10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2005

OR

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

For the transition period from

to

Commission file number 000-50795

AFFIRMATIVE INSURANCE HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

Delaware	75-2770432
(State of other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
4450 Sojourn Drive, Suite 500 Addison, Texas	75001
(Address of principal executive offices)	(Zip Code)

(972) 728-6300
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act):
o Yes þ No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

The number of shares outstanding of the registrant’s common stock,
$.01 par value, as of May 12, 2005
16,852,753

Affirmative Insurance Holdings, Inc.
Index

	Page
Part I            Financial Information
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004		1
Consolidated Statements of Operations for the Three Months Ended March 31, 2005 and 2004		2
Consolidated Statements of Stockholders’ Equity and Comprehensive Income for the Three Months Ended March 31, 2005 and 2004		3
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2005 and 2004		4
Notes to Consolidated Financial Statements		5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		12
Item 3. Quantitative and Qualitative Disclosures About Market Risk		17
Item 4. Control Procedures		18
Part II Other Information
Item 1. Legal Proceedings		18
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		18
Item 3. Defaults Upon Senior Securities		18
Item 4. Submission of Matters to a Vote of Security Holders		18
Item 5. Other Information		18
Item 6. Exhibits		19
Signatures		19
Desription of Non-Employee Director Compensation
Quota Share Reinsurance Agreement - A-Affordable Managing General Agency, Inc.
Quota Share Reinsurance Agreement - American Agencies General Agency, Inc.
Certification of CEO Pursuant to Section 302
Certification of CFO Pursuant to Section 302
Certification of CEO Pursuant to Section 906
Certification of CFO Pursuant to Section 906

Part I

Item 1. Financial Statements

Affirmative Insurance Holdings, Inc.

Consolidated Balance Sheets

March 31, 2005 and December 31, 2004

	March 31,			December 31,
	2005			2004
(dollars in thousands, except share data)	(unaudited)
Assets
Fixed maturities — available for sale, at fair value (amortized cost 2005: $161,006; 2004: $157,296)	$	158,866		$	157,666
Short-term investments		—			1,995
		158,866			159,661
Cash and cash equivalents		30,268			24,096
Fiduciary and restricted cash		27,230			16,267
Accrued investment income		2,115			1,979
Premiums and fees receivable (includes related parties - 2005: $33,887; 2004: $30,980)		131,350			107,411
Commissions receivable (includes related parties - 2005: $3,038; 2004: $5,136)		8,678			11,890
Receivable from reinsurers (includes related parties - 2005: $25,099; 2004: $28,873)		55,294			75,403
Deferred acquisition costs		28,980			19,118
Receivable from affiliates		1,043			310
Deferred tax asset		7,515			6,637
Property and equipment, net		6,560			6,485
Goodwill		68,530			67,430
Other intangible assets, net		18,180			18,361
Other assets		7,616			5,872
Total assets	$	552,225		$	520,920
Liabilities and Stockholders’ Equity
Liabilities Reserves for losses and loss adjustment expenses (includes related parties - 2005: $23,132; 2004: $23,037)		103,808			93,030
Unearned premium (includes related parties - 2005: $14,636; 2004: $16,921)		119,567			90,695
Amounts due reinsurers (includes related parties - 2005: $12,133; 2004: $9,640)		28,673			43,167
Deferred revenue		28,076			24,478
Federal income taxes payable		6,509			7,526
Notes payable		30,928			30,928
Consideration due for acquisitions		1,068			1,098
Other liabilities		22,032			24,692
Total liabilities		340,661			315,614
Commitments and contingencies (Note 5)
Stockholders’ equity
Common stock, $0.01 par value; 75,000,000 shares authorized, 16,852,753 and 16,838,519 shares issued and outstanding at March 31, 2005 and December 31, 2005, respectively		169			168
Additional paid-in capital		151,976			151,752
Accumulated other comprehensive (loss) income		(1,375	)		251
Retained earnings		60,794			53,135
Total stockholders’ equity		211,564			205,306
Total liabilities and stockholders’ equity	$	552,225		$	520,920

1

Affirmative Insurance Holdings, Inc.

Consolidated Statements of Operations – (Unaudited)

Three Months Ended March 31, 2005 and 2004

	Three months ended
	March 31,
(dollars in thousands, except per share data)	2005		2004
Revenues
Net premiums earned	$	67,936	$	47,210
Commission income (includes related parties - 2005: $(189); 2004: $649)		3,808		10,924
Fee income		13,628		13,491
Claims processing fees		466		346
Net investment income		1,257		227
Realized gains (losses)		3		(17	)
Total revenues		87,098		72,181
Expenses
Losses and loss adjustment expenses		44,567		31,708
Policy acquisition expenses		14,503		12,653
Employee compensation and benefits		9,359		10,679
Depreciation and amortization		1,029		884
Operating expenses		4,626		4,283
Interest expense		579		217
Total expenses		74,663		60,424
Net income before income taxes, minority interest and equity interest in unconsolidated subsidiaries		12,435		11,757
Income tax expense		4,406		4,207
Minority interest, net of income taxes		33		95
Equity interest in unconsolidated subsidiaries, net of income taxes		—		173
Net income	$	7,996	$	7,282
Net income per common share — Basic	$	0.47	$	0.63
Net income per common share — Diluted	$	0.47	$	0.62
Weighted average shares outstanding
Basic		16,845,934		11,582,422
Diluted		17,119,853		11,700,663

2

Affirmative Insurance Holdings, Inc.

Consolidated Statements of Stockholders’ Equity and Comprehensive Income – (Unaudited)

Three Months Ended March 31, 2005 and 2004

													Accumulated
								Additional					Other			Total
	Common Stock							Paid-in		Retained			Comprehensive			Stockholders’
	Shares		Amount		Warrants			Capital		Earnings			Income (Loss)			Equity
	(dollars in thousands, except share data)
Balance, December 31, 2003		11,557,215	$	116	$	157		$	84,074	$	29,039		$	(9	)	$	113,377
Comprehensive income:
Net income											7,282						7,282
Other comprehensive income														272			272
Total comprehensive income																	7,554
Issuance of common stock		114,668		1		(157	)		1,156								1,000
Balance, March 31, 2004		11,671,883	$	117	$	—		$	85,230	$	36,321		$	263		$	121,931
Balance, December 31, 2004		16,838,519	$	168	$	—		$	151,752	$	53,135		$	251		$	205,306
Comprehensive income:
Net income											7,996						7,996
Other comprehensive loss														(1,626	)		(1,626	)
Total comprehensive income																	6,370
Dividends											(337	)					(337	)
Equity based compensation		14,234		1					224								225
Balance, March 31, 2005		16,852,753	$	169	$	—		$	151,976	$	60,794		$	(1,375	)	$	211,564

3

Affirmative Insurance Holdings, Inc.

Consolidated Statements of Cash Flows – (Unaudited)

Three Months Ended March 31, 2005 and 2004

	Three months ended
	March 31,
	2005			2004
	(dollars in thousands)
Cash flows from operating activities
Net income	$	7,996		$	7,282
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		1,029			884
Undistributed equity in unconsolidated subsidiaries		—			173
Equity based compensation		23			—
Realized (gains) losses		(3	)		17
Amortization of discount on investment		642			—
Changes in assets and liabilities:
Fiduciary and restricted cash		(10,963	)		(2,670	)
Premiums, fees and commissions receivable		(20,726	)		(43,935	)
Reserves for loss and loss expenses		10,778			14,983
Amounts due reinsurers		5,616			(3,400	)
Receivable from affiliates		(733	)		(300	)
Deferred revenue		3,598			4,317
Unearned premiums		28,872			23,602
Deferred acquisition costs		(9,862	)		2,489
Other		(5,358	)		9,366
Net cash provided by operating activities		10,909			12,808
Cash flows from investing activities
Proceeds from the sale of bonds		2,746			510
Cost of bonds acquired		(5,093	)		—
Purchases of property and equipment		(920	)		(862	)
Net cash paid for acquisitions		(1,133	)		(1,569	)
Net cash used in investing activities		(4,400	)		(1,921	)
Cash flows from financing activities
Principal payments under capital lease obligation		—			(53	)
Principal payments on note payable		—			(2,824	)
Proceeds from issuance of common stock		—			927
Dividends paid		(337	)		—
Net cash used in financing activities		(337	)		(1,950	)
Net increase in cash and cash equivalents		6,172			8,937
Cash and cash equivalents, beginning of period		24,096			14,699
Cash and cash equivalents, end of period	$	30,268		$	23,636

4

Affirmative Insurance Holdings, Inc.

Notes to Consolidated Financial Statement (Unaudited)

1. General

Affirmative Insurance Holdings, Inc., (“we”, “us”, “our”) is an insurance holding company and is engaged in underwriting, servicing and distributing non-standard automobile insurance policies and related products and services to individual consumers in highly targeted geographic areas. Our subsidiaries include two insurance companies, four underwriting agencies, five retail agencies with 183 owned and 42 franchise retail store locations as of March 31, 2005. We offer our products and services in 11 states, including Texas, Illinois, California and Florida. Our growth has been achieved principally as a result of the acquisition and integration of six retail and/or underwriting agencies in 2001 and 2002. We were formerly known as Instant Insurance Holdings, Inc., and we incorporated in Delaware on June 25, 1998.

As a result of a series of transactions commencing on December 21, 2000, Vesta Insurance Group, Inc. and its subsidiaries (“Vesta”) owned approximately 98.1% of our issued and outstanding common stock at June 31, 2004, which were acquired from former stockholders and the purchase of new common stock directly from us.

We completed our initial public offering of our common stock effective July 9, 2004. We issued 4,420,000 additional shares of our common stock and Vesta sold 3,750,000 shares of our common stock that they owned, at an initial public offering price of $14.00 per share. On July 26, 2004, our underwriters exercised their option to purchase an additional 663,000 shares from us, and an additional 562,500 shares from Vesta. As of March 31, 2005, Vesta beneficially owned approximately 42.8% of our issued and outstanding capital stock.

2. Basis of Presentation

Our unaudited consolidated financial statements included herein have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and include our accounts and the accounts of our operating subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial reporting. These financial statements should be read in conjunction with our audited financial statements for the year ended December 31, 2004 included in our report on Form 10-K filed with the SEC.

The interim financial data as of March 31, 2005 and 2004 is unaudited; however, in the opinion of the Company, the interim data includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the results for the interim periods.

Reclassification

Certain previously reported amounts have been reclassified in order to conform to current year presentation. Such reclassification had no effects on net income or stockholders’ equity.

Use of Estimates in the Preparation of the Financial Statements

Our preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect our reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of our financial statements and our reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates. These estimates and assumptions are particularly important in determining revenue recognition, reserves for losses and loss adjustment expenses, deferred policy acquisition costs, reinsurance receivables and impairment of assets.

Stock Based Compensation

In December 2002, the FASB issued SFAS No. 148 (“SFAS 148”), Accounting for Stock-Based Compensation – Transition and Disclosure. This statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure requirements of SFAS No. 123 (“SFAS 123”), Accounting for Stock-Based Compensation to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method on reported results. We have elected to continue to apply APB Opinion No. 25 (“APB 25”) Accounting for Stock Issued to Employees and related interpretations in accounting for stock options.

5

The following table illustrates the effect on our net income and net income per share if we had applied SFAS 123 to stock-based compensation (in thousands, except per share amounts):

	Three months ended
	March 31,
	2005			2004
Net income, as reported	$	7,996		$	7,282
Deduct: total stock-based compensation expense determined under fair value based method for all awards, net of related income taxes		(197	)		(25	)
Net income, pro forma	$	7,799		$	7,257
Basic earnings per share — as reported	$	0.47		$	0.63
Basic earnings per share — pro forma	$	0.46		$	0.63
Diluted earnings per share — as reported	$	0.47		$	0.62
Diluted earnings per share — pro forma	$	0.46		$	0.62

Recently Issued Accounting Standards

In March 2004, the Emerging Issues Task Force (“EITF”) of the FASB reached a consensus on Issue 03-1, The Meaning of Other-Than Temporary Impairment and Its Application to Certain Investments. EITF 03-1 provides guidance with respect to the meaning of other-than temporary impairment and its application to investments classified as either available-for-sale or held-to-maturity under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and investments accounted for under the cost method or the equity method. In September 2004, the FASB issued a Staff Position, FSP EITF 03-1-1, delaying the effective date for the measurement and recognition guidance included in EITF 03-1, and also issued an exposure draft, FSP EITF 03-1a, which proposes guidance relating to debt securities that are impaired because of interest rate and/or sector spread increases. The delay in the effective date for the measurement and recognition guidance of EITF 03-1 did not suspend existing requirements for assessing whether investment impairments are other-than-temporary. We do not anticipate that this will have a material impact on our financials, as our investment portfolio is primarily comprised of ‘A’ rated bonds.

In December 2004, the FASB issued SFAS No. 123R (“SFAS 123R”), Share-Based Compensation, which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award, the requisite service period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. SFAS 123R is effective for public entities that do not file as small business issuers as of the beginning of the first interim or annual reporting period that begins after December 31, 2005. We anticipate adopting the provisions of SFAS 123R in January 2006. We are currently evaluating the requirements and the potential impact of SFAS 123R and have not yet determined if SFAS 123R will have a material impact on our future operations.

3. Reinsurance

The effect of reinsurance on premiums written and earned is as follows (dollars in thousands):

	Three months ended						Three months ended
	March 31, 2005						March 31, 2004
	Written			Earned			Written			Earned
Direct	$	55,168		$	45,011		$	51,612		$	32,739
Assumed — affiliate		11,317			13,603			22,392			22,021
Assumed — non affiliate		38,617			17,195			5,752			1,393
Ceded — affiliate		—			(309	)		(259	)		(1,170	)
Ceded — non affiliate		(992	)		(7,564	)		(33,216	)		(7,773	)
	$	104,110		$	67,936		$	46,281		$	47,210

6

The amount of unpaid loss and loss adjustment expenses and unearned premium we would remain liable for in the event our reinsurers are unable to meet their obligations are as follows (dollars in thousands):

	As of March 31,		As of December 31,
	2005		2004
Affiliate
Loss and loss adjustment expense	$	21,385	$	23,815
Unearned premiums		401		656
Total	$	21,786	$	24,471
Non affiliate
Loss and loss adjustment expense	$	16,713	$	18,087
Unearned premiums		3,114		13,530
Total	$	19,827	$	31,617

As of and for the three months ended, March 31, 2005, we have ceded $6.8 million of paid losses and $3.5 million of incurred losses to various reinsurers.

Effective December 31, 2004, we terminated two ceded quota share reinsurance agreements with unaffiliated reinsurers on a run-off basis for business written through our underwriting agencies in the states of Illinois, Indiana, Missouri, New Mexico and South Carolina. Effective December 31, 2004, we terminated two quota share reinsurance agreements with Old American County Mutual Fire Insurance Company on a run-off basis, where we had assumed business written through our underwriting agencies in the state of Texas.

Effective January 1, 2005, we entered into two quota share reinsurance agreements with Old American County Mutual Fire Insurance Company, where we will assume 100% of the business written through our underwriting agencies in the state of Texas.

Effective May 1, 2004, we entered into a quota share reinsurance agreement with an unaffiliated reinsurer to cede 25% of the business written through our Florida underwriting agency. This contract continues in force until terminated by us or our reinsurer at any April 30 with not less than 90 days prior notice. Effective May 1, 2005, we have amended this agreement and will continue ceding 25% of the business written through our Florida underwriting agency to the unaffiliated reinsurer at substantially the same terms and conditions. The reinsurance under this agreement is provided by Folksamerica, which reinsures 100% of the premium we cede. Folksamerica is rated “A” by A.M. Best.

All of our quota share reinsurance agreements contain provisions for sliding scale commissions, under which the commission paid to us varies with the loss ratio results under each contract. The effect of this feature in the quota share reinsurance agreements is to limit the reinsurers aggregate exposure to loss and thereby reduce the ultimate cost to us as the ceding company. These features also have the effect of reducing the amount of protection relative to the quota share amount of premiums ceded by us. Before entering into these reinsurance agreements, and based on our prior operating history, we concluded that each agreement met the risk transfer test of SFAS No. 113 (“SFAS 113”) Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts as the reinsurers assume significant risk and have a reasonable possibility of significant loss.

On November 4, 2004, The Hawaiian Insurance & Guaranty Company, Ltd. (“Hawaiian”) was named among a group of four other named defendants and twenty unnamed defendants in a complaint filed in the Superior Court of the State of California for the County of Los Angeles alleging causes of action as follows: enforcement of coverage under Hawaiian’s policy of an underlying default judgment plaintiff obtained against Hawaiian’s former insured, who was denied a defense in the underlying lawsuit due to his failure to pay the Hawaiian policy premium; ratification and waiver of policy lapse and declaratory relief against Hawaiian; breach of implied covenant of good faith and fair dealing against Hawaiian with the plaintiff as the assignee of the insured; intentional misconduct as to the defendant SCJ Insurance Services; and professional negligence as to the defendants Prompt Insurance Services, Paul Ruelas, and Anthony David Medina. The plaintiff is seeking to enforce an underlying default judgment obtained against Hawaiian’s insured on September 24, 2004 in the amount of $35,000,643 and additional bad faith damages including punitive damages in the amount of $35,000,000.

Affirmative Insurance Company, a wholly-owned subsidiary of Affirmative Insurance Holdings, Inc. (“Affirmative), is a party to a 100% quota share reinsurance agreement with Hawaiian and is sharing in the defense of this matter. Hawaiian is ultimately a wholly-owned subsidiary of Vesta Insurance Group, Inc. which is a 42.9% stockholder of Affirmative. The other named defendants, SCJ Insurance Services, Prompt Insurance Services, Paul Ruelas, and Anthony David Medina, are unaffiliated persons to Affirmative.

This matter is currently proceeding through pre-trial discovery and depositions of pertinent witnesses in preparation for a September 6, 2005 trial date. Hawaiian and the other defendants thereto believe these allegations are without merit and are vigorously contesting the claims brought by the plaintiffs and exercising all available rights and remedies against them; however, the ultimate outcome of this matter is uncertain.

7

4. Related Party Transactions

We provide various services for Vesta and its subsidiaries, including underwriting, premium processing, and claims processing. For the three months ended March 31, the accompanying unaudited consolidated statements of operations reflect these services as follows (dollars in thousands):

	Three months ended
	March 31,
	2005			2004
Commission income	$	(189	)	$	649

In addition, we have presented, in the accompanying consolidated balance sheets, the following amounts related to contracts with Vesta and its subsidiaries (dollars in thousands):

	March 31,		December 31,
	2005		2004
Assets
Premiums and fees receivable	$	33,887	$	30,980
Commissions receivable		3,038		5,136
Receivable from reinsurer		25,099		28,873
Receivable from affiliates		1,043		310
	$	63,067	$	65,299
Liabilities
Loss and loss adjustment expense	$	23,132	$	23,037
Unearned premium		14,636		16,921
Amounts due reinsurers		12,133		9,640
	$	49,901	$	49,598

As part of the terms of the acquisition of Affirmative Insurance Company and Insura Property and Casualty Insurance Company from Vesta, Vesta has indemnified us for any losses due to uncollectible reinsurance related to reinsurance agreements entered into with unaffiliated reinsurers prior to December 31, 2003. As of March 31, 2005, all such unaffiliated reinsurers had A.M. Best ratings of “A-” or better.

5. Commitments and Contingencies

We and our subsidiaries are named from time to time as defendants in various legal actions arising in the ordinary course of our business and arising out of or related to claims made in connection with our insurance policies, claims handling and employment related disputes. The plaintiffs in some of these lawsuits have alleged bad faith or extra-contractual damages and some have claimed punitive damages. We believe that the resolution of these legal actions will not have a material adverse effect on our financial position or results of operations.

InsureOne’s former president, James Hallberg, is a defendant, along with eight former employees of InsureOne and two of Hallberg’s family trusts, in actions we brought in the Circuit Court of Cook County, Illinois in December 2003 and in the United States District Court for the Eastern District of Missouri in February 2004 to enforce non-compete and non-solicitation agreements entered into with those employees. Both courts entered interim orders prohibiting all defendants, including Hallberg, from hiring any employees of InsureOne or one of AIHI’s other underwriting agencies. The order expired in the Missouri action in November of 2004, but is still in effect in the Illinois action until the conclusion of the trial of the Illinois action, which is currently scheduled to begin in August of 2005. On May 17, 2004, the former president of InsureOne filed a counterclaim in the Illinois case seeking unspecified compensatory damages, specific performance, attorneys’ fees and court costs based on causes of action for breach of contract, fraud, negligent misrepresentation and breach of fiduciary duty in connection with Vesta’s original acquisition of the InsureOne business in 2002, the claimant’s employment with InsureOne and our purchase of the 20% minority interest in InsureOne in 2003. We filed a motion to dismiss these counterclaims, which was granted in part and denied in part. Hallberg subsequently filed amended counterclaims based on causes of action for breach of contract, fraud, and breach of fiduciary duty. We have answered those counterclaims, and believe the counterclaims are without merit. We are vigorously contesting the counterclaims and are exercising all rights and remedies available to us. In the Missouri action, the parties filed a joint motion for voluntary dismissal which was granted by the Court without prejudice and provided for the right of each party to re-file.

8

On May 6, 2004, the former minority owners of our InsureOne retail agency, including InsureOne’s former president, in his capacity as trustee of one of his family trusts, filed a complaint in the United States District Court for the Northern District of Illinois alleging causes of action against us and three of our executive officers under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, as well as causes of action for fraudulent misrepresentation, negligent misrepresentation and breach of fiduciary duty in connection with our purchase of the plaintiffs’ 20% minority interest in this retail agency in 2003. The plaintiffs sought damages equal to the difference between the amount paid for the 20% interest and the court’s determination of the value of this interest, plus attorneys’ fees and court costs. Defendants filed a motion to dismiss this case, which was granted by the Court on March 8, 2005. The Court’s March 8, 2005 Order dismissed all claims without prejudice and granted plaintiffs 20 days from the date of the order to attempt to replead their claims. On May 2, 2005, plaintiffs filed a motion to voluntarily dismiss this matter without prejudice, which was granted by the Court. Plaintiffs may still bring these claims in federal court at a later date, or alternatively, the plaintiffs may file the state law claims in state court. We believe these claims are without merit, and should the plaintiffs choose to refile them, we will vigorously contest the claims and exercise all rights and remedies available to us.

On November 4, 2004, The Hawaiian Insurance & Guaranty Company, Ltd. (“Hawaiian”) was named among a group of four other named defendants and twenty unnamed defendants in a complaint filed in the Superior Court of the State of California for the County of Los Angeles alleging causes of action as follows: enforcement of coverage under Hawaiian’s policy of an underlying default judgment plaintiff obtained against Hawaiian’s former insured, who was denied a defense in the underlying lawsuit due to his failure to timely pay the Hawaiian policy premium; ratification and waiver of policy lapse and declaratory relief against Hawaiian; breach of implied covenant of good faith and fair dealing against Hawaiian with the plaintiff as the assignee of the insured; intentional misconduct as to the defendant SCJ Insurance Services; and professional negligence as to the defendants Prompt Insurance Services, Paul Ruelas, and Anthony David Medina. The plaintiff is seeking to enforce an underlying default judgment obtained against Hawaiian’s insured on September 24, 2004 in the amount of $35,000,643, and additional bad faith damages including punitive damages in the amount of $35,000,000.

Affirmative Insurance Company, our wholly owned subsidiary is a party to a 100% quota share reinsurance agreement with Hawaiian and is sharing in the defense of this matter. Hawaiian is ultimately a wholly-owned subsidiary of Vesta, which owns 42.9% of our common stock. The other named defendants SCJ Insurance Services, Prompt Insurance Services, Paul Ruelas, and Anthony David Medina are unaffiliated persons to Affirmative.

This matter is currently proceeding through pre–trial discovery and depositions of pertinent witnesses in preparation for a September 6, 2005 trial date. Hawaiian and the other defendants thereto believe these allegations are without merit and are vigorously contesting the claims brought by the plaintiffs and exercising all available rights and remedies against them; however, the ultimate outcome of this matter is uncertain.

6. Credit Facility

On August 6, 2004, we entered into a senior secured credit facility with The Frost National Bank. Under this credit facility, the maximum amount available to us from time to time is $15.0 million, which may include up to $15.0 million under a two-year revolving line of credit, up to $10.0 million in five-year term loans and up to $10.0 million in five-year stand-by letters of credit. The borrowings under our credit facility will initially accrue interest at an annual rate of LIBOR plus 1.50% and we will pay letter of credit fees based on an initial annual rate of 0.75%. Our obligations under the facility are guaranteed by our material operating subsidiaries (other than our insurance companies) and are secured by a first lien security interest on all of our assets and the assets of our material operating subsidiaries (other than our insurance companies), including a pledge of 100% of the stock of Affirmative Insurance Company. The facility contains certain financial covenants, which include combined ratio, risk-based capital requirement, fixed charge coverage ratio, consolidated net worth and consolidated net income requirements and other restrictive covenants governing distributions and management changes. The proceeds are available to issue letters of credit securing our obligations under reinsurance agreements, to fund general working capital for our agency operations, capital surplus for our insurance companies and to finance acquisition activities. During the three months ended March 31, 2005, we executed letters of credit under this credit facility of approximately $2.3 million to collateralize a loss corridor position with certain of our reinsurers. Total fees were approximately $13,000. As of March 31, 2005, there were no outstanding loan amounts due under our credit facility, and we are in compliance with all of our financial and other restrictive covenants.

7. Stockholders’ Equity

In January 2005, we issued 6,734 shares of common stock to certain of our Board of Directors, in lieu of cash as their annual retainer. In February 2005, we issued 7,500 shares of common stock to certain of our Board of Directors for compensation related to services performed. We recorded prepaid expense for these grants of approximately $225,000 at the date of the grant and are amortizing the amount to compensation expense over the service period. Total compensation expense recorded for the three months ended March 31, 2005 was approximately $23,000.

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8.	Earnings per Share
	The provisions of SFAS No. 128 (“SFAS 128”) Earnings per Share require presentation of both basic and diluted earnings per share. A reconciliation of the numerators and denominators of the basic and diluted earnings per share computations as required by SFAS 128 is presented below:

	Income		Shares		Per Share
	(Numerator)		(Denominator)		Amount
	(dollars in thousands, except number of
	shares and per share amounts)
Three months ended March 31, 2005
Basic Earnings per Share
Net Income	$	7,996		16,845,934	$	0.47
Diluted Earnings per Share
Net Income	$	7,996		16,845,934	$	0.47
Effect of Dilutive Securities		—		273,919		—
	$	7,996		17,119,853	$	0.47
Three months ended March 31, 2004
Basic Earnings per Share
Net Income	$	7,282		11,582,422	$	0.63
Diluted Earnings per Share
Net Income	$	7,282		11,582,422	$	0.63
Effect of Dilutive Securities		—		118,241		(0.01	)
	$	7,282		11,700,663	$	0.62

9.	Segment Information
	In June 1997, the FASB issued SFAS No. 131 (“SFAS 131”) Disclosures about Segments of an Enterprise and Related Information. SFAS 131 defines an operating segment as a component of an enterprise if it meets the following criteria: (1) it engages in business activities from which it may earn revenue and incur expenses; (2) whose operating results are regularly reviewed by the enterprise’s chief operating decision maker; and (3) for which discrete financial information is available.
	We have reflected the requirements of SFAS 131 for the three months ended March 31, 2005 and 2004 in the following tables for our three operating segments: agency segment, insurance segment, and corporate segment.
	Our agency segment is comprised of our underwriting agencies and our retail agencies. Our underwriting agencies primarily design, distribute and service policies issued or reinsured by our insurance companies or another unaffiliated insurance company. In our insurance segment, we issue non-standard personal automobile insurance policies through our two Illinois-domiciled insurance company subsidiaries. Our insurance companies possess the certificates of authority and capital necessary to transact insurance business and issue policies, but they rely on both affiliated and unaffiliated underwriting agencies to design, distribute and service those policies.

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	Agency		Insurance		Corporate						Affirmative
Three months ended March 31, 2005	Segment		Segment		Segment			Eliminations			Consolidated
	(dollars in thousands)
Revenues:
Net premiums earned	$	—	$	67,936	$	—		$	—		$	67,936
Commission income		29,298		—		—			(25,490	)		3,808
Fee income		10,847		6,926		—			(4,145	)		13,628
Claims processing fees		7,519		—		—			(7,053	)		466
Investment income		46		1,211		—			—			1,257
Realized gains		3		—		—			—			3
Total revenues		47,713		76,073		—			(36,688	)		87,098
Expenses:
Losses and loss adjustment expenses incurred		—		44,567		—			—			44,567
Policy acquisition expenses		7,540		25,158					(18,195	)		14,503
Employee compensation and benefits		16,612		147		—			(7,400	)		9,359
Depreciation and amortization		1,029		—		—			—			1,029
Operating expenses		14,342		1,013		364			(11,093	)		4,626
Interest expense		—		—		579			—			579
Total expenses		39,523		70,885		943			(36,688	)		74,663
Net income (loss) before income taxes, minority interest and equity interest		8,190		5,188		(943	)		—			12,435
Income tax expense (benefit)		2,902		1,839		(335	)		—			4,406
Minority interest, net of tax		33		—		—			—			33
Equity interest in unconsolidated subsidiaries, net of tax		—		—		—			—			—
Net income (loss)	$	5,255	$	3,349	$	(608	)	$	—		$	7,996
Total assets	$	127,853	$	418,222	$	6,150		$	—		$	552,225

	Agency		Insurance			Corporate						Affirmative
Three months ended March 31, 2004	Segment		Segment			Segment			Eliminations			Consolidated
	(dollars in thousands)
Revenues:
Net premiums earned	$	—	$	47,210		$	—		$	—		$	47,210
Commission income		25,400					—			(14,476	)		10,924
Fee income		10,914		7,103			—			(4,526	)		13,491
Claims processing fees		6,225					—			(5,879	)		346
Investment income		18		209			—			—			227
Realized gains (losses)		1		(18	)		—			—			(17	)
Total revenues		42,558		54,504			—			(24,881	)		72,181
Expenses:
Losses and loss adjustment expenses incurred		—		31,708			—			—			31,708
Policy acquisition expenses		8,035		18,026						(13,408	)		12,653
Employee compensation and benefits		14,667		—			—			(3,988	)		10,679
Depreciation and amortization		884		—			—			—			884
Operating expenses		10,881		887			—			(7,485	)		4,283
Interest expense		—		—			217			—			217
Total expenses		34,467		50,621			217			(24,881	)		60,424
Net income (loss) before income taxes, minority interest and equity interest		8,091		3,883			(217	)		—			11,757
Income tax expense (benefit)		2,895		1,390			(78	)		—			4,207
Minority interest, net of tax		95		—			—			—			95
Equity interest in unconsolidated subsidiaries, net of tax		—		—			173			—			173
Net income (loss)	$	5,101	$	2,493		$	(312	)	$	—		$	7,282
Total assets	$	156,304	$	250,529		$	1,259		$	—		$	408,092

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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited consolidated financial statements and related notes thereto presented in this Form 10-Q and our annual report on Form 10-K for the year ended December 31, 2004. This discussion contains certain statements of a forward-looking nature that involve risks and uncertainties. As a result of many factors, our actual results may differ materially from those anticipated by such forward-looking statements.

Overview

We are an insurance holding company engaged in underwriting, servicing and distributing non-standard automobile insurance policies and related products and services to individual consumers in highly targeted geographic areas. Our subsidiaries include two insurance companies, four underwriting agencies and five retail agencies with 183 owned and 42 franchise retail store locations. We offer our products and services in 11 states, including Texas, Illinois, California and Florida.

Our insurance companies, underwriting agencies and retail agencies often function as a vertically integrated unit, capturing the premium (and associated risk) and commission and fee revenue generated from the sale of each insurance policy. However, each of these operations also works with unaffiliated entities on an unbundled basis, either functioning independently or with one or both of the other two operations. We believe that our ability to enter into a variety of business relationships with third parties allows us to maximize sales penetration and profitability through industry cycles better than if we employed a single, vertically integrated operating structure.

We measure the total gross premiums written from which we derive commissions by our underwriting agencies or premiums by our insurance companies as our Total Controlled Premium. We report consolidated financial information in three business segments: our agency segment, our insurance company segment and our corporate segment.

The following table displays our Total Controlled Premium by distribution channel for the three months ended March 31, 2005 and 2004:

	Three months ended
	March 31,
	2005		2004
	(Unaudited in thousands)
Our underwriting agencies:
Our retail stores	$	41,014	$	37,586
Independent agencies		47,066		53,936
Unaffiliated underwriting agencies		25,088		27,278
Total	$	113,168	$	118,800

Total Controlled Premium for the three months ended March 31, 2005 was $113.2 million, a decrease of $5.6 million, or 4.7%, as compared to $118.8 million for the same period in 2004. The decrease in Total Controlled Premium is principally due to a decrease in production by our Florida underwriting agency and the continued run-off of a cancelled unaffiliated underwriting agency program in California, partially offset by increases in our retail distribution channel from growth due to acquisitions and store openings in the state of Texas.

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Results of Operations

The following table summarizes our historical results of operations by reporting segment. For more detailed information concerning the components of revenues and expenses by segment, please refer to Note 9 to our consolidated financial statements included in this report.

	Three months ended
	March 31,
	2005			2004
(Unaudited in thousands)
Total Revenues:
Agency segment	$	47,713		$	42,558
Insurance segment		76,073			54,504
Corporate		—			—
Eliminations		(36,688	)		(24,881	)
Total	$	87,098		$	72,181
Total Expenses:
Agency segment	$	39,523		$	34,467
Insurance segment		70,885			50,621
Corporate		943			217
Eliminations		(36,688	)		(24,881	)
Total	$	74,663		$	60,424
Pretax Income:
Agency segment	$	8,190		$	8,091
Insurance segment		5,188			3,883
Corporate		(943	)		(217	)
Total	$	12,435		$	11,757

Comparison of the Three Months Ended March 31, 2005 to March 31, 2004

Consolidated. Total revenues for the three months ended March 31, 2005 were $87.1 million, an increase of $14.9 million, or 20.7%, as compared to total revenues of $72.2 million for the same period in 2004.

Total expenses for the three months ended March 31, 2005 were $74.7 million, an increase of $14.2 million, or 23.6%, as compared to total expenses of $60.4 million for the same period in 2004.

Pretax net income increased approximately $678,000, or 5.8%, to $12.4 million for the three months ended March 31, 2005 from $11.8 million for the same period in 2004. This increase is due to our increase in revenues of $14.9 million or 20.7% for the three months ended March 31, 2005, offset by an increase in expenses of $14.2 million, or 23.6%. The increase in revenues is due to an increase in the retention of gross premiums written, partially offset by a decrease in commissions due to consolidation. The increase in expenses was, primarily, due to an increase in our loss and loss adjustment and policy and acquisition expenses due to the increased retention of gross premiums and new general and administrative expenses due to our initial public offering and increased litigation costs.

Income tax expense for the three months ended March 31, 2005 was $4.4 million, or an effective rate of 35.4%, as compared to income tax expense of $4.2 million, or an effective rate of 35.8% for the same period in 2004. The decrease in our effective rate is primarily related to an increased amount of tax-exempt interest from our insurance companies’ investment portfolios. We invested a large portion of the proceeds from our initial public offering and the cash generated by our insurance companies in tax-exempt securities to reduce our effective tax rate.

For the three months ended March 31, 2005, minority interest, net of income taxes, was $33,000 as compared to $95,000 for the same period in 2004, as a result of a decrease in net income in our Florida underwriting agency.

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Agency segment. Total revenues for the three months ended March 31, 2005 were $47.7 million, an increase of $5.2 million, or 12.1%, as compared to total revenues of $42.6 million for the same period in 2004. Revenues for the three months ended March 31, 2005 and 2004 were generated primarily through commissions, policy fees and claims processing fees, as follows:

	Three months ended
	March 31,
	2005		2004
	(Unaudited in millions)
Commissions	$	29.3	$	25.4
Policy and other fees		10.9		10.9
Claims processing fees		7.5		6.2
Total	$	47.7	$	42.5

Commissions for the three months ended March 31, 2005 were $29.3 million, an increase of $3.8 million, or 15.1%, as compared to commissions of $25.4 million for the same period in 2004. We earned commissions in both our underwriting agencies and retail agencies. Commissions for our underwriting agencies, which include both provisional and profit-sharing commissions, for the three months ended March 31, 2005 were $26.6 million, an increase of $3.0 million, or 12.5%, as compared to $23.6 million for the same period in 2004.

Provisional commissions for our underwriting agencies for the three months ended March 31, 2005 were $23.8 million, an increase of $2.1 million, or 9.9%, as compared to $21.6 million for the same period in 2004. The increase in provisional commissions was principally due to an increase in the average commission rate, which increased to 27.0% in the first quarter of 2005 from 23.6% in the same period of the prior year, partially offset by a decrease in Total Controlled Premium produced by our underwriting agencies.

Profit sharing commissions for our underwriting agencies for the three months ended March 31, 2005 were $2.8 million, an increase of $809,000, or 40.7%, as compared to $2.0 million for the same period in 2004. The increase in profit sharing commissions was principally a result of favorable loss ratio development for business produced by our underwriting agencies as compared to loss ratios recorded as of the beginning of the period.

Commissions related to our retail agencies’ sales of unaffiliated insurance companies’ products were $2.7 million for the three months ended March 31, 2005, an increase of $943,000, or 52.9%, as compared to $1.8 million for the same period in 2004, primarily due to the acquisition of Fed USA in December 2004. The Fed USA acquisition added 24 owned and 42 franchise retail store locations which service the Florida market.

Policy and other fees for the three months ended March 31, 2005 were $10.9 million, a decrease of $67,000 as compared to $10.9 million for the same period in 2004. The comparability between periods was principally due to an increase in our retention rate, which resulted in an increase in the deferral, as well as our decreased premium volume in our Florida underwriting agency.

Claims processing fees for the three months ended March 31, 2005 were $7.5 million, an increase of $1.3 million, or 20.8%, as compared to $6.2 million for the same period of 2004. The increase in claims fees was principally due to the increase in the average rate paid to us and recognized for claims fees to 10.6% in the first quarter of 2005, as compared to 8.8% in the first quarter of 2004. The increase in the average rate for claims fees is primarily due to contractual changes where our payment of allocated loss adjustment expenses is included in all our claims administration contracts starting in 2004, where previously our payment of allocated loss adjustment expenses was only in some of our contracts.

Total expenses for the three months ended March 31, 2005 were $39.5 million, an increase of $5.1 million, or 14.7%, as compared to total expenses of $34.5 million for the same period in 2004.

•   Policy acquisition expenses, comprised solely of commission expenses in our agency segment, for the three months ended March 31, 2005 were $7.5 million, a decrease of $495,000, or 6.2%, as compared to $8.0 million for the same period in 2004, principally due to the decrease in premiums written and partially offset by an increase in average commission rate to 15.9% from 14.9% during the prior year. The increase in average commission rate was primarily caused by a higher proportion of our premiums written in markets where we pay higher commission rates.

•   Employee compensation and benefit expenses for the three months ended March 31, 2005 were $16.6 million, an increase of $1.9 million, or 13.3%, as compared to $14.7 million for the same period in 2004. The increase in employee compensation and benefit expenses was principally due to increased headcount to 1,222 for the three months ended March 31, 2005 as compared to 1,103 for the same period in 2004, principally related to the Fed USA acquisition, which added 97 employees.

•   Depreciation and amortization expenses for the three months ended March 31, 2005 were $1.0 million, an increase of $145,000, or 16.4%, as compared to $884,000 for the same period in 2004. The increases in depreciation and amortization expenses were principally due to increases in software and hardware purchases as well as the acceleration of amortization and depreciation of certain software assets to match their estimated remaining lives, in anticipation of replacing these systems with a new operating system in the second half of 2005.

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•   Operating expenses for the three months ended March 31, 2005 were $14.3 million, an increase of $3.5 million, or 31.8%, as compared to $10.9 million for the same period of 2004. The increase in operating expenses was principally due to increased payments of allocated loss adjustment expenses of $1.4 million as well as increases in front fees and premium taxes of $500,000. The increase in allocated loss adjustment expense payments is a result of changes in contractual terms where our payment of allocated loss adjustment expenses in included in all of our claims administration contracts starting in 2004, where previously our payment of allocated loss adjustment expenses was only included in some of our contracts. In addition, advertising expenditures increased $1.0 million over the prior period principally due to continued expansion of our retail branding and professional fees increases $400,000 over the prior periods due to increased audit fees.

Pretax income for the three months ended March 31, 2005 was $8.2 million, an increase of $99,000, or 1.2%, as compared to pretax income of $8.1 million for the same period in 2004. The pretax margin for the three months ended March 31, 2005 was 17.2%, a decrease from the 19.0% pre-tax margin recorded in the same period in 2004.

Insurance company segment. Total revenues for the three months ended March 31, 2005 were $76.1 million, an increase of $21.6 million, or 39.6%, as compared to total revenues of $54.5 million for the same period in 2004. The increase in total revenues was principally due to our continued increased retention of gross premiums written by our insurance companies. Following our initial public offering in July 2004 and the issuance of trust preferred securities in December 2004, we were able to increase retention amounts at July 2004 and, again, at January 2005. We retained approximately 92.0% of our Total Controlled Premium for the three months ended March 31, 2005, as compared to 39.0% in the same period in 2004.

Net investment income for the three months ended March 31, 2005 was $1.2 million, an increase of $1.0 million from net investment income of $209,000 for the same period in 2004. The increase is primarily due to the increase in the size of our investment portfolio due to the capital contributions into our insurance subsidiaries after our initial public offering and the issuance of trust preferred securities, as well as increased cash flow resulting from the increased retention of gross premiums written. Net realized capital gains for the three months ended March 31, 2005 were zero compared to net realized capital losses of $18,000 for the same period in 2004.

Loss and loss adjustment expenses for the three months ended March 31, 2005, were $44.6 million compared to $31.7 million for the same period in 2004. Our loss and loss adjustment expense ratio for the three months ended March 31, 2005 was 59.5%, as compared to 58.4% in the same period in 2004. The increase in loss and loss adjustment expenses was due to our increased retention of gross premiums written as previously discussed.

Policy acquisition and operating expenses for the three months ended March 31, 2005 were $26.3 million, and increase of $7.4 million, or 39.2% compared to $18.9 million for the same period in 2004. The increase in policy acquisition and operating expenses was due to our increased retention of gross premiums written as previously discussed. Our expense ratio for the three months ended March 31, 2005 was 35.2%, as compared to 34.8% for the same period in 2004.

Pretax income for the three months ended March 31, 2005 was $5.2 million, an increase of $1.3 million, or 33.6%, as compared to $3.9 million for the same period in 2004. The increase in pretax income was principally a result of the increased retention of the business being retained starting January 1, 2004 and increasing at July 2004 and January 2005 as previously discussed. Our combined ratio for the three months ended March 31, 2005 was 94.7%, as compared to 93.2% for the same period in 2004.

Corporate and other segment. Operating expense for the three months ended March 31, 2005 was $364,000 as compared to zero for the same period in 2004. Operating expenses include investor relations costs, directors and officers insurance as well as directors fees and travel expenses. Prior to our initial public offering in July of 2004, we did not incur these expenses. Interest expense for the three months ended March 31, 2005 was $579,000, as compared to interest expense of $217,000 for the same period in 2004. The interest expense is primarily related to our $30.9 million note payable, which was issued in December 2004 following our private placement of $30.0 million of trust preferred securities.

Liquidity and Capital Resources

Sources and uses of funds. We are a holding company with no business operations of our own. Consequently, our ability to pay dividends to stockholders, meet our debt payment obligations and pay our taxes and administrative expenses is largely dependent on dividends or other distributions from our subsidiaries, including our insurance company subsidiaries.

There are no restrictions on the payment of dividends by our non-insurance company subsidiaries other than state corporate laws regarding solvency. As a result, our non-insurance company subsidiaries generate revenues, profits and net cash flows that are generally unrestricted as to their availability for the payment of dividends, and we expect to use those revenues to service our corporate financial obligations, such as debt service and stockholder dividends. As of March 31, 2005, we had $1.5 million of cash and invested assets at the holding company level and $4.9 million of cash and invested assets at our non-insurance company subsidiaries.

State insurance laws restrict the ability of our insurance company subsidiaries to declare stockholder dividends. These subsidiaries may not make an “extraordinary dividend” until 30 days after the applicable commissioner of insurance has received notice of the intended dividend and has not objected in such time or until the commissioner has approved the payment of the extraordinary dividend within the 30-day period. An extraordinary dividend is defined as any dividend or distribution of cash or other property whose fair market value, together with that of other dividends and distributions made within the preceding 12 months, exceeds the greater of 10.0% of the insurance company’s surplus as of the preceding December 31 or the insurance company’s net income for the 12-month period ending the preceding December 31, in each case determined in accordance with statutory accounting practices. In addition, an insurance company’s remaining surplus after payment of a dividend or other distribution to stockholder affiliates must be both reasonable in relation to its outstanding liabilities and adequate to its financial needs. In 2005, our insurance companies may pay up to $13.6 million in ordinary dividends without prior regulatory approval, although we do not anticipate that our insurance company subsidiaries will pay dividends in the foreseeable future because we intend to reduce our reinsurance purchases and seek stronger financial strength ratings for our insurance company subsidiaries, both of which will require that the statutory surplus of our insurance company subsidiaries be increased.

The National Association of Insurance Commissioners’ model law for risk-based capital provides formulas to determine the amount of capital that an insurance company needs to ensure that it has an acceptable expectation of not becoming financially impaired. At March 31, 2005, the capital ratios of both of our insurance companies substantially exceeded the risk-based capital requirements. As of March 31, 2005, the capital ratios of both of our insurance companies exceeded the highest level for regulatory action under the risk-based capital guidelines.

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On July 12, 2004, A.M. Best Co. upgraded the financial strength ratings of our insurance subsidiaries, Affirmative Insurance Company and Insura, to B+ (Very Good) from B (Fair). The ratings of our insurance companies were removed from review and assigned a stable outlook. Our rating of B+ (Very Good) is the sixth highest of 15 rating levels.

Our operating subsidiaries’ primary sources of funds are premiums received, commission and fee income, investment income and the proceeds from the sale and maturity of investments. Funds are used to pay claims and operating expenses, to purchase investments and to pay dividends to our holding company.

Net cash provided by operating activities was $10.9 million for the three months ended March 31, 2005, as compared to net cash provided by operating activities of $12.8 million for the same period in 2004. The change in the operating cash flow is principally due to the increased cash flow as a result of our increased retention of written premiums. This increase was offset by the decrease in cash flow as a result of the increased fiduciary and restricted cash balance due to the timing of the settlements on these accounts.

Net cash used in investing activities was $4.4 million for the three months ended March 31, 2005, as compared to net cash used in investing activities of $1.9 million for the same period in 2004. The increase in cash used in investing activities was primarily due to increases in bonds acquired by our insurance companies due to increased cash flow.

We invest our insurance portfolio funds in highly rated fixed income securities. Our portfolio is managed by an outside investment advisor on an active basis in compliance with investment policies provided by us. Information about our investment portfolio is as follows:

	As of
	March 31,			December 31,
($ in thousands)	2005			2004
Invested assets	$	158,866		$	159,661
Tax equivalent book yield		4.15	%		4.03	%
Average duration in years		3.7			3.8
Average S&P rating		AA+			AA+

Net cash used in financing activities was $0.3 million for the three months ended March 31, 2005, as compared to net cash used in financing activities of $2.0 million for the same period in 2004. The decrease in cash used in financing activities was primarily related to payments made during the first quarter of 2004 on our note payable that we did not make in the first quarter of 2005.

We believe that existing cash and investment balances, as well as new cash flows generated from operations and available borrowings under our credit facility, will be adequate to meet our capital and liquidity needs during the 12-month period following the date of this report at both the holding company and insurance company levels. We do not currently know of any events that could cause a material increase or decrease in our long-term liquidity needs. If such events materialize, we will identify the source and develop and disclose our plan of action to remedy any deficiency.

Initial public offering. We completed our initial public offering of our common stock effective July 9, 2004. We issued 4,420,000 additional shares of our common stock and Vesta sold 3,750,000 shares of our common stock that they owned, at an initial public offering price of $14 per share. On July 26, 2004, our underwriters exercised their option to purchase an additional 663,000 shares from us, and an additional 562,500 shares from Vesta. Our net proceeds from the offering were $65.3 million, after deducting our offering expenses. We contributed $64.3 million of the net proceeds to our insurance companies in order to increase their policyholders’ surplus.

Credit facility. On August 6, 2004, we entered into a senior secured credit facility with The Frost National Bank. Under this credit facility, the maximum amount available to us from time to time is $15.0 million, which may include up to $15.0 million under a two-year revolving line of credit, up to $10.0 million in five-year term loans and up to $10.0 million in five-year stand-by letters of credit. The borrowings under our credit facility will initially accrue interest at an annual rate of LIBOR plus 1.50% and we will pay letter of credit fees based on an initial annual rate of 0.75%. Our obligations under the facility are guaranteed by our material operating subsidiaries (other than our insurance companies) and are secured by a first lien security interest on all of our assets and the assets of our material operating subsidiaries (other than our insurance companies), including a pledge of 100% of the stock of Affirmative Insurance Company. The facility contains certain financial covenants, which include combined ratio, risk-based capital requirement, fixed charge coverage ratio, consolidated net worth and consolidated net income requirements, and other restrictive covenants governing distributions and management changes. The proceeds are available to issue letters of credit securing our obligations under reinsurance agreements, to fund general working capital for our agency operations, capital surplus for our insurance companies and to finance acquisitions activities. During the three months ended March 31, 2005, we executed letters of credit under this credit facility of approximately $2.3 million to collateralize a loss corridor position with certain of our reinsurers. Total fees were approximately $13,000. As of March 31, 2005, there were no outstanding loan amounts due under our credit facility, and we are in compliance with all of our financial and other restrictive covenants.

Trust Preferred Securities. On December 21, 2004, our newly formed trust subsidiary completed a private placement of $30.0 million on 30 year floating rate trust preferred securities. Simultaneously, we borrowed $30.9 million from the trust subsidiary and contributed $29.0 million to our insurance companies in order to increase their policyholders’ surplus. The note bears an initial interest rate of 7.545% until December 15, 2009, at which time the securities will adjust quarterly to the 90-day LIBOR rate plus 3.6 percentage points. As of March 31, 2005, the note balance was $30.9 million.

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New Accounting Pronouncements

In March 2004, the Emerging Issues Task Force (“EITF”) of the FASB reached a consensus on Issue 03-1, The Meaning of Other-Than Temporary Impairment and Its Application to Certain Investments. EITF 03-1 provides guidance with respect to the meaning of other-than temporary impairment and its application to investments classified as either available-for-sale or held-to-maturity under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and investments accounted for under the cost method or the equity method. In September 2004, the FASB issued a Staff Position, FSP EITF 03-1-1, delaying the effective date for the measurement and recognition guidance included in EITF 03-1, and also issued an exposure draft, FSP EITF 03-1a, which proposes guidance relating to debt securities that are impaired because of interest rate and/or sector spread increases. The delay in the effective date for the measurement and recognition guidance of EITF 03-1 did not suspend existing requirements for assessing whether investment impairments are other-than-temporary. We currently perform an analysis for impairment of investments on a quarterly basis. We do not anticipate that this will have a material impact on our financials, as our investment portfolio is primarily comprised of ‘A’ rated bonds.

In December 2004, the FASB issued SFAS No. 123R (“SFAS 123R”), Share-Based Compensation, which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award, the requisite service period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. SFAS 123R is effective for public entities that do not file as small business issuers as of the beginning of the first interim or annual reporting period that begins after December 31, 2005. We anticipate adopting the provisions of SFAS 123R in January 2006. We are currently evaluating the requirements and the potential impact of SFAS 123R and have not yet determined if SFAS 123R will have a material impact on our future operations.

Special Note Regarding Forward-Looking Statements

Any statement contained in this report which is not a historical fact, or which might otherwise be considered an opinion or projection concerning the Company or its business, whether express or implied, is meant as and should be considered a forward-looking statement as that term is defined in the Private Securities Litigation Reform Act of 1996. Forward-looking statements are based on assumptions and opinions concerning a variety of known and unknown risks, including but not necessarily limited to changes in market conditions, natural disasters and other catastrophic events, increased competition, changes in availability and cost of reinsurance, changes in governmental regulations, and general economic conditions, as well as other risks more completely described in our filings with the Securities and Exchange Commission. If any of these assumptions or opinions prove incorrect, any forward-looking statements made on the basis of such assumptions or opinions may also prove materially incorrect in one or more respects.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We believe that interest rate risk and credit risk are the two types of market risk to which we are principally exposed.

Interest rate risk. Our investment portfolio consists principally of investment-grade, fixed income securities, all of which are classified as available for sale. Accordingly, the primary market risk exposure to our debt securities is interest rate risk. In general the fair market value of a portfolio of fixed income securities increases or decreases inversely with changes in market interest rates, while net investment income realized from future investments in fixed income securities increases or decreases along with interest rates. In addition, some of our fixed income securities have call or prepayment options. This could subject us to reinvestment risk should interest rates fall and issuers call their securities and we reinvest at lower interest rates. We attempt to mitigate this interest rate risk by investing in securities with varied maturity dates and by managing the duration of our investment portfolio to a defined range of three to four years. The fair value of our fixed income securities as of March 31, 2005 was $158.9 million. The effective duration of the portfolio as of March 31, 2005 was 3.7 years. Should the market interest rates increase 1.0%, our fixed income investment portfolio would be expected to decline in market value by 3.7%, or $5.8 million, representing the effective duration multiplied by the change in market interest rates. Conversely, a 1.0% decline in interest rates would result in a 3.7%, or $5.87 million, increase in the market value of our fixed income investment portfolio.

Credit risk. An additional exposure to our fixed income securities portfolio is credit risk. We attempt to manage our credit risk by investing only in investment grade securities and limiting our exposure to a single issuer. As of March 31, 2005, our fixed income investments were invested in the following: U.S. Treasury securities — 3.3%, mortgage-backed securities — 10.2%, corporate securities — 15.0%, and tax-exempt securities – 71.4%. As of March 31, 2005, all of our fixed income securities were rated investment grade by nationally recognized statistical rating organizations.

We are subject to credit risks with respect to our reinsurers. Although a reinsurer is liable for losses to the extent of the coverage which it assumes, our reinsurance contracts do not discharge our insurance companies from primary liability to each policyholder for the full amount of the applicable policy, and consequently our insurance companies remain obligated to pay claims in accordance with the terms of the policies regardless of whether a reinsurer fulfills or defaults on its obligations under the related reinsurance agreement. In order to mitigate credit risk to reinsurance companies, we attempt to select financially strong reinsurers with an A.M. Best rating of “A-” or better and continue to evaluate their financial condition.

At March 31, 2005, we had a total of $55.3 million of receivables from reinsurers, including $7.0 million net recoverable from Vesta Fire. Our reinsurance agreement with Vesta Fire allows us and Vesta Fire to offset amounts due to one another under the agreement. Vesta Fire is currently rated “B” (Fair) by A.M. Best. According to our reinsurance agreement, if Vesta Fire’s A.M. Best financial strength rating remained below “B+” we have the right to require Vesta Fire to provide a letter of credit or establish a trust account to collateralize the net amount due to us from Vesta Fire under the reinsurance agreement. On July 27, 2004, we notified Vesta to establish a trust account collateralizing the net amount due to us, due to the fact that Vesta Fire’s A.M. Best rating was below a “B+”. We have $10.3 million currently in a trust account and have notified Vesta to decrease the collateral held in this account to $7.0 million, which will fully collateralize the net amount due to us as of March 31, 2005.

As part of the terms of the acquisition of Affirmative Insurance Company and Insura, Vesta has indemnified us for any losses due to uncollectible reinsurance related to reinsurance agreements entered into with unaffiliated reinsurers prior to December 31, 2003. As of March 31, 2005, all such unaffiliated reinsurers had A.M. Best ratings of “A-” or better.

17

Effects of inflation. We do not believe that inflation has a material effect on our results of operations, except for the effect that inflation may have on interest rates and claims costs. The effects of inflation are considered in pricing and estimating reserves for unpaid claims and claim expenses. The actual effects of inflation on our results are not known until claims are ultimately settled. In addition to general price inflation, we are exposed to a persisting long-term upward trend in the cost of judicial awards for damages. We attempt to mitigate the effects of inflation in our pricing and establishing of loss and loss adjustment expense reserves.

Item 4. Controls and Procedures

We carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2005 pursuant to Rule 13a-15 of the Securities and Exchange Act of 1934, as amended. Based on this evaluation, our principal executive officer and principal financial officer concluded that as of March 31, 2005 our disclosure controls and procedures are effective. Disclosure controls and procedures are controls and procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms and include controls and procedures designed to ensure that information we are required to disclose in such reports is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

There have been no changes in our internal controls over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II

Item 1. Legal Proceedings

We and our subsidiaries are named from time to time as defendants in various legal actions arising in the ordinary course of our business and arising out of or related to claims made in connection with our insurance policies, claims handling and employment related disputes. The plaintiffs in some of these lawsuits have alleged bad faith or extra-contractual damages and some have claimed punitive damages. We believe that the resolution of these legal actions will not have a material adverse effect on our financial position or results of operations.

InsureOne’s former president, James Hallberg, is a defendant, along with eight former employees of InsureOne and two of Hallberg’s family trusts, in actions we brought in the Circuit Court of Cook County, Illinois in December 2003 and in the United States District Court for the Eastern District of Missouri in February 2004 to enforce non-compete and non-solicitation agreements entered into with those employees. Both courts entered interim orders prohibiting the defendants from hiring any employees of InsureOne or one of AIHI’s other underwriting agencies. The order expired in the Missouri action in November of 2004, but is still in effect in the Illinois action and prohibits all defendants, including Hallberg, from hiring any employees of InsureOne et al. until the conclusion of the trial of the Illinois action. The trial in the Illinois action is currently scheduled to begin in August of 2005. On May 17, 2004, the former president of InsureOne filed a counterclaim in the Illinois case seeking unspecified compensatory damages, specific performance, attorneys’ fees and court costs based on causes of action for breach of contract, fraud, negligent misrepresentation and breach of fiduciary duty in connection with Vesta’s original acquisition of the InsureOne business in 2002, the claimant’s employment with InsureOne and our purchase of the 20% minority interest in InsureOne in 2003. InsureOne et al. filed a motion to dismiss these counterclaims, which was granted in part and denied in part. Hallberg subsequently filed amended counterclaims based on causes of action for breach of contract, fraud, and breach of fiduciary duty. InsureOne et al. have answered those counterclaims, and believe the counterclaims are without merit. We are vigorously contesting the counterclaims and are exercising all rights and remedies available to us. In the Missouri action, the parties filed a joint motion for voluntary dismissal which was granted by the Court without prejudice and provided for the right of each party to re-file.

On May 6, 2004, the former minority owners of our InsureOne retail agency, including InsureOne’s former president, in his capacity as trustee of one of his family trusts, filed a complaint in the United States District Court for the Northern District of Illinois alleging causes of action against us and three of our executive officers under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, as well as causes of action for fraudulent misrepresentation, negligent misrepresentation and breach of fiduciary duty in connection with our purchase of the plaintiffs’ 20% minority interest in this retail agency in 2003. The plaintiffs sought damages equal to the difference between the amount paid for the 20% interest and the court’s determination of the value of this interest, plus attorneys’ fees and court costs. Defendants filed a motion to dismiss this case, which was granted by the Court on March 8, 2005. The Court’s March 8, 2005 Order dismissed all claims without prejudice and granted plaintiffs 20 days from the date of the order to attempt to replead their claims. On May 2, 2005, plaintiffs filed a motion to voluntarily dismiss this matter without prejudice, which was granted by the Court. Plaintiffs may still bring these claims in federal court at a later date, or alternatively, the plaintiffs may file the state law claims in state court. We believe these claims are without merit, and should the plaintiffs choose to refile them, we will vigorously contest the claims and exercise all rights and remedies available to us.

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

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of Security Holders

None.

Item 5. Other information

None.

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Item 6. Exhibits

a)   EXHIBITS

3.1	Amended and Restated Certificate of Incorporation of Affirmative Insurance Holdings, Inc. (incorporated by reference to Exhibit 3.1 to our Registration Statement on Form S-1 filed with the SEC on March 22, 2004, File No. 333-113793).
3.2	Amended and Restated Bylaws of Affirmative Insurance Holdings, Inc. (incorporated by reference to Exhibit 3.2 to our Registration Statement on Form S-1 filed with the SEC on March 22, 2004, File No. 333-113793).
4.1	Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 to Amendment No. 3 to our Registration Statement on Form S-1 filed with the SEC on June 14, 2004, File No. 333-113793).
4.2	Form of Registration Rights Agreement between Affirmative Insurance Holdings, Inc. and Vesta Insurance Group, Inc. (incorporated by reference to Exhibit 4.2 to Amendment No. 2 to our Registration Statement on Form S-1 filed with the SEC on May 27, 2004, File No. 333-113793).
10.1	Form of Stock Option Agreement (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on March 1, 2005, File No. 000-50795).
10.2	Form of Restricted Stock Agreement (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed with the SEC on March 1, 2005, File No. 000-50795).
*10.3	Description of Non-Employee Director Compensation
*10.4	Quota Share Reinsurance Agreement between Old American County Mutual Fire Insurance Company and Affirmative Insurance Company dated as of January 1, 2005, for the business written through A-Affordable Managing General Agency, Inc.
*10.5	Quota Share Reinsurance Agreement between Old American County Mutual Fire Insurance Company and Affirmative Insurance Company dated as of January 1, 2005, for the business written through American Agencies General Agency, Inc
*31.1	Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
*31.2	Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
*32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
*32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

* Filed herewith

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.

	Affirmative Insurance Holdings, Inc.
Date: May 16, 2005
	/s/ Timothy A. Bienek
	By: Timothy A. Bienek
	Executive Vice President and Chief Financial Officer
	(and in his capacity as Principal Financial Officer)

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EX-10.3

Exhibit 10.3

Description of Non-Employee Director Compensation

      Pursuant to the Company’s pre-existing policies, non-employee directors receive $25,000 per year for serving on the Company’s Board (their “Annual Retainer”). Committee Chairmen receive an additional $5,000 per year. Non-employee directors receive $2,000 for each regular director meeting attended and $1,000 for each special meeting or committee meeting attended. On May 25, 2004, the Company adopted the Affirmative Insurance Holdings, Inc. 2004 Stock Incentive Plan (the “Stock Incentive Plan”). Under the Stock Incentive Plan, each non-employee director will receive annually, on January 31, an option to purchase 5,000 shares of the Company’s common stock at a price equal to the closing price on the last day of trading in January of that year with a vesting period of one year from the date of grant.

      On February 22, 2005, the Compensation Committee recommended and on February 23, 2005, the Board approved, that in addition to the forgoing, the non-employee directors would receive an annual grant of 1,000 shares of restricted stock and that members of the audit committee would receive an annual grant of an additional 500 shares of restricted stock. This restricted stock will vest on the first anniversary of the grant date, provided however, that the non-employee director must fulfill his or her term for which the restricted shares were granted in order for the restrictions to be lifted.

EX-10.4

Exhibit 10.4

Quota Share Reinsurance Agreement
Number A-AFFORD-05- 001
Table of Contents

Article 1	Recitals
Article 2	Definitions
Article 3	Business Reinsured
Article 4	Obligatory Agreement
Article 5	Term and Cancellation
Article 6	Consideration
Article 7	Loss and Loss Adjustment Expense
Article 8	Reports and Remittances
Article 9	Fronting Fees, Premium Taxes and Provisional Ceding Commission,
Article 10	Errors and Omissions
Article 11	Inspection of Records
Article 12	Offset Clause
Article 13	Arbitration
Article 14	Honorable Undertaking
Article 15	Assessments and Assignments
Article 16	Conservation, Liquidation or Insolvency
Article 17	Hold Harmless
Article 18	Regulatory Matters
Article 19	Loss in Excess of Policy Limits/Extra Contractual Obligations
Article 20	Savings Clause
Article 21	Unauthorized (Non-Admitted) Reinsurance
Article 22	Program Review
Article 23	Service of Suit
Article 24	Intermediary
Article 25	Miscellaneous

QUOTA SHARE

1

QUOTA SHARE REINSURANCE AGREEMENT
NUMBER A-AFFORD-05- 001

This Agreement is made and entered into by and between OLD AMERICAN COUNTY MUTUAL FIRE INSURANCE COMPANY (hereinafter referred to as the “Company”) and AFFIRMATIVE INSURANCE COMPANY (hereinafter referred to as the “Reinsurer”).

THE COMPANY AND REINSURER HEREBY AGREE AS FOLLOWS:

ARTICLE 1 – RECITALS

1.1 The Company and Reinsurer hereby wish to enter into a reinsurance arrangement through which the Company is to bear no business, credit or insurance risk whatsoever (save the risk of the Reinsurer’s insolvency). The Reinsurer shall hold the Company fully harmless and indemnify it for these and all risks arising pursuant to this Agreement.

1.2 The Company and Reinsurer hereby agree that the full consideration provided by the Company in exchange for the fees set forth herein, is to permit the Policies as defined herein to be issued in the name of the Company and reinsured one hundred percent (100%) under this Agreement.

1.3 It is understood and agreed that neither the Company nor the Reinsurer is obligated by any representations or warranties made by any of the parties involved in this transaction unless such representations and warranties are formally included in writing, in this Agreement.

1.4 All business reinsured hereunder shall be produced by A-AFFORDABLE MANAGING GENERAL AGENCY, INC. (Managing General Agent), in accordance with the terms and conditions of the Managing General Agency Agreement effective April 1, 2002, (Managing General Agency Agreement) between the Managing General Agent and the Company, a copy of said Agreement is attached hereto and fully incorporated herein.

1.5 This Agreement sets forth all of the duties and obligations between the Company and the Reinsurer and supersedes any and all prior or contemporaneous or written agreements with respect to matters referred to in this Agreement. This Agreement may not be modified, amended or changed except by an agreement in writing signed by both parties.

ARTICLE 2 – DEFINITIONS

2.1 “Policies” is defined as all policies, endorsements, certificates, contracts, agreements and binders of insurance issued or renewed by Managing General Agent or its designated representatives on or after the effective date of this Agreement on behalf of the Company.

2.2 “Net Written Premium” is defined as the gross premium on all original and renewal Policies written by the Company, less return premium and cancellations.

2.3 “Net Collected Premium” is defined as the total of all collected premiums, including down payments received, on policies written by the Managing General Agent between the Company and the Managing General Agent less return premium and cancellations.

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2

2.4 “Loss in Excess of Policy Limits” (XPL) is defined as any amount which the Company pays or would have been contractually held liable to pay had it not been for the limit of the original Policy.

2.5 “Extra Contractual Obligation” (ECO) is defined as those liabilities not covered under any other provision of this Agreement which arise from the handling of any claim on business covered hereunder, because of, but not limited to, failure by the Company to settle within the policy limit, or by reason of alleged or actual negligence, fraud or bad faith in rejecting an offer of settlement or in the preparation of the defense or in the trial of any action against its insured or reinsured or in the preparation or prosecution of an appeal consequent upon such action. The date on which any ECO is incurred by the Company shall be deemed, in all circumstances, to be the date of the original disaster and/or casualty.

2.6 “Loss Adjustment Expense” shall mean expenditures by the Company that are not part of the indemnity under the original policy (i.e. which do not contribute to exhaustion of the original policy limit), made in connection with the disposition of a claim, loss or legal proceeding (including investigation, negotiation, cost of bonds, court costs, statutory penalties, prejudgment interest or delayed damages, and interest on any judgment or award and legal expenses of litigation) and the Company’s defense costs and legal expenses incurred in direct connection with legal actions (including, but not limited to, Declaratory Judgment actions) brought to determine the Company’s defense and/or indemnification obligations that are allocable only to Policies and claims under Policies subject to this Contract. Any Declaratory Judgment action expenses shall be deemed to have been fully incurred on the same date as the original loss (if any) giving rise to the action.

2.7 “Prejudgment Interest” or “Delayed Damages” shall mean interest or damages added to a settlement, verdict, award or judgment based on the amount of time prior to the settlement, verdict, award or judgment whether or not made part of the settlement, verdict, award or judgment.

ARTICLE 3 – BUSINESS REINSURED

3.1 The Reinsurer hereby reinsures the Company for a one hundred percent (100%) quota share in respect of all liability, including, but not limited to, losses and Loss Adjustment Expenses, under Policies as classified by the Company in the attached Schedule of Business.

3.2 It is understood that the classes of business reinsured under this Agreement are deemed to include coverages required for non-resident drivers under the motor vehicle financial responsibility law or the motor vehicle compulsory insurance law or any similar law of any state or province, following the provisions of the Company’s policies when they include or are deemed to include so-called “Out of State Insurance” provisions.

3.3 All insurance under this Agreement shall be subject to the same rates, terms, conditions and waivers, and to the same modifications and alterations as the respective Policies of the Company.

QUOTA SHARE

3

ARTICLE 4 – OBLIGATORY AGREEMENT

4.1 The Company agrees to cede to the Reinsurer, and the Reinsurer agrees to accept from the Company, a one hundred percent (100%) quota share reinsurance participation under all Policies effective on or after the effective date hereof by the Company covering risks situated in Texas. The liability of the Reinsurer shall commence obligatorily and simultaneously with that of the Company subject to the terms, conditions and limitations set forth in this Agreement.

4.2 Business ceded hereunder shall include every original policy, rewrite, renewal or extension (whether before or after the termination of this Agreement) required by statute or by rule or regulation of the Texas Department of Insurance, or other authority having competent jurisdiction, of any policy of insurance originally ceded hereunder by the Company to the Reinsurer.

4.3 The parties understand and intend that the Managing General Agent and the Reinsurer will agree on the rates to be charged under this program. Rate changes proposed by the Reinsurer shall be incorporated into the rate filing by the Managing General Agent.

ARTICLE 5 – TERM AND CANCELLATION

5.1 This Agreement shall become effective 12:00:01 a.m. (Central Standard Time) on the first day of January 2005, as respects losses arising under Policies effective on or after such date, and shall remain continuously in force unless terminated by either party.

5.2 This Agreement may be terminated by either party at any annual anniversary, giving the other party written notice at least ninety (90) days prior to such date.

5.3 In addition to the provisions set forth in Article 5.2 herein, this Agreement may be terminated at any time in accordance with the following terms and conditions:

a. After thirty (30) days written notice by the Reinsurer or the Company in the event the Reinsurer or Company:

     (i) Is acquired and/or merged by or in any manner becomes under the control of any other company or corporation;

     (ii) Change a majority of its officers or board of directors; or

     (iii) Are the subject of a filing or petition or initiation of any proceeding for supervision, rehabilitation, conservation or liquidation, or any other proceedings for the protection of the Company’s or the Reinsurer’s creditor.

b. By the Company, immediately and automatically, without prior written notice should the Texas Department of Insurance require cancellation or disallow credit for this reinsurance.

c. After fifteen (15) days written notice by the Reinsurer or the Company, in the event of breach of conditions, fraud or default by either party under the terms and conditions of the Agreement.

d. On the effective date of any termination of the Managing General Agency Agreement.

5.4 When the Agreement terminates for any reason, reinsurance hereunder shall continue to apply to the business in force at the time and date of termination until expiration or cancellation of such business. The parties understand and agree that any Policies with effective dates prior to the termination date, but issued after the termination date, are covered under this Agreement.

QUOTA SHARE

4

Additionally, the reinsurance hereunder shall continue to apply as to Policies that must be issued or renewed, as a matter of state law or regulation or because an agent (appointed by the Company at the request of the Reinsurer) has not been timely canceled, or non-renewed, until the expiration dates on said Policies.

5.5 Upon termination of this Agreement for any reason, the Reinsurer and the Company shall not be relieved or released from any obligation that relate to outstanding insurance business created by or under this Agreement. The parties hereto expressly covenant and agree that they will cooperate with each other in the handling of all such run-off insurance business until all Policies have expired and all outstanding losses and Loss Adjustment Expenses have been settled.

While by law and regulations, the Company recognizes its primary obligations to its Policyholders, the Reinsurer recognizes that there shall be no cost or involvement by the Company, unless specifically agreed, in servicing this run-off. The Reinsurer shall bear all costs and expenses associated with handling of such run-off business following the cancellation or termination of this Agreement. If for any reason any managing general agent or agent fails to service any such run-off business (or any business while the Agreement is still in effect), including the payment of claims, then consistent with this Agreement, the Reinsurer’s obligation with respect to such run-off business shall continue and the Reinsurer shall either service such run-off business directly or appoint, at the Reinsurer’s expense, a successor to such managing general agent and/or agent, subject to the approval of the Company, which approval shall not be unreasonably withheld. Such successor shall perform all of the duties and obligations of the managing general agent and/or agent with respect to servicing such run-off business.

5.6 Notices hereunder shall be provided in accordance with Article 23.2, hereof.

ARTICLE 6 – CONSIDERATION

6.1 In consideration of the acceptance by the Reinsurer of one hundred percent (100%) of the Company’s liability on insurance business reinsured hereunder, the Reinsurer is entitled to one hundred percent (100%) of the Net Premium produced by the Managing General Agent and/or agent or the Reinsurer on Policies reinsured less the Provisional Ceding Commission allowed to the Company, which includes premium taxes and fronting fees on Policies subject to reinsurance hereunder.

ARTICLE 7 – LOSS AND LOSS ADJUSTMENT EXPENSE

7.1 All loss settlements, judgments and all interest on said judgments, including losses in excess of policy limits (XPL) and extra contractual obligations (ECO) made by the Company or the Company’s designee under the terms of this Agreement, whether under strict policy conditions or by way of compromise, shall be unconditionally binding upon the Reinsurer. The Reinsurer shall also be liable for one hundred percent (100%) of and pay, or cause to be paid, on behalf of the Company all Loss Adjustment Expenses as defined in Article 2.6. The Reinsurer shall be credited with all salvage or recoveries by the Company on business reinsured hereunder.

7.2 The Reinsurer shall provide a loss adjustment expense allowance equal to 9.0% of net earned premium, inclusive of direct loss adjustment expense charged to specific claim files. Such allowance shall be passed to the Managing General Agency .

QUOTA SHARE

5

7.3 Claims handling shall be accomplished by the Managing General Agent or its designated representative (“Claims Agent”) pursuant to the Managing General Agency Agreement and whose designation is subject to the Company’s continuing approval and shall not be inconsistent with the terms and conditions of this Agreement.

7.4 The Reinsurer’s share of losses, Loss Adjustment Expenses and loss recoveries shall be carried into the monthly account for which provision is hereinafter made; however, when the amount of loss paid by the Company under insurance subject to this Agreement exceeds the balance due the Reinsurer pursuant to Article 8, the Reinsurer will, at the option and the demand of the Company, immediately reimburse the Company by special remittance. The Reinsurer shall retain the right to deduct from any such special remittance any overdue balance due the Reinsurer by the Company.

ARTICLE 8 – REPORTS AND REMITTANCES

8.1 Within thirty-five (35) days after the end of each calendar month, the Company shall provide the Reinsurer a net monthly account of the following:

a. Ceded net written premium;
b. Ceded collected premium for the month;
c. Provisional Ceding Commission on such premium as provided in Article 9.1;
d. Ceded losses and Loss Adjustment Expenses paid during the month;
e. Ceded earned and unearned premium at the end of the month;
f. Ceded outstanding losses and Loss Adjustment Expenses at the end of the month; and
g. Inception to date ceded uncollected premium.

8.2 The Company will immediately settle with the Reinsurer upon receipt of funds from the Managing General Agency, any and all sums due to the Reinsurer, on a Net Collected Premium basis, pursuant to this Agreement (b-c-d).

8.3 The Reinsurer shall remit balances due directly to the Company via wire transfer within forty-eight (48) hours, or as soon as commercially feasible if the net monthly account results in an amount due to the Company, or if during the month, there are no funds to pay losses, and the Company submits additional reports reflecting an amount due to the Company.

ARTICLE 9 – FRONTING FEES, PREMIUM TAXES AND PROVISIONAL CEDING COMMISSION,

9.1 The Reinsurer will allow the Company a Provisional Ceding Commission of twenty-seven percent (27%), which shall be calculated on the basis of all Net Written Premium reinsured hereunder and shall be settled on a Net Collected Premium basis. The Provisional Ceding Commission paid to the Company by the Reinsurer shall be adjusted periodically in accordance with the provisions of Sections 9.4 below.

9.2 The Company will be liable for remitting state premium taxes based on net written premium and net policy fees charged. If service fees charged on any policy covered by this Agreement are deemed taxable for premium tax purposes, then such service fees should be added to the net written premium and net policy fees charged to determine the amount subject to Fronting Fees. Since premium taxes are required to be paid semiannually on March 1st and

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August 1st, the Company may bill the Reinsurers for their proportionate share of the prepayment and shall allow credit for premium taxes on the monthly accounts.

9.3 The Reinsurer acknowledges that the Company is not responsible for any contingent commission adjustment, and any such adjustment shall be settled directly between the Managing General Agent and the Reinsurer. The Reinsurer shall seek any recovery for any contingent commission adjustment directly from the Managing General Agent.

9.4 The Adjusted Ceding Commission Rate shall be calculated as follows and be applied to net earned premium for the underwriting year under consideration as follows:

a. If the ratio of losses incurred to net earned premium is 70.0% or greater, then the Adjusted Ceding Commission for the underwriting year under consideration shall be 24%;

b. If the ratio of losses incurred to net earned premium is less than 70.0%, but not less than 58.0%, then the Adjusted Ceding Commission for the underwriting year under consideration shall be 24.0%, plus 100% of the difference in percentage points between 70.0% and the actual ratio of losses incurred to net earned premium;

c. If the ratio of losses incurred to net earned premium is 58.0% or less, then the Adjusted Ceding Commission for the underwriting year under consideration shall be 36.0%.

Within 45 days of the end of the First Underwriting Year, and for each subsequent quarter thereafter until all losses for the Policies in the First Underwriting Year have been finally settled, the Managing General Agent shall calculate and report the Adjusted Ceding Commission on net earned premium for the First Underwriting Year, subject to the following:

a. With respect to the first and second calculation, if the Adjusted Ceding Commission on net earned premium is greater than the Provisional Ceding Commission previously allowed by the Reinsurer on net earned premium for the underwriting year, the Reinsurer shall remit 75.0% of the difference to the Managing General Agent as promptly as possible after receipt and verification of the Managing General Agent’s report.

b. With respect to the third and each subsequent calculation, if the Adjusted Ceding Commission on net earned premium is less than the Provisional Ceding Commission previously allowed by the Reinsurer on net earned premium for the underwriting year, the Managing General Agent shall remit the difference to the Reinsurer with its report as promptly as possible after receipt and verification of the Managing General Agent’s report. If the Adjusted Ceding Commission on net earned premium is greater than the Provisional Ceding Commission previously allowed by the Reinsurer on net earned premium for the underwriting year, the Reinsurer shall remit the difference to the Managing General Agent as promptly as possible after receipt and verification of the Managing General Agent’s report, but in any event no more than 30 days following receipt and acceptance of the report.

c. Each underwriting year subsequent to the First Underwriting Year shall undergo the adjustment described above.

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ARTICLE 10 – ERRORS AND OMISSIONS

10.1 Inadvertent delays, errors or omissions made in connection with this Agreement or any transaction hereunder shall not relieve either party from any liability which would have attached had such delay, error or omission not occurred, provided always that such error or omission is rectified as soon as possible after discovery.

ARTICLE 11 – INSPECTION OF RECORDS

11.1 All records pertaining to Policies issued on behalf of the Company through or by the Reinsurer or its designated representative subject to this Agreement, shall be deemed to be jointly owned records of the Company and the Reinsurer, and shall be made immediately available to the Company or the Reinsurer or their representative or any duly appointed examiner for any State within the United States; and these records shall be kept in the State of Texas. Notwithstanding the foregoing, the Reinsurer is authorized to maintain duplicate working files of all such records outside the State of Texas. The Company and the Reinsurer agree that neither will destroy any such records in their possession without the prior written approval of the other, except that the Company and Reinsurer shall not be required to retain files longer than required by the guidelines set by the Texas Department of Insurance.

ARTICLE 12 – OFFSET CLAUSE

12.1 The Company or the Reinsurer shall have the right to offset any balance or amounts due from one party to the other under the terms of this Agreement. The party asserting the right of offset may exercise such right at any time whether the balances due are on account of premiums or losses or otherwise.

12.2 The Reinsurer and the Company shall not offset obligations arising under this Agreement with obligations arising under any other agreement except to the extent permitted under state law and/or regulations.

ARTICLE 13 – ARBITRATION

13.1 Unless both parties mutually agree to waive arbitration with respect to a particular dispute, the parties to this Contract hereby agree that binding arbitration shall be the sole remedy for any and all dispute(s) arising between them with reference to any transactions, terms, or conditions under this Contract including its formation and validity. Arbitration proceedings brought hereunder shall be referred for final determination to the majority decision of a Panel of three disinterested arbitrators. Notice of demand for arbitration shall be made in writing and shall be served via certified or registered mail, return receipt requested, on the Respondent to the Arbitration at the Respondent’s current address. The notice requesting arbitration shall identify the contract(s) involved in the dispute, the issues to be resolved in the view of the Petitioner, and the arbitrator selected by the Petitioner. The term “days” as used herein shall mean calendar days.

13.2 The Respondent shall appoint an arbitrator within 30 days of receiving a request by the Petitioner in writing and served via certified or registered mail, return receipt requested, to do so. At the same time as the appointment, the Respondent shall identify in writing any issues which in its view must be resolved in the arbitration proceeding and which were not identified by the Petitioner. If the Respondent fails to appoint its arbitrator within 30 days of being requested

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to do so, in writing, by the Petitioner, the Petitioner shall have the right to appoint the second arbitrator. Within 30 days after their appointment, the two arbitrators so chosen shall select a third arbitrator to act as umpire. If the two arbitrators do not agree as to the selection of a third arbitrator within 60 days after their appointment, the third arbitrator shall be selected from a list of six individuals (three named by each arbitrator) by a judge of the federal district court in Dallas County, Texas.

13.3 Each arbitrator shall be a disinterested, active, or retired official or officer of an insurance or reinsurance company, not under the control or management of either party to this Contract, and shall have experience in the class and type of business subject to this dispute.

13.4 Within 30 days after notice of appointment of all arbitrators, the Petitioner and the Respondent shall each submit a statement of position to the Panel.

13.5 Within 60 days after notice of appointment of all arbitrators, each party shall provide the other with its relevant books, records, and/or other papers not protected from disclosure by either the work-product or attorney client privilege. Other than the exchange of relevant documents, both parties shall refrain from engaging in any type of discovery including, but not limited to, depositions and interrogatories.

13.6 Within 30 days following the exchange of documents, the Petitioner and the Respondent shall submit re-hearing briefs to the Panel.

13.7 Unless some other location is mutually agreeable to the parties, arbitration proceedings shall take place within the municipality wherein the Home Office of the Company is located. Arbitration shall commence as soon as practicable but in no event longer than 120 days after selection of the third arbitrator with notice thereof to the parties. The specific time and site of arbitration shall be promptly agreed to by the parties, or if no Contract is reached, then determined by the Panel.

13.8 The Panel shall be relieved from applying the strict rules of evidence and/or procedure and shall make its decision based on the custom and practice of the insurance and reinsurance business with a view toward affecting this Contract in a reasonable manner. Should either party fail to appear at an arbitration and/or fail to furnish the Panel with any subpoenaed papers or information, the Panel is empowered to proceed ex parte. The Panel shall make its award within 60 days following the close of the hearing. The majority decision of the Panel shall be final and binding upon the parties and shall be reduced to a written award, which may include factual findings, and shall be signed by any two of the three arbitrators, dated and delivered overnight to the parties. The Panel may award pre-judgment and post-judgment interest, but in no case shall the authority of the Panel extend to awarding punitive or exemplary damages. Judgment may be entered upon the award by any court having jurisdiction.

13.9 The expense of its own arbitrator, but shall equally share with the other the expense of the third arbitrator. In the event that the two arbitrators are chosen by one party, as above provided, the expense of the two arbitrators, the third arbitrator and the arbitration shall be equally divided between the Petitioner and the Respondent. Unless mutually agreed other wise, a court reporter transcript shall be taken of the hearing with costs to be divided equally between the parties. The remaining costs of arbitration shall be allocated by the Panel.

13.10 The Arbitration proceeding brought hereunder, any or all provisions contained herein, and arbitration awards entered pursuant to this Article are specifically governed by, subject to

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and enforceable under the Federal Arbitration Act (Title 9, United States Code, Sections 1-14, as amended.)

13.11 Each party agrees that time is of the essence with respect to all terms and conditions referenced in this Article. All deadlines contained in this Article may be extended by mutual Contract of the parties, and if the Panel has been selected, the Panel’s Contract must also be obtained.

13.12 Each party agrees that any arbitration award entered pursuant to and governed by this Article shall not have any precedential or collateral estoppel effect on future arbitrations, proceedings, or controversies, if any, between the parties. Any claim of res judicata or claim preclusion shall itself be subject to arbitration.

13.13 This Article shall survive the termination of this Contract.

ARTICLE 14 – HONORABLE UNDERTAKING

14.1 The purposes of this Contract are not to be defeated by narrow or technical legal interpretations of its provisions. This Contract shall be construed as an honorable undertaking and should be interpreted for the purpose of giving effect to the intentions of the parties hereto.

ARTICLE 15 – ASSESSMENTS AND ASSIGNMENTS

15.1 The Reinsurer hereby assumes liability for any and all costs, assessments or assignments imposed as a result of Policies reinsured hereunder (whether before or after the termination of this Agreement) levied or made by a guaranty fund, insolvency fund, plan, pool, association, or other arrangement created by statute or regulation including, but not limited to, assessments levied by the Volunteer Fire Departments, TAIPA or the Texas Property & Casualty Insurance Guaranty Association.

ARTICLE 16 – CONSERVATION, LIQUIDATION OR INSOLVENCY

16.1 In the event of the insolvency of the Company, the Reinsurance afforded by this Agreement shall be payable directly by the Reinsurer to the Company or its liquidator, receiver or statutory successor on the basis of the liability of the Company under the Policies, without diminution because of the insolvency of the Company, in accordance with the provisions of any State Law which may be involved except:

a. where the Agreement specifically provides another payee of such reinsurance in the event of the insolvency of the Company; or

b. where the Reinsurer with the consent of the direct insured(s) has assumed such Policy obligations of the Company as direct obligations of the Reinsurer to the payees under such policies and in substitution for the obligations of the Company to the payees.

16.2 In the event of the insolvency of the Company, the liquidator, receiver, or statutory successor of the Company shall give written notice to the Reinsurer of the pendency of a claim against the insolvent Company on a Policy within a reasonable time after such claim is filed in the insolvency proceedings. During the pendency of such claim, the Reinsurer may investigate such claim and interpose at its own expense, in the proceeding where such claim is to be adjudicated, any defense or defenses which it may deem available to the Company or its

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liquidator, receiver or statutory successor. The expense thus incurred by the Reinsurer shall be chargeable, subject to court approval, against the insolvent Company as part of the expense of liquidation to the extent of the proportionate share of the benefits that may accrue to the Company solely as a result of the defense undertaken by the Reinsurer.

16.3 If two (2) or more reinsurers are involved in the same claim and a majority in interest elects to interpose defense to such claim, the expense shall be apportioned in accordance with the terms of this Agreement as though such expense had been incurred by the Company.

16.4 As respects subject business assumed as reinsurance under this Agreement, the parties agree that if the Company has a conservator, liquidator, or receiver appointed for it, or becomes the subject of any conservation, liquidation or insolvency proceeding, and the Company is permitted to have all its liabilities under the Policies reinsured hereunder assumed by another licensed insurer, such assuming insurer shall be substituted for the Company as payee of any reinsurance recoverable hereunder in respect of losses under Policies subject hereto, and the Reinsurer shall make payments thereof directly to the substituted insurer.

16.5 In the event the foregoing provisions apply, all the other provisions of this Agreement shall apply to the substituted insurer in the same manner as if said insurer were substituted for the Company as the reinsured party hereunder, and to the extent this Agreement reinsures such substituted insurer, coverage hereunder shall be excluded as respects the Company.

ARTICLE 17 – HOLD HARMLESS

17.1 In consideration of these presents and the reciprocal benefits derived by the Company and the Reinsurer, the Reinsurer assumes liability for any and all uncollected balances, unsettled finance agreements, claims, commission adjustments, losses, loss corridors, demands, causes of action (including, but not limited to, violations of the Texas Deceptive Trade Practices Act or insurance laws or regulations), damages (including, but not limited to, any and all extra contractual or liability in excess of policy limits), judgments and expenses (including, but not limited to, attorney’s fees and costs of court) which may be made against the Company and which are incurred, either directly or indirectly, in connection with this Agreement or contracts related to this Agreement or any actions or failure to take action by the Managing General Agent or any agent or by the Company in successfully asserting its rights hereunder in connection with or with respect to this Agreement. Notwithstanding anything to the contrary, this provision shall not apply to fraud, dishonesty, theft or collusion on the part of any Director, Officer or employee of the Company; or policies not reinsured hereunder; or the Company’s failure to perform its duties and obligations under this Agreement.

17.2 If, for any reason, the Managing General Agent or agent fails, or is unable, to administer the Policies reinsured hereunder (whether the Agreement is still in effect or the business is being run-off), the Reinsurer shall appoint, a third party, subject to the Company’s approval, to administer the business in accordance with the terms and conditions of this Agreement and the agreement with the Managing General Agent. The Reinsurer shall be responsible for the cost of such administration. The Company agrees to cooperate with the Reinsurer and the third party administrator in the run-off of the business. If return premiums or other funds need to be returned or paid to premium finance companies, policyholders, sub-agents or any other party, the Reinsurer shall pay these amounts if the Managing General Agent or agent does not.

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ARTICLE 18 – REGULATORY MATTERS

18.1 It is the parties’ understanding that the Texas Department of Insurance views current premium due over ninety (90) days past due (aged by item and effective date) from insureds or their designated representative to the Company as non-admitted assets. In confirmation of the liabilities assumed by the Reinsurer under this Agreement, the Reinsurer hereby assumes its share of all liability and responsibility for all premiums in the course of collection.

18.2 The Reinsurer shall agree, at no cost to the Company, to take those actions (including, but not limited to, modifications in how funds are handled and how accounts are cleared and settled) and agree to those arrangements necessary to ensure that the Company suffers no adverse impact because of this reinsurance program and is in compliance with the laws of the State of Texas and regulations promulgated by any governmental entity thereof, including the Texas Department of Insurance, insofar as this reinsurance program is concerned, subject to the provisions of Article 16.

18.3 The parties acknowledge that the Company is subject to Article 5.144 of the Texas Insurance Code, which allows the Commissioner of Insurance to order refunds or discounts of premiums determined to be excessive or unfairly discriminatory. The Reinsurer and Managing General Agent agree to be bound by any such determination by the Commissioner and to proportionately make any refund or provide any discount ordered by the Commissioner. This provision shall survive termination of this Agreement and the run-off of all policies under Article 5 of this Agreement.

18.4 The parties acknowledge that the Company currently qualifies for the non-standard auto exemption under subsection 13(f) of the Article 5.13 2 of the Texas Insurance Code and the parties agree to take all necessary action for the Company to continue to qualify for said exemption, including the limitation of premium volume on new business and the non-renewal existing business.

ARTICLE 19 – LOSS IN EXCESS OF POLICY LIMITS/EXTRA CONTRACTUAL OBLIGATIONS

19.1 This Agreement shall protect the Company for one hundred percent (100%) of any loss in excess of Policy limits (XPL) and/or one hundred percent (100%) of the extra contractual obligations (ECO) which shall be deemed to be a loss under the Policy involved and shall be subject to this Agreement.

19.2 Notwithstanding anything stated herein, this Agreement shall not apply to any extra contractual obligation (ECO) incurred by the Company as a result of any fraudulent and/or criminal act by any officer or director of the Company acting individually or collectively or in collusion with any individual or corporation or any other organization or party involved in the presentation, defense or settlement of any claim covered hereunder.

ARTICLE 20 – SAVINGS CLAUSE

20.1 If any law or regulation of any Federal, State or Local Government of the United States of America, or the ruling of officials having supervision over insurance companies, should prohibit or render illegal this Agreement or any portion thereof, as to risks or properties located in the jurisdiction of such authority, either the Company or the Reinsurer may, upon written notice to the other, suspend or abrogate this Agreement insofar as it relates to risks or

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properties located within such jurisdiction to such extent as may be necessary to comply with such law, regulation or ruling. Such illegality shall in no way affect any other portion thereof, provided, however, that the Reinsurer or the Company may terminate or suspend this Agreement insofar as it relates to the Business to which such law or regulation may apply.

20.2 Should any portion of this Agreement be held to be unenforceable by Arbitration or any court of competent jurisdiction, the remainder of such Agreement shall be construed as if originally written without the unenforceable portion thereof, giving effect to the extent possible of the original intent of the parties hereto as expressed in such Agreement as originally written.

ARTICLE 21 – UNAUTHORIZED (NON-ADMITTED) REINSURANCE

21.1 In the event the Company is unable to take reserve credit under this Agreement or the Reinsurer’s A.M. Best rating is below “A-“, the Reinsurer hereby agrees to secure delivery to the Company, prior to the effective date of this Agreement, a clean, irrevocable, evergreen, unconditional letter of credit drawn on a bank that is a member of the Federal Reserve System and approved by the National Association of Insurance Commissioners, and in accordance with the rules and regulations as set forth by the Texas Department of Insurance or any other regulatory authority having jurisdiction, for an amount equal to the Reinsurer’s share of the reserves for unearned premium and outstanding losses and loss expenses, including incurred but not reported losses. The Company agrees to furnish the Reinsurer with necessary accounting data to establish the amount of such letter of credit.

21.2 In the event the Reinsurer and the Company mutually agree, the Reinsurer may, instead of complying with Article 21.1, enter into a security trust agreement and establish a trust account for the benefit of the Company in a bank that is a member of the Federal Reserve System, approved by the National Association of Insurance Commissioners and in accordance with the rules and regulations as set forth by the Texas Department of Insurance or any other regulatory authority having jurisdiction. Such amount shall be determined in accordance with Article 21.1 above.

21.3 The assets deposited in the trust account shall be valued, according to their current fair market value, and shall consist only of cash, certificates of deposit, and/or investments of the types permitted by the Texas Insurance Code, Article 5.75-1 (d), provided that such investments are issued by an institution that is not the parent, subsidiary, or affiliate of either the guarantor or the beneficiary.

21.4 The trust agreement shall further require that all settlements of account between the Company and the Reinsurer be made in cash or its equivalent.

21.5 The Reinsurer and the Company hereby agree that the assets in the trust account established pursuant to this Agreement may be withdrawn by the Company at any time, notwithstanding any other provisions in this Agreement. Such withdrawals shall be utilized and applied by the Company or its successors in interest by operation of law, including without limitation any liquidator, rehabilitator, receiver, or conservator of such Company, without diminution because of insolvency on the part of the Company or the Reinsurer, only for the following purposes:

a. to reimburse the Company for the Reinsurer’s share of premiums returned to the owners of Policies reinsured under this Agreement on account of cancellations of such Policies; or

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b. to reimburse the Company for the Reinsurer’s share of surrenders and benefits or losses paid by the Company pursuant to the provisions of the Policies reinsured under this Agreement; or

c. in the event of notice of termination of the trust, to fund an account with the Company in an amount at least equal to the reinsurers share of reserves described in Article 21.1 above; or

d. to pay any other amounts due the Company under this Agreement.

ARTICLE 22 – PROGRAM REVIEW

22.1 The Reinsurer acknowledges that it has been afforded the opportunity to review the records of the Managing General Agent including but not limited to rate levels, rate filings, underwriting guidelines and claims handling. Although the Company may perform reviews as well, it is understood that the participation of the Reinsurer on this contract is based upon its continuing due diligence and not based upon due diligence performed by the Company.

ARTICLE 23 – SERVICE OF SUIT (BRMA 49C)

23.1 It is agreed that in the event the Reinsurer fails to pay any amount claimed to be due hereunder, the Reinsurer, at the request of the Company, will submit to the jurisdiction of any court of competent jurisdiction within the United States. Nothing in this Article constitutes or should be understood to constitute a waiver of the Reinsurer’s rights to commence an action in any court of competent jurisdiction in the United States, to remove an action to a United States District Court, or to seek a transfer of a case to another court as permitted by the laws of the United States or of any state in the United States.

23.2 Further, pursuant to any statute of any state, territory or district of the United States which makes provision therefore, the Reinsurer hereby designates the party named in its Interests and Liabilities Agreement, or if no party is named therein, the Superintendent, Commissioner or Director of Insurance or other officer specified for that purpose in the statute, or his successor or successors in office, as its true and lawful attorney upon whom may be served any lawful process in any action, suit or proceeding instituted by or on behalf of the Company or any beneficiary hereunder arising out of this Contract.

ARTICLE 24 – INTERMEDIARY

24.1 Neither party hereto has utilized the services of a Reinsurance Intermediary for any actions taken with regard to the negotiation drafting, and/or execution of this Agreement.

ARTICLE 25 – MISCELLANEOUS

25.1 This Agreement has been made and entered into in the State of Texas.

25.2 All notices required to be given hereunder shall be deemed to have been duly given by personally delivering such notice in writing or by mailing it, Certified Mail, return receipt requested, with postage prepaid. Any party may change the address to which notices and other communications hereunder are to be sent to such party by giving the other party written notice thereof in accordance with this provision.

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25.3 This Agreement shall be binding upon the parties hereto, together with their respective executors, administrators, personal representatives, heirs and assigns.

25.4 This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument.

25.5 This Agreement may be amended, modified, or supplemented only by a written instrument executed by all parties hereto.

25.6 This Agreement is the entire Agreement between the parties and supersedes one and all previous agreements, written or oral, and amendments thereto.

25.7 A waiver by the Company, the Reinsurer or its designated representative of any breach or default by the other party under this Agreement shall not constitute a continuing waiver or a waiver by the Company, the Reinsurer or its designated representative of any subsequent act in breach or of default hereunder.

25.8 Headings used in this agreement are for reference purposes only and shall not be deemed a part of this Agreement.

The Company:		The Reinsurer:
OLD AMERICAN COUNTY MUTUAL		AFFIRMATIVE INSURANCE COMPANY
FIRE INSURANCE COMPANY
By:	/s/ Thomas A. McCall	By:	/s/ Teresa K. Hitchcock
Thomas A. McCall, President		Teresa K. Hitchcock, Assistant Vice President
Date: 2/10/2005		Date: 2/15/2005

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SCHEDULE OF BUSINESS

The Company, the Reinsurer and the Managing General Agent agree that the Managing General Agent has the authority to accept, on forms approved by the Company, any Policy, endorsement, binder, certificate, or proposal for insurance. The Managing General Agent’s authority is limited by this Schedule of Business.

     Overall:

Projected Treaty Year Premium	$40,000,000
Maximum Treaty Year Premium	$50,000,000
Territory	Texas only
Maximum policy term	Twelve Months

     Lines of business and maximum limits of liability

Coverage	Maximum Limits
Bodily Injury Liability	$25,023 each person
	$50,023 each accident
Property Damage Liability	$25,023 each accident
Uninsured/Underinsured Motorists
Bodily Injury	$20,023 each person
	$40,023 each accident
Property Damage	$15,023 each accident
Personal Injury Protection	$2,500 each person
Medical payments	$500 each person
Physical Damage	$50,000 each automobile

This Agreement does not apply to and specifically excludes the following:

a. Any business not produced by A-AFFORDABLE MANAGING GENERAL AGENCY, INC. or

b. Any business not classified as private passenger automobile liability or physical damage, or

c. Exclusions specified within the Quota Share Reinsurance Agreement.

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EX-10.5

Exhibit 10.5

Quota Share Reinsurance Agreement
Number AAGAI-05- 001
Table of Contents

Article 1	Recitals
Article 2	Definitions
Article 3	Business Reinsured
Article 4	Obligatory Agreement
Article 5	Term and Cancellation
Article 6	Consideration
Article 7	Loss and Loss Adjustment Expense
Article 8	Reports and Remittances
Article 9	Fronting Fees, Premium Taxes and Provisional Ceding Commission
Article 10	Errors and Omissions
Article 11	Inspection of Records
Article 12	Offset Clause
Article 13	Arbitration
Article 14	Honorable Undertaking
Article 15	Assessments and Assignments
Article 16	Conservation, Liquidation or Insolvency
Article 17	Hold Harmless
Article 18	Regulatory Matters
Article 19	Loss in Excess of Policy Limits/Extra Contractual Obligations
Article 20	Savings Clause
Article 21	Unauthorized (Non-Admitted) Reinsurance
Article 22	Program Review
Article 23	Service of Suit
Article 24	Intermediary
Article 25	Miscellaneous

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QUOTA SHARE REINSURANCE AGREEMENT
NUMBER AAGAI-05- 001

This Agreement is made and entered into by and between OLD AMERICAN COUNTY MUTUAL FIRE INSURANCE COMPANY (hereinafter referred to as the “Company”) and AFFIRMATIVE INSURANCE COMPANY (hereinafter referred to as the “Reinsurer”).

THE COMPANY AND REINSURER HEREBY AGREE AS FOLLOWS:

ARTICLE 1 – RECITALS

1.1 The Company and Reinsurer hereby wish to enter into a reinsurance arrangement through which the Company is to bear no business, credit or insurance risk whatsoever (save the risk of the Reinsurer’s insolvency). The Reinsurer shall hold the Company fully harmless and indemnify it for these and all risks arising pursuant to this Agreement.

1.2 The Company and Reinsurer hereby agree that the full consideration provided by the Company in exchange for the fees set forth herein, is to permit the Policies as defined herein to be issued in the name of the Company and reinsured one hundred percent (100%) under this Agreement.

1.3 It is understood and agreed that neither the Company nor the Reinsurer is obligated by any representations or warranties made by any of the parties involved in this transaction unless such representations and warranties are formally included in writing, in this Agreement.

1.4 All business reinsured hereunder shall be produced by AMERICAN AGENCIES GENERAL AGENCY, INC. dba AFFIRMATIVE INSURANCE SERVICES (Managing General Agent), in accordance with the terms and conditions of the Managing General Agency Agreement effective October 1, 2001, (Managing General Agency Agreement) between the Managing General Agent and the Company, a copy of said Agreement is attached hereto and fully incorporated herein.

1.5 This Agreement sets forth all of the duties and obligations between the Company and the Reinsurer and supersedes any and all prior or contemporaneous or written agreements with respect to matters referred to in this Agreement. This Agreement may not be modified, amended or changed except by an agreement in writing signed by both parties.

ARTICLE 2 – DEFINITIONS

2.1 “Policies” is defined as all policies, endorsements, certificates, contracts, agreements and binders of insurance issued or renewed by Managing General Agent or its designated representatives on or after the effective date of this Agreement on behalf of the Company.

2.2 “Net Written Premium” is defined as the gross premium on all original and renewal Policies written by the Company, less return premium and cancellations.

2.3 “Net Collected Premium” is defined as the total of all collected premiums, including down payments received, on policies written by the Managing General Agent between the Company and the Managing General Agent less return premium and cancellations.

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2.4 “Loss in Excess of Policy Limits” (XPL) is defined as any amount which the Company pays or would have been contractually held liable to pay had it not been for the limit of the original Policy.

2.5 “Extra Contractual Obligation” (ECO) is defined as those liabilities not covered under any other provision of this Agreement which arise from the handling of any claim on business covered hereunder, because of, but not limited to, failure by the Company to settle within the policy limit, or by reason of alleged or actual negligence, fraud or bad faith in rejecting an offer of settlement or in the preparation of the defense or in the trial of any action against its insured or reinsured or in the preparation or prosecution of an appeal consequent upon such action. The date on which any ECO is incurred by the Company shall be deemed, in all circumstances, to be the date of the original disaster and/or casualty.

2.6 “Loss Adjustment Expense” shall mean expenditures by the Company that are not part of the indemnity under the original policy (i.e. which do not contribute to exhaustion of the original policy limit), made in connection with the disposition of a claim, loss or legal proceeding (including investigation, negotiation, cost of bonds, court costs, statutory penalties, prejudgment interest or delayed damages, and interest on any judgment or award and legal expenses of litigation) and the Company’s defense costs and legal expenses incurred in direct connection with legal actions (including, but not limited to, Declaratory Judgment actions) brought to determine the Company’s defense and/or indemnification obligations that are allocable only to Policies and claims under Policies subject to this Contract. Any Declaratory Judgment action expenses shall be deemed to have been fully incurred on the same date as the original loss (if any) giving rise to the action.

2.7 “Prejudgment Interest” or “Delayed Damages” shall mean interest or damages added to a settlement, verdict, award or judgment based on the amount of time prior to the settlement, verdict, award or judgment whether or not made part of the settlement, verdict, award or judgment.

ARTICLE 3 – BUSINESS REINSURED

3.1 The Reinsurer hereby reinsures the Company for a one hundred percent (100%) quota share in respect of all liability, including, but not limited to, losses and Loss Adjustment Expenses, under Policies as classified by the Company in the attached Schedule of Business.

3.2 It is understood that the classes of business reinsured under this Agreement are deemed to include coverages required for non-resident drivers under the motor vehicle financial responsibility law or the motor vehicle compulsory insurance law or any similar law of any state or province, following the provisions of the Company’s policies when they include or are deemed to include so-called “Out of State Insurance” provisions.

3.3 All insurance under this Agreement shall be subject to the same rates, terms, conditions and waivers, and to the same modifications and alterations as the respective Policies of the Company.

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ARTICLE 4 – OBLIGATORY AGREEMENT

4.1 The Company agrees to cede to the Reinsurer, and the Reinsurer agrees to accept from the Company, a one hundred percent (100%) quota share reinsurance participation under all Policies effective on or after the effective date hereof by the Company covering risks situated in Texas. The liability of the Reinsurer shall commence obligatorily and simultaneously with that of the Company subject to the terms, conditions and limitations set forth in this Agreement.

4.2 Business ceded hereunder shall include every original policy, rewrite, renewal or extension (whether before or after the termination of this Agreement) required by statute or by rule or regulation of the Texas Department of Insurance, or other authority having competent jurisdiction, of any policy of insurance originally ceded hereunder by the Company to the Reinsurer.

4.3 The parties understand and intend that the Managing General Agent and the Reinsurer will agree on the rates to be charged under this program. Rate changes proposed by the Reinsurer shall be incorporated into the rate filing by the Managing General Agent.

ARTICLE 5 – TERM AND CANCELLATION

5.1 This Agreement shall become effective 12:00:01 a.m. (Central Standard Time) on the first day of January 2005, as respects losses arising under Policies effective on or after such date, and shall remain continuously in force unless terminated by either party.

5.2 This Agreement may be terminated by either party at any annual anniversary, giving the other party written notice at least ninety (90) days prior to such date.

5.3 In addition to the provisions set forth in Article 5.2 herein, this Agreement may be terminated at any time in accordance with the following terms and conditions:

a. After thirty (30) days written notice by the Reinsurer or the Company in the event the Reinsurer or Company:

     (i) Is acquired and/or merged by or in any manner becomes under the control of any other company or corporation;

     (ii) Change a majority of its officers or board of directors; or

     (iii) Are the subject of a filing or petition or initiation of any proceeding for supervision, rehabilitation, conservation or liquidation, or any other proceedings for the protection of the Company’s or the Reinsurer’s creditor.

b. By the Company, immediately and automatically, without prior written notice should the Texas Department of Insurance require cancellation or disallow credit for this reinsurance.

c. After fifteen (15) days written notice by the Reinsurer or the Company, in the event of breach of conditions, fraud or default by either party under the terms and conditions of the Agreement.

d. On the effective date of any termination of the Managing General Agency Agreement.

5.4 When the Agreement terminates for any reason, reinsurance hereunder shall continue to apply to the business in force at the time and date of termination until expiration or cancellation of such business. The parties understand and agree that any Policies with effective dates prior to the termination date, but issued after the termination date, are covered under this Agreement. Additionally, the reinsurance hereunder shall continue to apply as to Policies that must be

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issued or renewed, as a matter of state law or regulation or because an agent (appointed by the Company at the request of the Reinsurer) has not been timely canceled, or non-renewed, until the expiration dates on said Policies.

5.5 Upon termination of this Agreement for any reason, the Reinsurer and the Company shall not be relieved or released from any obligation that relate to outstanding insurance business created by or under this Agreement. The parties hereto expressly covenant and agree that they will cooperate with each other in the handling of all such run-off insurance business until all Policies have expired and all outstanding losses and Loss Adjustment Expenses have been settled.

While by law and regulations, the Company recognizes its primary obligations to its Policyholders, the Reinsurer recognizes that there shall be no cost or involvement by the Company, unless specifically agreed, in servicing this run-off. The Reinsurer shall bear all costs and expenses associated with handling of such run-off business following the cancellation or termination of this Agreement. If for any reason any managing general agent or agent fails to service any such run-off business (or any business while the Agreement is still in effect), including the payment of claims, then consistent with this Agreement, the Reinsurer’s obligation with respect to such run-off business shall continue and the Reinsurer shall either service such run-off business directly or appoint, at the Reinsurer’s expense, a successor to such managing general agent and/or agent, subject to the approval of the Company, which approval shall not be unreasonably withheld. Such successor shall perform all of the duties and obligations of the managing general agent and/or agent with respect to servicing such run-off business.

5.6 Notices hereunder shall be provided in accordance with Article 23.2, hereof.

ARTICLE 6 – CONSIDERATION

6.1 In consideration of the acceptance by the Reinsurer of one hundred percent (100%) of the Company’s liability on insurance business reinsured hereunder, the Reinsurer is entitled to one hundred percent (100%) of the Net Premium produced by the Managing General Agent and/or agent or the Reinsurer on Policies reinsured less the Provisional Ceding Commission allowed to the Company, which includes premium taxes and fronting fees on Policies subject to reinsurance hereunder.

ARTICLE 7 – LOSS AND LOSS ADJUSTMENT EXPENSE

7.1 All loss settlements, judgments and all interest on said judgments, including losses in excess of policy limits (XPL) and extra contractual obligations (ECO) made by the Company or the Company’s designee under the terms of this Agreement, whether under strict policy conditions or by way of compromise, shall be unconditionally binding upon the Reinsurer. The Reinsurer shall also be liable for one hundred percent (100%) of and pay, or cause to be paid, on behalf of the Company all Loss Adjustment Expenses as defined in Article 2.6. The Reinsurer shall be credited with all salvage or recoveries by the Company on business reinsured hereunder.

7.2 The Reinsurer shall provide a loss adjustment expense allowance equal to 12.0% of net earned premium, inclusive of direct loss adjustment expense charged to specific claim files. Such allowance shall be passed to the Managing General Agency .

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7.3 Claims handling shall be accomplished by the Managing General Agent or its designated representative (“Claims Agent”) pursuant to the Managing General Agency Agreement and whose designation is subject to the Company’s continuing approval and shall not be inconsistent with the terms and conditions of this Agreement.

7.4 The Reinsurer’s share of losses, Loss Adjustment Expenses and loss recoveries shall be carried into the monthly account for which provision is hereinafter made; however, when the amount of loss paid by the Company under insurance subject to this Agreement exceeds the balance due the Reinsurer pursuant to Article 8, the Reinsurer will, at the option and the demand of the Company, immediately reimburse the Company by special remittance. The Reinsurer shall retain the right to deduct from any such special remittance any overdue balance due the Reinsurer by the Company.

ARTICLE 8 – REPORTS AND REMITTANCES

8.1 Within thirty-five (35) days after the end of each calendar month, the Company shall provide the Reinsurer a net monthly account of the following:

a. Ceded net written premium;
b. Ceded collected premium for the month;
c. Provisional Ceding Commission on such premium as provided in Article 9.1;
d. Ceded losses and Loss Adjustment Expenses paid during the month;
e. Ceded earned and unearned premium at the end of the month;
f. Ceded outstanding losses and Loss Adjustment Expenses at the end of the month; and
g. Inception to date ceded uncollected premium.

8.2 The Company will immediately settle with the Reinsurer upon receipt of funds from the Managing General Agency, any and all sums due to the Reinsurer, on a Net Collected Premium basis, pursuant to this Agreement (b-c-d).

8.3 The Reinsurer shall remit balances due directly to the Company via wire transfer within forty-eight (48) hours, or as soon as commercially feasible if the net monthly account results in an amount due to the Company, or if during the month, there are no funds to pay losses, and the Company submits additional reports reflecting an amount due to the Company.

ARTICLE 9 – FRONTING FEES, PREMIUM TAXES AND PROVISIONAL CEDING COMMISSION

9.1 The Reinsurer will allow the Company a Provisional Ceding Commission of twenty-five percent (25%), which shall be calculated on the basis of all Net Written Premium reinsured hereunder and shall be settled on a Net Collected Premium basis. The Provisional Ceding Commission paid to the Company by the Reinsurer shall be adjusted periodically in accordance with the provisions of Sections 9.4 below.

9.2 The Company will be liable for remitting state premium taxes based on net written premium and net policy fees charged. If service fees charged on any policy covered by this

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Agreement are deemed taxable for premium tax purposes, then such service fees should be added to the net written premium and net policy fees charged to determine the amount subject to Fronting Fees. Since premium taxes are required to be paid semiannually on March 1st and August 1st, the Company may bill the Reinsurers for their proportionate share of the prepayment and shall allow credit for premium taxes on the monthly accounts.

9.3 The Reinsurer acknowledges that the Company is not responsible for any contingent commission adjustment, and any such adjustment shall be settled directly between the Managing General Agent and the Reinsurer. The Reinsurer shall seek any recovery for any contingent commission adjustment directly from the Managing General Agent.

9.4 The Adjusted Ceding Commission Rate shall be calculated as follows and be applied to net earned premium for the underwriting year under consideration as follows:

a. If the ratio of losses incurred to net earned premium is 73.5% or greater, then the Adjusted Ceding Commission for the underwriting year under consideration shall be 21%;

b. If the ratio of losses incurred to net earned premium is less than 73.5%, but not less than 59.5%, then the Adjusted Ceding Commission for the underwriting year under consideration shall be 21.0%, plus 100% of the difference in percentage points between 73.5% and the actual ratio of losses incurred to net earned premium;

c. If the ratio of losses incurred to net earned premium is 59.5% or less, then the Adjusted Ceding Commission for the underwriting year under consideration shall be 35.0%.

Within 45 days of the end of the First Underwriting Year, and for each subsequent quarter thereafter until all losses for the Policies in the First Underwriting Year have been finally settled, the Managing General Agent shall calculate and report the Adjusted Ceding Commission on net earned premium for the First Underwriting Year, subject to the following:

a. With respect to the first and second calculation, if the Adjusted Ceding Commission on net earned premium is greater than the Provisional Ceding Commission previously allowed by the Reinsurer on net earned premium for the underwriting year, the Reinsurer shall remit 75.0% of the difference to the Managing General Agent as promptly as possible after receipt and verification of the Managing General Agent’s report.

b. With respect to the third and each subsequent calculation, if the Adjusted Ceding Commission on net earned premium is less than the Provisional Ceding Commission previously allowed by the Reinsurer on net earned premium for the underwriting year, the Managing General Agent shall remit the difference to the Reinsurer with its report as promptly as possible after receipt and verification of the Managing General Agent’s report. If the Adjusted Ceding Commission on net earned premium is greater than the Provisional Ceding Commission previously allowed by the Reinsurer on net earned premium for the underwriting year, the Reinsurer shall remit the difference to the Managing General Agent as promptly as possible after receipt and verification of the Managing General Agent’s report, but in any event no more than 30 days following receipt and acceptance of the report.

c. Each underwriting year subsequent to the First Underwriting Year shall undergo the adjustment described above.

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ARTICLE 10 – ERRORS AND OMISSIONS

10.1 Inadvertent delays, errors or omissions made in connection with this Agreement or any transaction hereunder shall not relieve either party from any liability which would have attached had such delay, error or omission not occurred, provided always that such error or omission is rectified as soon as possible after discovery.

ARTICLE 11 – INSPECTION OF RECORDS

11.1 All records pertaining to Policies issued on behalf of the Company through or by the Reinsurer or its designated representative subject to this Agreement, shall be deemed to be jointly owned records of the Company and the Reinsurer, and shall be made immediately available to the Company or the Reinsurer or their representative or any duly appointed examiner for any State within the United States; and these records shall be kept in the State of Texas. Notwithstanding the foregoing, the Reinsurer is authorized to maintain duplicate working files of all such records outside the State of Texas. The Company and the Reinsurer agree that neither will destroy any such records in their possession without the prior written approval of the other, except that the Company and Reinsurer shall not be required to retain files longer than required by the guidelines set by the Texas Department of Insurance.

ARTICLE 12 – OFFSET CLAUSE

12.1 The Company or the Reinsurer shall have the right to offset any balance or amounts due from one party to the other under the terms of this Agreement. The party asserting the right of offset may exercise such right at any time whether the balances due are on account of premiums or losses or otherwise.

12.2 The Reinsurer and the Company shall not offset obligations arising under this Agreement with obligations arising under any other agreement except to the extent permitted under state law and/or regulations.

ARTICLE 13 – ARBITRATION

13.1 Unless both parties mutually agree to waive arbitration with respect to a particular dispute, the parties to this Contract hereby agree that binding arbitration shall be the sole remedy for any and all dispute(s) arising between them with reference to any transactions, terms, or conditions under this Contract including its formation and validity. Arbitration proceedings brought hereunder shall be referred for final determination to the majority decision of a Panel of three disinterested arbitrators. Notice of demand for arbitration shall be made in writing and shall be served via certified or registered mail, return receipt requested, on the Respondent to the Arbitration at the Respondent’s current address. The notice requesting arbitration shall identify the contract(s) involved in the dispute, the issues to be resolved in the view of the Petitioner, and the arbitrator selected by the Petitioner. The term “days” as used herein shall mean calendar days.

13.2 The Respondent shall appoint an arbitrator within 30 days of receiving a request by the Petitioner in writing and served via certified or registered mail, return receipt requested, to do so. At the same time as the appointment, the Respondent shall identify in writing any issues which in its view must be resolved in the arbitration proceeding and which were not identified by the Petitioner. If the Respondent fails to appoint its arbitrator within 30 days of being requested

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to do so, in writing, by the Petitioner, the Petitioner shall have the right to appoint the second arbitrator. Within 30 days after their appointment, the two arbitrators so chosen shall select a third arbitrator to act as umpire. If the two arbitrators do not agree as to the selection of a third arbitrator within 60 days after their appointment, the third arbitrator shall be selected from a list of six individuals (three named by each arbitrator) by a judge of the federal district court in Dallas County, Texas.

13.3 Each arbitrator shall be a disinterested, active, or retired official or officer of an insurance or reinsurance company, not under the control or management of either party to this Contract, and shall have experience in the class and type of business subject to this dispute.

13.4 Within 30 days after notice of appointment of all arbitrators, the Petitioner and the Respondent shall each submit a statement of position to the Panel.

13.5 Within 60 days after notice of appointment of all arbitrators, each party shall provide the other with its relevant books, records, and/or other papers not protected from disclosure by either the work-product or attorney client privilege. Other than the exchange of relevant documents, both parties shall refrain from engaging in any type of discovery including, but not limited to, depositions and interrogatories.

13.6 Within 30 days following the exchange of documents, the Petitioner and the Respondent shall submit re-hearing briefs to the Panel.

13.7 Unless some other location is mutually agreeable to the parties, arbitration proceedings shall take place within the municipality wherein the Home Office of the Company is located. Arbitration shall commence as soon as practicable but in no event longer than 120 days after selection of the third arbitrator with notice thereof to the parties. The specific time and site of arbitration shall be promptly agreed to by the parties, or if no Contract is reached, then determined by the Panel.

13.8 The Panel shall be relieved from applying the strict rules of evidence and/or procedure and shall make its decision based on the custom and practice of the insurance and reinsurance business with a view toward affecting this Contract in a reasonable manner. Should either party fail to appear at an arbitration and/or fail to furnish the Panel with any subpoenaed papers or information, the Panel is empowered to proceed ex parte. The Panel shall make its award within 60 days following the close of the hearing. The majority decision of the Panel shall be final and binding upon the parties and shall be reduced to a written award, which may include factual findings, and shall be signed by any two of the three arbitrators, dated and delivered overnight to the parties. The Panel may award pre-judgment and post-judgment interest, but in no case shall the authority of the Panel extend to awarding punitive or exemplary damages. Judgment may be entered upon the award by any court having jurisdiction.

13.9 The expense of its own arbitrator, but shall equally share with the other the expense of the third arbitrator. In the event that the two arbitrators are chosen by one party, as above provided, the expense of the two arbitrators, the third arbitrator and the arbitration shall be equally divided between the Petitioner and the Respondent. Unless mutually agreed other wise, a court reporter transcript shall be taken of the hearing with costs to be divided equally between the parties. The remaining costs of arbitration shall be allocated by the Panel.

13.10 The Arbitration proceeding brought hereunder, any or all provisions contained herein, and arbitration awards entered pursuant to this Article are specifically governed by, subject to

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and enforceable under the Federal Arbitration Act (Title 9, United States Code, Sections 1-14, as amended.)

13.11 Each party agrees that time is of the essence with respect to all terms and conditions referenced in this Article. All deadlines contained in this Article may be extended by mutual Contract of the parties, and if the Panel has been selected, the Panel’s Contract must also be obtained.

13.12 Each party agrees that any arbitration award entered pursuant to and governed by this Article shall not have any precedential or collateral estoppel effect on future arbitrations, proceedings, or controversies, if any, between the parties. Any claim of res judicata or claim preclusion shall itself be subject to arbitration.

13.13 This Article shall survive the termination of this Contract.

ARTICLE 14 – HONORABLE UNDERTAKING

14.1 The purposes of this Contract are not to be defeated by narrow or technical legal interpretations of its provisions. This Contract shall be construed as an honorable undertaking and should be interpreted for the purpose of giving effect to the intentions of the parties hereto.

ARTICLE 15 – ASSESSMENTS AND ASSIGNMENTS

15.1 The Reinsurer hereby assumes liability for any and all costs, assessments or assignments imposed as a result of Policies reinsured hereunder (whether before or after the termination of this Agreement) levied or made by a guaranty fund, insolvency fund, plan, pool, association, or other arrangement created by statute or regulation including, but not limited to, assessments levied by the Volunteer Fire Departments, TAIPA or the Texas Property & Casualty Insurance Guaranty Association.

ARTICLE 16 – CONSERVATION, LIQUIDATION OR INSOLVENCY

16.1 In the event of the insolvency of the Company, the Reinsurance afforded by this Agreement shall be payable directly by the Reinsurer to the Company or its liquidator, receiver or statutory successor on the basis of the liability of the Company under the Policies, without diminution because of the insolvency of the Company, in accordance with the provisions of any State Law which may be involved except:

a. where the Agreement specifically provides another payee of such reinsurance in the event of the insolvency of the Company; or

b. where the Reinsurer with the consent of the direct insured(s) has assumed such Policy obligations of the Company as direct obligations of the Reinsurer to the payees under such policies and in substitution for the obligations of the Company to the payees.

16.2 In the event of the insolvency of the Company, the liquidator, receiver, or statutory successor of the Company shall give written notice to the Reinsurer of the pendency of a claim against the insolvent Company on a Policy within a reasonable time after such claim is filed in the insolvency proceedings. During the pendency of such claim, the Reinsurer may investigate such claim and interpose at its own expense, in the proceeding where such claim is to be adjudicated, any defense or defenses which it may deem available to the Company or its

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liquidator, receiver or statutory successor. The expense thus incurred by the Reinsurer shall be chargeable, subject to court approval, against the insolvent Company as part of the expense of liquidation to the extent of the proportionate share of the benefits that may accrue to the Company solely as a result of the defense undertaken by the Reinsurer.

16.3 If two (2) or more reinsurers are involved in the same claim and a majority in interest elects to interpose defense to such claim, the expense shall be apportioned in accordance with the terms of this Agreement as though such expense had been incurred by the Company.

16.4 As respects subject business assumed as reinsurance under this Agreement, the parties agree that if the Company has a conservator, liquidator, or receiver appointed for it, or becomes the subject of any conservation, liquidation or insolvency proceeding, and the Company is permitted to have all its liabilities under the Policies reinsured hereunder assumed by another licensed insurer, such assuming insurer shall be substituted for the Company as payee of any reinsurance recoverable hereunder in respect of losses under Policies subject hereto, and the Reinsurer shall make payments thereof directly to the substituted insurer.

16.5 In the event the foregoing provisions apply, all the other provisions of this Agreement shall apply to the substituted insurer in the same manner as if said insurer were substituted for the Company as the reinsured party hereunder, and to the extent this Agreement reinsures such substituted insurer, coverage hereunder shall be excluded as respects the Company.

ARTICLE 17 – HOLD HARMLESS

17.1 In consideration of these presents and the reciprocal benefits derived by the Company and the Reinsurer, the Reinsurer assumes liability for any and all uncollected balances, unsettled finance agreements, claims, commission adjustments, losses, loss corridors, demands, causes of action (including, but not limited to, violations of the Texas Deceptive Trade Practices Act or insurance laws or regulations), damages (including, but not limited to, any and all extra contractual or liability in excess of policy limits), judgments and expenses (including, but not limited to, attorney’s fees and costs of court) which may be made against the Company and which are incurred, either directly or indirectly, in connection with this Agreement or contracts related to this Agreement or any actions or failure to take action by the Managing General Agent or any agent or by the Company in successfully asserting its rights hereunder in connection with or with respect to this Agreement. Notwithstanding anything to the contrary, this provision shall not apply to fraud, dishonesty, theft or collusion on the part of any Director, Officer or employee of the Company; or policies not reinsured hereunder; or the Company’s failure to perform its duties and obligations under this Agreement. [Mutual Indemnification/Hold Harmless/Failure to Perform]

17.2 If, for any reason, the Managing General Agent or agent fails, or is unable, to administer the Policies reinsured hereunder (whether the Agreement is still in effect or the business is being run-off), the Reinsurer shall appoint, a third party, subject to the Company’s approval, to administer the business in accordance with the terms and conditions of this Agreement and the agreement with the Managing General Agent. The Reinsurer shall be responsible for the cost of such administration. The Company agrees to cooperate with the Reinsurer and the third party administrator in the run-off of the business. If return premiums or other funds need to be returned or paid to premium finance companies, policyholders, sub-agents or any other party, the Reinsurer shall pay these amounts if the Managing General Agent or agent does not.

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ARTICLE 18 – REGULATORY MATTERS

18.1 It is the parties’ understanding that the Texas Department of Insurance views current premium due over ninety (90) days past due (aged by item and effective date) from insureds or their designated representative to the Company as non-admitted assets. In confirmation of the liabilities assumed by the Reinsurer under this Agreement, the Reinsurer hereby assumes its share of all liability and responsibility for all premiums in the course of collection.

18.2 The Reinsurer shall agree, at no cost to the Company, to take those actions (including, but not limited to, modifications in how funds are handled and how accounts are cleared and settled) and agree to those arrangements necessary to ensure that the Company suffers no adverse impact because of this reinsurance program and is in compliance with the laws of the State of Texas and regulations promulgated by any governmental entity thereof, including the Texas Department of Insurance, insofar as this reinsurance program is concerned, subject to the provisions of Article 16.

18.3 The parties acknowledge that the Company is subject to Article 5.144 of the Texas Insurance Code, which allows the Commissioner of Insurance to order refunds or discounts of premiums determined to be excessive or unfairly discriminatory. The Reinsurer and Managing General Agent agree to be bound by any such determination by the Commissioner and to proportionately make any refund or provide any discount ordered by the Commissioner. This provision shall survive termination of this Agreement and the run-off of all policies under Article 5 of this Agreement.

18.4 The parties acknowledge that the Company currently qualifies for the non-standard auto exemption under subsection 13(f) of the Article 5.13 2 of the Texas Insurance Code and the parties agree to take all necessary action for the Company to continue to qualify for said exemption, including the limitation of premium volume on new business and the non-renewal existing business.

ARTICLE 19 – LOSS IN EXCESS OF POLICY LIMITS/EXTRA CONTRACTUAL OBLIGATIONS

19.1 This Agreement shall protect the Company for one hundred percent (100%) of any loss in excess of Policy limits (XPL) and/or one hundred percent (100%) of the extra contractual obligations (ECO) which shall be deemed to be a loss under the Policy involved and shall be subject to this Agreement.

19.2 Notwithstanding anything stated herein, this Agreement shall not apply to any extra contractual obligation (ECO) incurred by the Company as a result of any fraudulent and/or criminal act by any officer or director of the Company acting individually or collectively or in collusion with any individual or corporation or any other organization or party involved in the presentation, defense or settlement of any claim covered hereunder.

ARTICLE 20 – SAVINGS CLAUSE

20.1 If any law or regulation of any Federal, State or Local Government of the United States of America, or the ruling of officials having supervision over insurance companies, should prohibit or render illegal this Agreement or any portion thereof, as to risks or properties located in the jurisdiction of such authority, either the Company or the Reinsurer may, upon written notice to the other, suspend or abrogate this Agreement insofar as it relates to risks or

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properties located within such jurisdiction to such extent as may be necessary to comply with such law, regulation or ruling. Such illegality shall in no way affect any other portion thereof, provided, however, that the Reinsurer or the Company may terminate or suspend this Agreement insofar as it relates to the Business to which such law or regulation may apply.

20.2 Should any portion of this Agreement be held to be unenforceable by Arbitration or any court of competent jurisdiction, the remainder of such Agreement shall be construed as if originally written without the unenforceable portion thereof, giving effect to the extent possible of the original intent of the parties hereto as expressed in such Agreement as originally written.

ARTICLE 21 – UNAUTHORIZED (NON-ADMITTED) REINSURANCE

21.1 In the event the Company is unable to take reserve credit under this Agreement or the Reinsurer’s A.M. Best rating is below “A-“, the Reinsurer hereby agrees to secure delivery to the Company, prior to the effective date of this Agreement, a clean, irrevocable, evergreen, unconditional letter of credit drawn on a bank that is a member of the Federal Reserve System and approved by the National Association of Insurance Commissioners, and in accordance with the rules and regulations as set forth by the Texas Department of Insurance or any other regulatory authority having jurisdiction, for an amount equal to the Reinsurer’s share of the reserves for unearned premium and outstanding losses and loss expenses, including incurred but not reported losses. The Company agrees to furnish the Reinsurer with necessary accounting data to establish the amount of such letter of credit.

21.2 In the event the Reinsurer and the Company mutually agree, the Reinsurer may, instead of complying with Article 21.1, enter into a security trust agreement and establish a trust account for the benefit of the Company in a bank that is a member of the Federal Reserve System, approved by the National Association of Insurance Commissioners and in accordance with the rules and regulations as set forth by the Texas Department of Insurance or any other regulatory authority having jurisdiction. Such amount shall be determined in accordance with Article 21.1 above.

21.3 The assets deposited in the trust account shall be valued, according to their current fair market value, and shall consist only of cash, certificates of deposit, and/or investments of the types permitted by the Texas Insurance Code, Article 5.75-1 (d), provided that such investments are issued by an institution that is not the parent, subsidiary, or affiliate of either the guarantor or the beneficiary.

21.4 The trust agreement shall further require that all settlements of account between the Company and the Reinsurer be made in cash or its equivalent.

21.5 The Reinsurer and the Company hereby agree that the assets in the trust account established pursuant to this Agreement may be withdrawn by the Company at any time, notwithstanding any other provisions in this Agreement. Such withdrawals shall be utilized and applied by the Company or its successors in interest by operation of law, including without limitation any liquidator, rehabilitator, receiver, or conservator of such Company, without diminution because of insolvency on the part of the Company or the Reinsurer, only for the following purposes:

a. to reimburse the Company for the Reinsurer’s share of premiums returned to the owners of Policies reinsured under this Agreement on account of cancellations of such Policies; or

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b. to reimburse the Company for the Reinsurer’s share of surrenders and benefits or losses paid by the Company pursuant to the provisions of the Policies reinsured under this Agreement; or

c. in the event of notice of termination of the trust, to fund an account with the Company in an amount at least equal to the reinsurers share of reserves described in Article 21.1 above; or

d. to pay any other amounts due the Company under this Agreement.

ARTICLE 22 – PROGRAM REVIEW

22.1 The Reinsurer acknowledges that it has been afforded the opportunity to review the records of the Managing General Agent including but not limited to rate levels, rate filings, underwriting guidelines and claims handling. Although the Company may perform reviews as well, it is understood that the participation of the Reinsurer on this contract is based upon its continuing due diligence and not based upon due diligence performed by the Company.

ARTICLE 23 – SERVICE OF SUIT (BRMA 49C)

23.1 It is agreed that in the event the Reinsurer fails to pay any amount claimed to be due hereunder, the Reinsurer, at the request of the Company, will submit to the jurisdiction of any court of competent jurisdiction within the United States. Nothing in this Article constitutes or should be understood to constitute a waiver of the Reinsurer’s rights to commence an action in any court of competent jurisdiction in the United States, to remove an action to a United States District Court, or to seek a transfer of a case to another court as permitted by the laws of the United States or of any state in the United States.

23.2 Further, pursuant to any statute of any state, territory or district of the United States which makes provision therefore, the Reinsurer hereby designates the party named in its Interests and Liabilities Agreement, or if no party is named therein, the Superintendent, Commissioner or Director of Insurance or other officer specified for that purpose in the statute, or his successor or successors in office, as its true and lawful attorney upon whom may be served any lawful process in any action, suit or proceeding instituted by or on behalf of the Company or any beneficiary hereunder arising out of this Contract.

ARTICLE 24 – INTERMEDIARY

24.1 Neither party hereto has utilized the services of a Reinsurance Intermediary for any actions taken with regard to the negotiation drafting, and/or execution of this Agreement.

ARTICLE 25 – MISCELLANEOUS

25.1 This Agreement has been made and entered into in the State of Texas.

25.2 All notices required to be given hereunder shall be deemed to have been duly given by personally delivering such notice in writing or by mailing it, Certified Mail, return receipt requested, with postage prepaid. Any party may change the address to which notices and other communications hereunder are to be sent to such party by giving the other party written notice thereof in accordance with this provision.

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25.3 This Agreement shall be binding upon the parties hereto, together with their respective executors, administrators, personal representatives, heirs and assigns.

25.4 This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument.

25.5 This Agreement may be amended, modified, or supplemented only by a written instrument executed by all parties hereto.

25.6 This Agreement is the entire Agreement between the parties and supersedes one and all previous agreements, written or oral, and amendments thereto.

25.7 A waiver by the Company, the Reinsurer or its designated representative of any breach or default by the other party under this Agreement shall not constitute a continuing waiver or a waiver by the Company, the Reinsurer or its designated representative of any subsequent act in breach or of default hereunder.

25.8 Headings used in this agreement are for reference purposes only and shall not be deemed a part of this Agreement.

The Company:		The Reinsurer:
OLD AMERICAN COUNTY MUTUAL		AFFIRMATIVE INSURANCE COMPANY
FIRE INSURANCE COMPANY
By:	/s/ Thomas A. McCall	By:	/s/ Teresa K. Hitchcock
Thomas A. McCall, President		Teresa K. Hitchcock, Assistant Vice President
Date: 2/10/2005		Date: 2/15/2005

AAGAI QUOTA SHARE 2005

15

SCHEDULE OF BUSINESS

The Company, the Reinsurer and the Managing General Agent agree that the Managing General Agent has the authority to accept, on forms approved by the Company, any Policy, endorsement, binder, certificate, or proposal for insurance. The Managing General Agent’s authority is limited by this Schedule of Business.

     Overall:

Projected Treaty Year Premium	$85,000,000
Maximum Treaty Year Premium	$110,000,000
Territory	Texas only
Maximum policy term	Twelve Months

     Lines of business and maximum limits of liability

Coverage	Maximum Limits
Bodily Injury Liability	$25,057 each person
	$50,057 each accident
Property Damage Liability	$25,057 each accident
Uninsured/Underinsured Motorists
Bodily Injury	$20,057 each person
	$40,057 each accident
Property Damage	$15,057 each accident
Personal Injury Protection	$2,500 each person
Medical payments	$500 each person
Physical Damage	$50,000 each automobile

This Agreement does not apply to and specifically excludes the following:

a. Any business not produced by AMERICAN AGENCIES GENERAL AGENCY, INC dba AFFIRMATIVE INSURANCE SERVICES; or

b. Any business not classified as private passenger automobile liability or physical damage, or

c. Exclusions specified within the Quota Share Reinsurance Agreement.

AAGAI QUOTA SHARE 2005

16

EX-31.1

Exhibit 31.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

I, Thomas E. Mangold, certify that:

1.	I have reviewed this report on Form 10-Q of Affirmative Insurance Holdings, Inc.;
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(s) 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)) 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) 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

(c) 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(s) 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: May 16, 2005

/s/ Thomas E. Mangold  

Thomas E. Mangold 

President and Chief Executive Officer
(Principal Executive Officer) 

EX-31.2

Exhibit 31.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER

      I, Timothy A. Bienek, certify that:

1.	I have reviewed this report on Form 10-Q of Affirmative Insurance Holdings, Inc.;
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(s) 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)) 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) 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

(c) 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(s) 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: May 16, 2005

/s/ Timothy A. Bienek  

Timothy A. Bienek 

Executive Vice President and Chief Financial
Officer (Principal Financial Officer) 

EX-32.1

Exhibit 32.1

CERTIFICATION OF PERIODIC REPORT

      The undersigned, Thomas E. Mangold, President and Chief Executive Officer of Affirmative Insurance Holdings, Inc. (the “Company”), certifies, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that:

(1)	the Interim Report on Form 10-Q of the Company for the period ended March 31, 2005 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and
(2)	the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Dated: May 16, 2005

/s/ Thomas E. Mangold  

Thomas E. Mangold 

President and Chief Executive Officer
(Principal Executive Officer) 

A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

EX-32.2

Exhibit 32.2

CERTIFICATION OF CFO OF PERIODIC REPORT

      The undersigned, Timothy A. Bienek, Executive Vice President and Chief Financial Officer of Affirmative Insurance Holdings, Inc. (the “Company”), certifies, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that:

(1)	the Interim Report on Form 10-Q of the Company for the period ended March 31, 2005 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and
(2)	the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Dated: May 16, 2005

/s/ Timothy A. Bienek  

Timothy A. Bienek 

Executive Vice President and Chief
Financial Officer (Principal Financial
Officer) 

A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.