity and Capital Resources” and “Contractual Obligations and Contingent Liabilities” in “Item 2. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations”).

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures.

Zenith’s management, with the participation of Zenith’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of Zenith’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, Zenith’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, Zenith’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by Zenith in the reports that it files or submits under the Exchange Act and are effective in ensuring that information required to be disclosed by Zenith in the reports that it files or submits under the Exchange Act is accumulated and communicated to Zenith’s management, including Zenith’s 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 Zenith’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, Zenith’s internal control over financial reporting.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

PART II. OTHER INFORMATION

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

(c) The following sets out the purchase made by Zenith National of its common stock during the quarter ended September 30, 2005 (number of shares and per share amounts shown below have not been restated for the 3-for-2 stock split declared September 7, 2005):

Period	(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
07/01/05-07/31/05								929,019
08/01/05-08/31/05								929,019
09/01/05-09/30/05		65,614		$	64.32			929,019

In September 2005, a Zenith employee exercised his option to purchase from Zenith National 178,638 shares of Zenith National’s common stock at the exercise price of $23.63 per share, resulting in an aggregate exercise price of $4.2 million. In lieu of cash payment, 65,614 shares of Zenith National’s common stock valued at $4.2 million previously acquired by the employee were tendered to, and accepted by, Zenith in payment of the aggregate exercise price. The exercise of the stock options had no net effect on stockholders’ equity in 2005 because the increase in treasury stock of $4.2 million for the shares tendered was offset by an increase in common stock of $0.2 million and an increase in additional paid-in capital of $4.0 million for the 178,638 shares issued. Also, in lieu of cash payment for the employee’s income tax withholding related to the income from the exercise of the stock options, 51,787 shares of Zenith National’s common stock valued at $3.3 million were withheld by Zenith National from the 178,638 shares to be issued for the option exercise. The effect of withholding shares to pay the income tax was an increase in treasury stock of $3.3 million and a decrease in cash of $3.3 million in the third quarter of 2005.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

Item 6. Exhibits

3.1		Certificate of Incorporation of Zenith National Insurance Corp., dated May 28, 1971. (Incorporated herein by reference to Exhibit 3.1 to Zenith’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.)
3.2		Certificate of Amendment of Certificate of Incorporation of Zenith National Insurance Corp., dated September 12, 1977. (Incorporated herein by reference to Exhibit 3.2 to Zenith’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.)
3.3		Certificate of Amendment of Certificate of Incorporation of Zenith National Insurance Corp., dated May 31, 1979. (Incorporated herein by reference to Exhibit 3.3 to Zenith’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.)
3.4		Certificate of Amendment of Certificate of Incorporation of Zenith National Insurance Corp., dated September 6, 1983. (Incorporated herein by reference to Exhibit 3.4 to Zenith’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.)
3.5		Certificate of Designation of Zenith National Insurance Corp., dated September 10, 1985. (Incorporated herein by reference to Exhibit 3.5 to Zenith’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.)
3.6		Certificate of Amendment of Certificate of Incorporation of Zenith National Insurance Corp., dated November 22, 1985. (Incorporated herein by reference to Exhibit 3.6 to Zenith’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.)
3.7		Certificate of Amendment of Certificate of Incorporation of Zenith National Insurance Corp., dated May 19, 1987. (Incorporated herein by reference to Exhibit 3.7 to Zenith’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.)
3.8		Certificate of Change of Address of Registered Office and of Registered Agent of Zenith National Insurance Corp., dated October 10, 1989. (Incorporated herein by reference to Exhibit 3.8 to Zenith’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.)
3.9		By-laws of Zenith National Insurance Corp., as currently in effect. (Incorporated herein by reference to Exhibit 3.9 to Zenith’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002.)
10.1		Amendment No. 1 to Amended and Restated Reinsurance and Pooling Agreement between Zenith Insurance Company, ZNAT Insurance Company and Zenith Star Insurance Company dated September 15, 2005.
11		Statement re: computation of per share earnings. (Note 3 to Consolidated Financial Statements (Unaudited) included in Item 1 of Part I of this Quarterly Report on Form 10-Q is incorporated herein by reference.)
31.1		Certification of the Chairman of the Board and President pursuant to Exchange Rule 13a-14(a) or Rule 15d-14(a).
31.2		Certification of the CFO pursuant to Exchange Rule 13a-14(a) or Rule 15d-14(a).
32		Certification of the CEO and CFO pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

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, on October 26, 2005.

	ZENITH NATIONAL INSURANCE CORP.
	By:	/s/ STANLEY R. ZAX
		Stanley R. Zax
		Chairman of the Board and President (Principal Executive Officer)
	By:	/s/ WILLIAM J. OWEN
		William J. Owen
		Senior Vice President & Chief Financial Officer
		(Principal Financial and Accounting Officer)

EX-10.1 2 a05-18468_1ex10d1.htm EX-10.1

Exhibit 10.1

AMENDMENT NO. 1

AMENDED AND RESTATED

REINSURANCE AND POOLING AGREEMENT

WHEREAS, Zenith Insurance Company (“Zenith”), ZNAT Insurance Company (“ZNAT”) and Zenith Star Insurance Company (“Zenith Star”) have previously entered into an Amended and Restated Reinsurance and Pooling Agreement, effective April 1, 2005, and;

WHEREAS, effective June 30, 2005 Zenith Star has merged with Zenith, and no longer exists as a corporate entity;

NOW, THEREFORE, Zenith and ZNAT agree as follows:

1. Article V – Proportionate Shares – is deleted and the following substituted therefor:

“V. Proportionate Shares.

The results of underwriting operations will be apportioned cumulatively, without restatement of prior periods. The proportionate shares of the Companies are as follows:

Zenith Insurance Company	98.0	%

ZNAT Insurance Company	2.0	%

The proportionate shares of Zenith and ZNAT may be changed from time to time by mutual consent as of the close of any calendar year quarter. Such changes shall be set forth in an amendment to this Agreement.”

IN WITNESS WHEREOF, each of the undersigned parties has caused this Amendment to be executed on its behalf this 15th day of September, 2005.

	ZENITH INSURANCE COMPANY

/s/ Diane Heidenreich	By:	/s/ Jack D. Miller
Witness – Diane Heidenreich		Jack D. Miller, President

	ZNAT INSURANCE COMPANY

/s/ Diane Heidenreich	By:	/s/ Jack D. Miller
Witness – Diane Heidenreich		Jack D. Miller, President

EX-31.1 3 a05-18468_1ex31d1.htm 302 CERTIFICATION

Exhibit 31.1

CERTIFICATION OF CHAIRMAN OF THE BOARD
AND PRESIDENT PURSUANT TO
EXCHANGE ACT RULE 13a-14(a) OR RULE 15d-14(a)

I, Stanley R. Zax, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Zenith National Insurance Corp.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: October 26, 2005	/s/ STANLEY R. ZAX
	Stanley R. Zax
	Chairman of the Board and President
	Zenith National Insurance Corp.

EX-31.2 4 a05-18468_1ex31d2.htm 302 CERTIFICATION

Exhibit 31.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO
EXCHANGE ACT RULE 13a-14(a) OR RULE 15d-14(a)

I, William J. Owen, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Zenith National Insurance Corp.;

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: October 26, 2005	/s/ WILLIAM J. OWEN
	William J. Owen
	Senior Vice President & Chief Financial Officer
	Zenith National Insurance Corp.

EX-32 5 a05-18468_1ex32.htm 906 CERTIFICATION

Exhibit 32

Certification of CEO and CFO Pursuant to
18 U.S.C. Section 1350,
as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Quarterly Report on Form 10-Q of Zenith National Insurance Corp. (the “Company”) for the quarterly period ended September 30, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), Stanley R. Zax, as Chief Executive Officer of the Company, and William J. Owen, as Chief Financial Officer of the Company, each hereby certifies, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ STANLEY R. ZAX
Name:	Stanley R. Zax
Title:	Chairman of the Board and President
Date:	October 26, 2005
/s/ WILLIAM J. OWEN
Name:	William J. Owen
Title:	Chief Financial Officer
Date:	October 26, 2005