10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2011

OR

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

For the transition period from             to

Commission file number 000-50795

(Exact name of registrant as specified in its charter)

Delaware	75-2770432
(State or 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.    Yes  x    No  ¨

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

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

Large accelerated filer	¨		Accelerated filer	¨
Non-accelerated filer	¨	(Do not check if a smaller reporting company)	Smaller reporting company	x

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

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

The number of shares outstanding of the registrant’s common stock, $.01 par value, as of November 11, 2011: 15,408,358

AFFIRMATIVE INSURANCE HOLDINGS, INC.

NINE MONTHS ENDED SEPTEMBER 30, 2011

INDEX TO FORM 10-Q

PART I – FINANCIAL INFORMATION	3
Item 1. Financial Statements	3
Consolidated Balance Sheets – September 30, 2011 and December 31, 2010	3
Consolidated Statements of Income (Loss) – Three and Nine Months Ended September  30, 2011 and 2010	4
Consolidated Statements of Stockholders’ Equity – Nine Months Ended September  30, 2011 and 2010	5
Consolidated Statements of Comprehensive Income (Loss) – Three and Nine Months Ended September  30, 2011 and 2010	5
Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2011 and 2010	6
Notes to Consolidated Financial Statements	7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3. Quantitative and Qualitative Disclosures About Market Risk	30
Item 4. Controls and Procedures	31
PART II – OTHER INFORMATION	32
Item 1. Legal Proceedings	32
Item 1A. Risk Factors	32
Item 6. Exhibits	32
SIGNATURES	33

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

	September 30, 2011			December 31, 2010
	(Unaudited)
Assets
Available-for-sale securities, at fair value	$	142,588		$	210,263
Other invested assets		2,809			2,564
Cash and cash equivalents		28,660			46,364
Fiduciary and restricted cash		342			3,866
Accrued investment income		1,501			1,829
Premiums and fees receivable, net		26,368			43,313
Premium finance receivable, net		42,009			43,143
Commissions receivable		2,320			1,652
Receivable from reinsurers		188,660			140,211
Deferred acquisition costs		9,507			11,742
Income taxes receivable		901			1,803
Investment in real property, net		11,913			11,896
Property and equipment (net of accumulated depreciation of $48,884 for 2011 and $41,678 for 2010)		34,096			39,197
Goodwill		163,570			163,570
Other intangible assets (net of accumulated amortization of $7,622 for 2011 and $7,495 for 2010)		16,340			16,468
Prepaid expenses		6,211			5,295
Other assets (net of allowance for doubtful accounts of $7,213 for 2011 and 2010)		2,007			2,545
Total assets	$	679,802		$	745,721
Liabilities and Stockholders’ Equity
Liabilities:
Reserves for losses and loss adjustment expenses	$	262,497		$	252,084
Unearned premium		65,777			92,202
Amounts due to reinsurers		19,391			38,172
Deferred revenue		5,693			7,894
Capital lease obligation		21,584			25,302
Senior secured credit facility		94,014			95,974
Notes payable		76,861			76,873
Deferred tax liability		13,052			12,095
Other liabilities (includes interest rate swaps of $1,453 for 2010)		46,917			52,117
Total liabilities		605,786			652,713
Stockholders’ equity:
Common stock, $0.01 par value; 75,000,000 shares authorized, 18,202,221 shares issued and 15,408,358 shares outstanding at September 30, 2011 and 17,768,721 shares issued and 15,408,358 shares outstanding at December 31, 2010		182			178
Additional paid-in capital		166,135			165,776
Treasury stock, at cost (2,793,863 shares at September 30, 2011 and 2,360,363 shares at December 31, 2010)		(32,910	)		(32,906	)
Accumulated other comprehensive income		14			445
Retained deficit		(59,405	)		(40,485	)
Total stockholders’ equity		74,016			93,008
Total liabilities and stockholders’ equity	$	679,802		$	745,721

See accompanying Notes to Consolidated Financial Statements

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AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (LOSS)

(in thousands, except per share data)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
	(Unaudited)
Revenues
Net premiums earned	$	42,042		$	91,075		$	139,264		$	280,212
Commission income and fees		16,265			18,231			53,593			64,091
Net investment income		1,078			1,160			3,891			3,735
Net realized gains (losses)		(45	)		1,115			71			8,295
Other income (loss)		8			(1,077	)		257			(6,110	)
Total revenues		59,348			110,504			197,076			350,223
Expenses
Net losses and loss adjustment expenses		31,562			76,345			101,376			228,257
Selling, general and administrative expenses		27,919			48,689			89,894			133,775
Depreciation and amortization		2,533			2,381			7,340			7,196
Total expenses		62,014			127,415			198,610			369,228
Operating loss		(2,666	)		(16,911	)		(1,534	)		(19,005	)
Loss on interest rate swaps		—			(252	)		(2	)		(862	)
Interest expense		5,561			5,491			16,291			17,527
Loss before income tax expense		(8,227	)		(22,654	)		(17,827	)		(37,394	)
Income tax expense		231			466			1,093			1,301
Net loss	$	(8,458	)	$	(23,120	)	$	(18,920	)	$	(38,695	)
Basic loss per common share:
Net loss	$	(0.55	)	$	(1.50	)	$	(1.23	)	$	(2.51	)
Diluted loss per common share:
Net loss	$	(0.55	)	$	(1.50	)	$	(1.23	)	$	(2.51	)
Weighted average common shares outstanding:
Basic		15,408			15,415			15,408			15,415
Diluted		15,408			15,415			15,408			15,415

See accompanying Notes to Consolidated Financial Statements

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AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands, except share data)

	Nine Months Ended September 30,
	2011					2010
	Shares		Amounts			Shares		Amounts
	(Unaudited)
Common stock
Balance at beginning of year		17,768,721	$	178			17,768,721	$	178
Issuance of restricted stock awards		433,500		4			—		—
Balance at end of period		18,202,221	$	182			17,768,721	$	178
Additional paid-in capital
Balance at beginning of year				165,776					164,752
Stock-based compensation				359					982
Balance at end of period				166,135					165,734
Retained earnings (deficit)
Balance at beginning of year				(40,485	)				48,446
Net loss				(18,920	)				(38,695	)
Balance at end of period				(59,405	)				9,751
Treasury stock
Balance at beginning of year		2,360,363	$	(32,906	)		2,353,363	$	(32,880	)
Repurchase of restricted stock awards		433,500		(4	)		—		—
Balance at end of period		2,793,863	$	(32,910	)		2,353,363	$	(32,880	)
Accumulated other comprehensive income (loss)
Balance at beginning of year				445					2,859
Change in net unrealized loss on available-for-sale investment securities				(431	)				(879	)
Balance at end of period				14					1,980
Total stockholders’ equity			$	74,016				$	144,763

AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
	(Unaudited)
Net loss	$	(8,458	)	$	(23,120	)	$	(18,920	)	$	(38,695	)
Other comprehensive income (loss):
Unrealized gains (losses) on available-for-sale investment securities arising during period		(472	)		1,137			(360	)		521
Reclassification adjustment for gains (losses) included in net loss		45			(43	)		(71	)		(1,400	)
Other comprehensive income (loss), net		(427	)		1,094			(431	)		(879	)
Total comprehensive loss	$	(8,885	)	$	(22,026	)	$	(19,351	)	$	(39,574	)

See accompanying Notes to Consolidated Financial Statements

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AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

	Nine Months Ended September 30,
	2011			2010
	(Unaudited)
Cash flows from operating activities
Net loss	$	(18,920	)	$	(38,695	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		7,340			7,196
Stock-based compensation expense		316			1,165
Amortization of debt modification costs		310			359
Amortization of debt discount		3,428			4,883
Net realized gains from sales of available-for-sale securities		(71	)		(1,400	)
Realized gain on trading securities		—			(6,897	)
Fair value loss on settlement rights for auction-rate securities		—			6,707
Fair value gain on investment in hedge fund		(245	)		—
Amortization of premiums on investments, net		2,306			2,535
Provision for doubtful premiums receivable		(180	)		342
Loss on interest rate swaps		2			862
Proceeds from insurance recoveries		(212	)		—
Change in operating assets and liabilities:
Fiduciary and restricted cash		3,524			8,458
Premiums, fees and commissions receivable, net		15,764			10,377
Reserves for losses and loss adjustment expenses		10,413			29,699
Amounts due from reinsurers		(66,537	)		(41,631	)
Premium finance receivable, net (related to our insurance premiums)		3,794			(9,715	)
Deferred revenue		(2,201	)		(1,612	)
Unearned premium		(26,425	)		(1,391	)
Deferred acquisition costs		2,235			(16	)
Deferred tax liability		956			956
Income taxes receivable		902			1,290
Other		(3,788	)		2,137
Net cash used in operating activities		(67,289	)		(24,391	)
Cash flows from investing activities
Proceeds from sales of available-for-sale securities		56,277			102,231
Proceeds from maturities of available-for-sale securities		27,163			48,510
Proceeds from sales of trading securities		—			35,470
Purchases of available-for-sale securities		(18,431	)		(160,688	)
Premium finance receivable, net (related to third-party insurance premiums)		(2,660	)		3,763
Purchases of property and equipment		(2,335	)		(4,922	)
Investment in real property		(550	)		(5,630	)
Net cash provided by investing activities		59,464			18,734
Cash flows from financing activities
Proceeds from financing under capital lease obligations		—			28,189
Principal payments under capital lease obligations		(3,718	)		(1,748	)
Principal payments on senior secured credit facility		(5,388	)		(18,360	)
Debt modification costs paid		(769	)		—
Repurchase of restricted stock		(4	)		—
Net cash provided by (used in) financing activities		(9,879	)		8,081
Net increase (decrease) in cash and cash equivalents		(17,704	)		2,424
Cash and cash equivalents at beginning of year		46,364			60,928
Cash and cash equivalents at end of period	$	28,660		$	63,352
Supplemental disclosure of cash flow information:
Cash paid for interest	$	10,911		$	11,795
Cash paid for income taxes	$	335		$	364

See accompanying Notes to Consolidated Financial Statements

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AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

1. General

Affirmative Insurance Holdings, Inc. (the Company), formerly known as Instant Insurance Holdings, Inc., was incorporated in Delaware in June 1998. The Company is a distributor and producer of non-standard personal automobile insurance policies and related products and services for individual consumers in targeted geographic areas. The Company currently offers insurance directly to individual consumers through retail stores in 9 states (Louisiana, Texas, Illinois, Alabama, Missouri, Indiana, South Carolina, Kansas and Wisconsin) as well as through 4,900 independent agents or brokers in 8 states (Louisiana, Texas, Illinois, Alabama, California, Missouri, Indiana and South Carolina).

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements of the Company. In the opinion of management, all adjustments necessary for a fair presentation have been included and are of a normal recurring nature. Interim results are not necessarily indicative of the results that may be expected for the year. The consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2010 included in the Company’s Annual Report on Form 10-K.

The consolidated balance sheet at December 31, 2010 was derived from the audited financial statements at that date but does not include all of the information and notes required by GAAP. All material intercompany transactions and balances have been eliminated in consolidation.

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the 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 reserves for losses and loss adjustment expenses, deferred policy acquisition costs, reinsurance receivables, valuation of available-for-sale securities, goodwill and other intangible assets, and deferred income taxes.

Recently Issued Accounting Standards

ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS, provides identical guidance with concurrently issued international financial reporting standard (IFRS) 13, Fair Value Measurements. Most of the changes in the new standard are clarifications of existing guidance, but it expands the disclosures about fair value measurements, and will require the categorization by level of the fair value hierarchy for items that are not measured at fair value in the statement of financial position, but for which the fair value is required to be disclosed, which would consist of the Company’s debt. In addition, for fair value measurements categorized as Level 3 within the fair value hierarchy, the valuation processes and sensitivity of the fair value measurements to changes in unobservable inputs shall be disclosed. This standard is effective for interim and annual periods beginning after December 15, 2011, and should be applied prospectively. Early adoption is not permitted. The adoption of this standard will not impact the Company’s consolidated financial position, results of operations or cash flows.

ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, will require companies to present the components of net income and comprehensive income in either one or two consecutive financial statements. Companies will no longer be permitted to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. Reclassifications from other comprehensive income must be presented in both the consolidated statement of income and the consolidated statement of other comprehensive income. This standard is effective for interim and annual periods beginning after December 15, 2011, and should be applied retrospectively. Early adoption is permitted. The adoption of this standard will not impact the Company’s consolidated financial position, results of operations or cash flows.

ASU 2010-26, Financial Services-Insurance (Topic 944), modifies the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal insurance contracts. The Task Force reached a final Consensus that requires costs to be incremental or directly related to the successful acquisition of new or renewal contracts to be capitalized as a deferred acquisition

7

cost. This standard is effective for interim and annual periods beginning after December 15, 2011 and may be early adopted as of the beginning of an annual reporting period using either the prospective or retrospective method. Adoption of the new standard could have a material impact on the Company’s consolidated financial position or results of operations. Management is evaluating the impact.

ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (Topic 310), an amended guidance for disclosures about the credit quality of financing receivables and the allowance for credit losses. This update amends existing guidance by requiring more robust and disaggregated disclosures by an entity about the credit quality of its financing receivables and its allowance for credit losses. These disclosures will provide additional information about the nature of credit risks inherent in a company’s financing receivables, how a company analyzes and assesses credit risk in determining its allowance for credit losses, and the reasons for any changes a company may make in its allowance for credit losses. This update is generally effective for interim and annual reporting periods ending on or after December 15, 2010; however, certain aspects of the update pertaining to activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. The adoption of the new guidance had no significant effect on the Company’s consolidated financial statements.

ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820), requires additional disclosures about fair value measurements, including transfers in and out of Levels 1 and 2 and activity in Level 3 on a gross basis, and clarifies certain other existing disclosure requirements including level of disaggregation and disclosures around inputs and valuation techniques. The provisions of the new standard are effective for interim or annual reporting periods beginning after December 15, 2009, except for the additional Level 3 disclosures which became effective for fiscal years beginning after December 15, 2010. This standard is disclosure-only in nature and does not change accounting requirements. Accordingly, adoption of the new standard had no impact on the Company’s consolidated financial position, results of operations or cash flows.

3. Available-for-Sale Investment Securities

The Company’s available-for-sale investment securities are carried at fair value with unrealized gains and losses, net of income taxes, reported in accumulated other comprehensive income, a separate component of stockholders’ equity. Gains and losses realized on the disposition of investment securities are determined on the specific-identification basis and credited or charged to income.

The amortized cost, gross unrealized gains (losses), and estimated fair value of the Company’s available-for-sale securities at September 30, 2011, and December 31, 2010, were as follows (in thousands):

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
September 30, 2011
U.S. Treasury and government agencies	$	12,813	$	181	$	(2	)	$	12,992
Mortgage-backed securities		11,674		290		(148	)		11,816
States and political subdivisions		17,619		369		(1	)		17,987
Corporate debt securities		75,361		898		(182	)		76,077
FDIC-insured certificates of deposit		23,568		151		(3	)		23,716
Total	$	141,035	$	1,889	$	(336	)	$	142,588
December 31, 2010
U.S. Treasury and government agencies	$	25,611	$	142	$	(73	)	$	25,680
Mortgage-backed securities		10,554		295		(19	)		10,830
States and political subdivisions		22,245		280		(137	)		22,388
Corporate debt securities		123,182		1,505		(132	)		124,555
FDIC-insured certificates of deposit		26,687		126		(3	)		26,810
Total	$	208,279	$	2,348	$	(364	)	$	210,263

Expected maturities may differ from contractual maturities because certain borrowers may have the right to call or prepay obligations with or without penalties. The Company’s amortized cost and estimated fair values of fixed-income securities at September 30, 2011 by contractual maturity were as follows (in thousands):

	Amortized Cost		Fair Value
Due in one year or less	$	45,021	$	45,250
Due after one year through five years		77,679		78,769
Due after five years through ten years		6,661		6,753
Mortgage-backed securities		11,674		11,816
Total	$	141,035	$	142,588

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Gross realized gains and losses on available-for-sale investments for the nine months ended September 30 were as follows (in thousands):

	2011			2010
Gross gains	$	237		$	1,455
Gross losses		(166	)		(55	)
Total	$	71		$	1,400

The following table summarizes the Company’s available-for-sale securities in an unrealized loss position at September 30, 2011, and December 31, 2010, the fair value and amount of gross unrealized losses, aggregated by investment category and length of time those securities have been continuously in an unrealized loss position (in thousands):

	September 30, 2011
	Less Than Twelve Months					Twelve Months or Greater					Total
	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
U.S. Treasury and government agencies	$	571	$	(2	)	$	—	$	—		$	571	$	(2	)
Mortgage-backed securities		6,151		(148	)		—		—			6,151		(148	)
States and political subdivisions		551		—			75		(1	)		626		(1	)
Corporate debt securities		9,343		(146	)		1,561		(36	)		10,904		(182	)
FDIC-insured certificates of deposit		749		(1	)		399		(2	)		1,148		(3	)
Total	$	17,365	$	(297	)	$	2,035	$	(39	)	$	19,400	$	(336	)
	December 31, 2010
	Less Than Twelve Months					Twelve Months or Greater					Total
	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
U.S. Treasury and government agencies	$	12,707	$	(73	)	$	—	$	—		$	12,707	$	(73	)
Mortgage-backed securities		3,770		(19	)		—		—			3,770		(19	)
States and political subdivisions		8,619		(137)			—		—			8,619		(137)
Corporate debt securities		23,801		(132	)		—		—			23,801		(132	)
FDIC-insured certificates of deposit		2,183		(3	)		—		—			2,183		(3	)
Total	$	51,080	$	(364	)	$	—	$	—		$	51,080	$	(364	)

The Company’s portfolio contains approximately 37 and 64 individual investment securities that were in an unrealized loss position as of September 30, 2011 and December 31, 2010, respectively.

The unrealized losses at September 30, 2011 were attributable to changes in market interest rates since the securities were purchased. Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include (1) duration and magnitude of the decline in value, (2) the financial condition of the issuer or issuers, (3) structure of the security and (4) the Company’s intent to sell the security or whether its more likely than not that the Company would be required to sell the security before its anticipated recovery in market value. At September 30, 2011, management performed its quarterly analysis of all securities with an unrealized loss and concluded no individual securities were other-than-temporarily impaired.

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4. Reinsurance

In the ordinary course of business, the Company places reinsurance with other insurance companies in order to provide greater diversification of its business and limit the potential for losses arising from large risks. In addition, the Company assumes reinsurance from other insurance companies.

Effective October 1, 2010, the Company entered into a quota-share reinsurance agreement with a third-party reinsurance company ceding 40% of premiums and losses on policies in-force in certain states on October 1, 2010 and policies written through December 31, 2010 on a run-off basis. The Company receives provisional ceding commission which may be adjusted based on the fully-developed loss ratio of the reinsured policies. Written premiums ceded under this agreement totalled $114.6 million as of September 30, 2011.

A separate quota-share reinsurance agreement was put in place effective January 1, 2011. Under the terms of the 2011 agreement, the Company cedes 28% of gross written premium in all states other than Michigan through December 31, 2011. Written premiums ceded under this agreement totalled $15.6 million and $49.5 million during the three and nine months ended September 30, 2011, respectively.

The Company’s quota-share ceding commission rate structure varies based on loss experience for both quota-share agreements. The estimates of loss experience are continually reviewed and adjusted, and the resulting adjustments to ceding commissions are reflected in current operations.

In June 2011, the Company entered into a reinsurance agreement with third-party reinsurers which provides $7.0 million in excess of the first $3.0 million of losses coverage for catastrophic events that may involve multiple insured losses.

In August 2010, the Company entered into an excess of loss reinsurance contract with third-party reinsurers which provides coverage for individual losses in excess of $100,000 up to $1 million. This contract terminated July 31, 2011 on a run-off basis.

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

	Three Months Ended September 30,
	2011									2010
	Written Premium			Earned Premium			Loss and Loss Adjustment Expenses			Written Premium			Earned Premium			Loss and Loss Adjustment Expenses
Direct	$	46,296		$	50,672		$	88,983		$	74,963		$	75,099		$	105,455
Reinsurance assumed		8,224			9,127			9,299			18,331			19,082			18,221
Reinsurance ceded		(15,918	)		(17,757	)		(66,720	)		(3,140	)		(3,106	)		(47,331	)
Total	$	38,602		$	42,042		$	31,562		$	90,154		$	91,075		$	76,345
	Nine Months Ended September 30,
	2011									2010
	Written Premium			Earned Premium			Loss and Loss Adjustment Expenses			Written Premium			Earned Premium			Loss and Loss Adjustment Expenses
Direct	$	154,363		$	173,983		$	184,557		$	231,365		$	228,763		$	224,502
Reinsurance assumed		27,536			33,185			18,569			51,971			57,018			55,502
Reinsurance ceded		(52,084	)		(67,904	)		(101,750	)		(5,588	)		(5,569	)		(51,747	)
Total	$	129,815		$	139,264		$	101,376		$	277,748		$	280,212		$	228,257

10

Under certain of the Company’s reinsurance transactions, the Company has received ceding commissions. The ceding commission rate structure varies based on loss experience. The estimates of loss experience are continually reviewed and adjusted, and the resulting adjustments to ceding commissions are reflected in current operations. Ceding commissions recognized were reflected as a reduction of selling, general and administrative expenses as follows (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Selling, general and administrative expenses	$	(5,367	)	$	(10	)	$	(14,386	)	$	(20	)

The amount of loss reserves and unearned premium the Company would remain liable for in the event its reinsurers are unable to meet their obligations were as follows (in thousands):

	September 30, 2011		December 31, 2010
Losses and loss adjustment expense reserves	$	153,164	$	93,084
Unearned premium reserve		18,329		34,149
Total	$	171,493	$	127,233

The Michigan Catastrophic Claims Association (MCCA) is the mandatory reinsurance facility that covers no-fault medical losses above a specific retention amount in Michigan. For policies effective in 2011 and 2010, the required retention is $0.5 million. As a writer of personal automobile policies in the state of Michigan, the Company cedes premiums and claims to the MCCA. Funding for MCCA comes from assessments against automobile insurers based upon their proportionate market share of the state’s automobile liability insurance market. Insurers are allowed to pass along this cost to Michigan automobile policyholders.

The table below presents the ceded premiums written and ceded loss and loss adjustment expenses to the MCCA for the three and nine months ended September 30, 2011 and 2010 (in thousands):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2011			2010		2011		2010
Ceded premiums written	$	(21	)	$	1,839	$	527	$	3,997
Ceded loss and loss adjustment expenses	$	48,467		$	46,718	$	50,591	$	51,065

The table below presents the total amount of receivables due from reinsurers as of September 30, 2011 and December 31, 2010 (in thousands):

	September 30, 2011		December 31, 2010
MCCA	$	112,580	$	65,727
Quota-share reinsurer for agreements effective in fourth quarter of 2010 and in 2011		49,168		53,743
Vesta Insurance Group		13,107		13,161
Excess of loss reinsurer		4,685		1,429
Excess of loss reinsurer		4,685		1,429
Other		4,435		4,722
Total reinsurance receivable	$	188,660	$	140,211

The quota-share reinsurer for the agreements effective in the fourth quarter of 2010 and in 2011, and the excess of loss reinsurers all have A ratings from A.M. Best. Accordingly, the Company believes there is minimal credit risk related to these reinsurance receivables. Under the reinsurance agreement with Vesta Insurance Group (VIG), including primarily Vesta Fire Insurance Corporation (VFIC), the Company’s wholly-owned subsidiaries, Affirmative Insurance Company (AIC) and Insura Property and Casualty Insurance Company (Insura), had the right, under certain circumstances, to require VFIC to provide a letter of credit or establish a trust account to collateralize gross amounts due from VFIC under the reinsurance agreement. Accordingly, AIC, Insura and VFIC entered into a Security Fund Agreement effective September 2004. In August 2005, AIC received a letter from VFIC’s President that irrevocably confirmed VFIC’s duty and obligation under the Security Fund Agreement to provide security sufficient to satisfy VFIC’s gross obligations under the reinsurance agreement (the VFIC Trust). At September 30, 2011, the VFIC Trust held $16.8 million (after cumulative withdrawals of $8.7 million through September 30, 2011), consisting of a $13.1 million U.S. Treasury money market account and $3.7 million of corporate bonds rated BBB+ or higher, to collateralize the $13.1 million net recoverable (net of $2.9 million payable) from VFIC.

The Company assumes reinsurance from a Texas county mutual insurance company (the county mutual) whereby the Company has assumed 100% of the policies issued by the county mutual for business produced by the Company’s owned MGAs. The county mutual does not retain any of this business and there are no loss limits other than the underlying policy limits. AIC has established a trust to secure the Company’s obligation under this reinsurance contract with a balance of $54.3 million and $52.0 million as of September 30, 2011 and December 31, 2010, respectively.

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At September 30, 2011, $3.6 million was included in reserves for losses and loss adjustment expenses that represented the amounts owed by AIC and Insura under reinsurance agreements with the VIG affiliated companies, including Hawaiian Insurance and Guaranty Company, Ltd (Hawaiian). Affirmative established a trust account to collateralize this payable, which currently holds $20.7 million in securities (the AIC Trust). The Special Deputy Receiver in Texas had cumulative withdrawals from the AIC Trust of $0.4 million through September 2011, and the Special Deputy Receiver in Hawaii had cumulative withdrawals from the AIC Trust of $1.7 million through September 2011.

5. Premium Finance Receivables, Net

Premium finance receivables (related to policies of both the Company and third-party carriers) are secured by unearned premiums from the underlying insurance policies and consisted of the following at September 30, 2011 and December 31, 2010 (in thousands):

	September 30, 2011			December 31, 2010
Premium finance contracts	$	44,662		$	45,866
Unearned finance charges		(2,266	)		(2,286	)
Allowance for credit losses		(387	)		(437	)
Total	$	42,009		$	43,143

Premium finance receivables are secured by the underlying unearned insurance premiums for which the Company obtains assignment from the policyholder in the event of non-payment. When a payment becomes past due, the Company cancels the underlying policy with the insurance carrier and receives the unearned premium to clear unpaid principal and interest. The loan is closed by writing off any uncollected amounts or refunding any overpayment to the customer. Therefore, no finance receivables are past due in excess of thirty days. Losses due to non-realization of premium finance receivables were $0.2 million and 0.5% of total premiums financed for the three months ended September 30, 2011, and $0.2 million and 0.4% of total premiums financed for the three months ended September 30, 2010. Losses due to non-realization of premium finance receivables were $0.5 million and 0.4% of total premiums financed for the nine months ended September 30, 2011, and $0.5 million and 0.4% of total premiums financed for the nine months ended September 30, 2010.

6. Deferred Policy Acquisition Costs

Policy acquisition costs, consisting of primarily commissions, advertising, premium taxes, underwriting and agency expenses, net of ceding commission income, are deferred and charged against income ratably over the terms of the related policies. The components of deferred policy acquisition costs and the related amortization expense were as follows (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Beginning balance	$	10,386		$	24,276		$	11,742		$	24,230
Additions		7,842			21,158			26,244			63,889
Amortization		(8,721	)		(21,188	)		(28,479	)		(63,873	)
Ending balance	$	9,507		$	24,246		$	9,507		$	24,246

7. Goodwill and Other Intangible Assets

The Company completed its annual goodwill and indefinite lived intangible asset impairment analyses as of September 30, 2011. The Company reports under a single reporting segment and, as such, the goodwill analysis is measured under one reporting unit. Consistent with prior assessments, the fair value of the Company’s reporting unit was determined using an internally developed discounted cash flow methodology and other relevant indicators of value available in the market place such as market transactions and trading values of similar companies. Based upon the results of the assessment, the Company concluded that the carrying values of goodwill and other intangible assets were not impaired as of September 30, 2011.

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8. Debt

The Company’s long-term debt instruments and balances outstanding at September 30, 2011 and December 31, 2010 were as follows (in thousands):

	September 30, 2011		December 31, 2010
Notes payable due 2035	$	30,928	$	30,928
Notes payable due 2035		25,774		25,774
Notes payable due 2035		20,159		20,171
Total notes payable		76,861		76,873
Senior secured credit facility		94,014		95,974
Total long-term debt	$	170,875	$	172,847

The $30.9 million notes payable due 2035 are redeemable in whole or in part by the Company. The notes bore an initial interest rate of 7.545% until March 15, 2010. Since March 15, 2010, the securities adjust quarterly to the three-month LIBOR rate plus 3.60%. The interest rate as of September 30, 2011 was 3.95%.

The $25.8 million notes payable due 2035 are redeemable in whole or in part by the Company. The notes bore an initial interest rate of 7.792% until June 15, 2010. Since June 15, 2010, the securities adjust quarterly to the three-month LIBOR rate plus 3.55%. The interest rate as of September 30, 2011 was 3.90%.

The $20.2 million notes payable due 2035 are redeemable by the Company in whole or in part. The notes bore an initial interest rate of the three-month LIBOR rate plus 3.95% not exceeding 12.50% through March 2010 with no limit thereafter. The interest rate as of September 30, 2011 was 4.30%.

In March 2011, the Company entered into an amendment to the facility. The amendment included the following significant items:

• A waiver of any defaults or events of default for the period prior to the effective date of the amendment related to the risk-based capital ratio and loss ratio covenants under the prior terms of the agreement.

• The permitted dividend leverage ratio was changed from 1.5 to 1.0.

• Indebtedness under the baskets for qualified additional subordinated debt and Affirmative Premium Finance Company was eliminated. The Company did not have any such debt.

• A provision was added allowing for the acquisition of $30 million of subordinated debt if the proceeds are used as a capital contribution to the regulated insurance entities.

• The assets and stock of Affirmative Premium Finance Company will be pledged and this entity will become a guarantor of the debt.

• The quarterly requirements for the leverage ratio covenant calculation were changed for the first three quarters of 2011.

• The quarterly requirements for the interest coverage ratio covenant calculation were changed for the first two quarters of 2011.

• The quarterly requirements for the loss ratio covenant calculation were changed from December 31, 2010 through March 31, 2012.

• The annual requirements for the risk-based capital covenant calculation were changed for December 31, 2010 and December 31, 2011.

• At every quarter end, the Company will make a payment to the lenders equal to the excess of cash at the non-regulated entities of $12 million at December 31 and March 31 and $10 million at June 30 and September 30.

• Effective April 1, 2011, the pricing under the agreement changed to if the leverage ratio is greater than 2.3, the pricing is LIBOR plus 9.00%. If the leverage ratio is greater than 2.0 and less than or equal to 2.3, the pricing is LIBOR plus 7.50%. If the leverage ratio is greater than 1.8 and less than or equal to 2.0, the pricing is LIBOR plus 6.25%. The pricing for leverage ratios less than or equal to 1.8 was unchanged.

• The Company has the option to capitalize interest that is in excess of the prior payment terms to the loan balance.

In addition, the Company paid a 0.25% fee to all lenders that approved the amendment.

13

In accordance with ASC 470-50 Debt Modifications and Extinguishments, the Company evaluated the present value of the cash flows under the terms of the amended credit agreement to determine if they were at least 10 percent different from the present value of the remaining cash flows under the terms of the existing credit agreement. It was determined that the terms were not substantially different and therefore should not be accounted for as a debt extinguishment. Accordingly, lender consent fees of approximately $0.3 million were capitalized and will be amortized, along with remaining unamortized debt issuance costs from the March 2009 debt modification, over the remaining term of the senior secured credit facility. Fees paid to other parties of approximately $0.7 million were expensed as incurred in the first nine months of 2011.

During the first nine months of 2011, the Company made principal payments of $5.4 million on the senior secured credit facility. As of September 30, 2011, the principal balance of the senior secured credit facility was $103.0 million with an interest rate of 12.0%.

9. Capital Lease Obligation

In May 2010, the Company entered into a capital lease obligation related to certain computer software, software licenses, and hardware used in the Company’s insurance operations. The Company received cash proceeds from the financing in the amount of $28.2 million. As required by the lease agreements, the Company purchased $28.2 million of FDIC-insured certificates of deposit held in brokerage accounts and pledged such securities as collateral against all of the Company’s obligations under the lease. The dollar amount of collateral pledged is set to decline over the term of the lease as the Company makes the scheduled lease payments. The lease term is 60 months with monthly rental payments totaling approximately $0.6 million. At the end of the initial term, the Company will have the right to purchase the software for a nominal fee, after which all rights, title and interest would transfer to the Company.

Property under capital lease at September 30, 2011 was as follows (in thousands):

	Cost		Accumulated Depreciation		Net
Computer software, software licenses and hardware	$	28,189	$	7,651	$	20,538

Estimated future lease payments for the years ending December 31 (in thousands):

2011	$	1,684
2012		6,736
2013		6,736
2014		6,736
2015		2,807
Total estimated future lease payments		24,699
Less: Amount representing interest		3,115
Present value of future lease payments	$	21,584

10. Income Taxes

The provision for income taxes for the three and nine months ended September 30, 2011 and 2010 consisted of the following (in thousands):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2011			2010		2011		2010
Current tax expense (benefit)	$	(88	)	$	147	$	137	$	345
Deferred tax expense		319			319		956		956
Net income tax expense	$	231		$	466	$	1,093	$	1,301

14

The Company’s effective tax rate differed from the statutory rate of 35% for the three and nine months ended September 30, 2011 and 2010 as follows (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Loss before income taxes	$	(8,227	)	$	(22,654	)	$	(17,827	)	$	(37,394	)
Tax provision computed at the federal statutory income tax rate		(2,879	)		(7,929	)		(6,239	)		(13,088	)
Increases (reductions) in tax resulting from:
Tax-exempt interest		(32	)		(48	)		(106	)		(357	)
State income taxes		(427	)		75			(457	)		140
Valuation allowance		3,701			8,430			7,954			14,586
Other		(132	)		(62	)		(59	)		20
Income tax expense	$	231		$	466		$	1,093		$	1,301
Effective tax rate		(2.8	)%		(2.1	)%		(6.1	)%		(3.5	)%

Net deferred tax assets prior to recognition of the valuation allowance were $60.5 million and $53.4 million at September 30, 2011 and December 31, 2010, respectively. In assessing the realizability of our deferred tax assets, we considered whether it was more likely than not that our deferred tax assets will be realized based upon all available evidence, including scheduled reversal of deferred tax liabilities, historical operating results, projected future operating results, tax carry-back availability, and limitations pursuant to Section 382 of the Internal Revenue Code, among others.

11. Legal and Regulatory Proceedings

The Company and its subsidiaries are named from time to time as parties in various legal actions arising in the ordinary course of the Company’s business and arising out of or related to claims made in connection with the Company’s insurance policies and claims handling. Except as noted below and in the Company’s prior Forms 10-Q for the 2011 fiscal year, there are no material changes with respect to legal and regulatory proceedings previously disclosed in Note 16 to the consolidated financial statements included in the Company’s Form 10-K for the year ended December 31, 2010. The Company believes that the resolution of these legal actions will not have a material adverse effect on the Company’s consolidated financial position or results of operations. However, the ultimate outcome of these matters is uncertain.

On October 26, 2010, the Chapter 7 Trustee for Brooke Corporation, Brooke Capital Corporation and Brooke Investments, Inc., along with Brooke Agency Services Company, LLC (“BASC”), filed an adversary proceeding in the U.S. Bankruptcy Court for the District of Kansas against Affirmative Insurance Holdings, Inc., Affirmative Insurance Services, Inc., Affirmative Insurance Services of Illinois, Inc., and Affirmative Insurance Company. On September 15, 2011, the parties reached a settlement of this matter which, subject to final court approval, will resolve all matters in controversy. The settlement will not have a material adverse effect on the Company’s consolidated financial position or results of operations.

On August 17, 2009, plaintiff Toni Hollinger filed a putative class action in the U.S. District Court for the Eastern District of Texas against several county mutual insurance companies and reinsurance companies, including Affirmative Insurance Company. The complaint alleges that defendants engaged in unfair discrimination and violated the Texas Insurance Code by charging different policy fees for the same class and hazard of insurance written through county mutual insurance companies. On August 5, 2010, the Court issued an order dismissing plaintiff’s claims for lack of subject matter jurisdiction, and Plaintiff appealed the dismissal of her claims. On September 6, 2011, the Fifth Circuit Court of Appeals affirmed the District Court’s dismissal of this action.

12. Net Loss Per Common Share

Net loss per common share is based on the weighted average number of shares outstanding. Diluted weighted average shares is calculated by adjusting basic weighted average shares outstanding by all potentially dilutive stock options and restricted stock. Stock options outstanding of 1,772,500 and 1,245,900 as of September 30, 2011 and 2010, respectively, were not included in the computation of diluted earnings per share because the exercise price of the options was greater than the average market price of the common stock and thus the inclusion would have been anti-dilutive.

15

The following table sets forth the reconciliation of numerators and denominators for the basic and diluted earnings per share computation for the three and nine months ended September 30, 2011 and 2010 (in thousands, except per share amounts):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Numerator:
Loss from continuing operations	$	(8,458	)	$	(23,120	)	$	(18,920	)	$	(38,695	)
Denominator:
Weighted average common shares outstanding		15,408			15,415			15,408			15,415
Weighted average diluted shares outstanding		15,408			15,415			15,408			15,415
Basic loss per common share from continuing operations:	$	(0.55	)	$	(1.50	)	$	(1.23	)	$	(2.51	)
Diluted loss per common share from continuing operations:	$	(0.55	)	$	(1.50	)	$	(1.23	)	$	(2.51	)

On March 18, 2011, 433,500 shares of Affirmative’s common stock were issued on a restricted basis, and the voting rights for all of the shares were assigned to New Affirmative, LLC via a written irrevocable proxy at the time the stock awards were made. These shares were not included in the computation of basic or diluted earnings per share due to the performance conditions not being met. On August 10, 2011, the restricted shares were repurchased at par and 1,272,500 stock options were awarded to various executives.

13. Related Party Transactions

The Company has entered into certain transactions with a partnership that is affiliated with J. Christopher Flowers. Mr. Flowers is affiliated with New Affirmative LLC, the majority shareholder of the Company. In the fourth quarter of 2010, the Company committed to invest $2.5 million in Varadero, a hedge fund, and $10.0 million in a related liquidity-focused product. The investment manager of Varadero is Varadero Capital, L.P., of which Varadero GP, LLC is the general partner. Both the investment manager and general partner are partially-owned by an entity affiliated with Mr. Flowers. As of September 30, 2011, the Company had funded $2.5 million in the hedge fund and approximately $9.3 million in the related liquidity-focused product. At September 30, 2011, the fair value of the hedge fund was approximately $2.8 million, based on net asset value and recorded as other invested assets, and the fair value of the liquidity-focused product was approximately $9.1 million, included in available-for-sale securities in the consolidated balance sheets.

14. Fair Value of Financial Instruments

The Company utilizes a hierarchy of valuation techniques for the disclosure of fair value estimates based on whether the significant inputs into the valuation are observable. In determining the level of hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect the Company’s significant market assumptions. The Company measures certain assets and liabilities at fair value on a recurring basis, including investment securities classified as available-for-sale, cash equivalents, other invested assets, other receivables and interest rate swaps. Following is a brief description of the type of valuation information that qualifies a financial asset or liability for each level:

Level 1 — Unadjusted quoted market prices for identical assets or liabilities in active markets which are accessible by the Company.

Level 2 — Observable prices in active markets for similar assets or liabilities. Prices for identical or similar assets or liabilities in markets that are not active. Directly observable market inputs for substantially the full term of the asset or liability, e.g., interest rates and yield curves at commonly quoted intervals, volatilities, prepayment speeds, default rates, and credit spreads. Market inputs that are not directly observable, but are derived from or corroborated by observable market data.

Level 3 — Unobservable inputs based on the Company’s own judgment as to assumptions a market participant would use, including inputs derived from extrapolation and interpolation that are not corroborated by observable market data.

The Company evaluates the various types of financial assets and liabilities to determine the appropriate fair value hierarchy based upon trading activity and the observability of market inputs. The Company employs control processes to validate the reasonableness of the fair value estimates of its assets and liabilities, including those estimates based on prices and quotes obtained from independent third-party sources. The Company’s procedures generally include, but are not limited to, initial and ongoing evaluation of methodologies used by independent third-parties and monthly analytical reviews of the prices against current pricing trends and statistics.

16

Where possible, the Company utilizes quoted market prices to measure fair value. For assets and liabilities that have quoted market prices in active markets, the Company uses the quoted market prices as fair value and includes these prices in the amounts disclosed in Level 1 of the hierarchy. When quoted market prices in active markets are unavailable, the Company determines fair values based on independent external valuation information, which utilizes various models and valuation techniques based on a range of inputs including pricing models, quoted market prices of publicly traded securities with similar duration and yield, time value, yield curve, prepayment speeds, default rates and discounted cash flows. In most cases, these estimates are determined based on independent third-party valuation information, and the amounts are disclosed as Level 2 or Level 3 of the fair value hierarchy depending on the level of observable market inputs.

Financial assets and financial liabilities measured at fair value on a recurring basis

The following table provides information as of September 30, 2011 about the Company’s financial assets measured at fair value on a recurring basis (in thousands):

	September 30, 2011		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
U.S. Treasury and government agencies	$	12,992	$	12,992	$	—	$	—
Mortgage-backed securities		11,816		—		11,816		—
States and political subdivisions		17,987		—		17,987		—
Corporate debt securities		76,077		—		76,077		—
FDIC-insured certificates of deposit		23,716		—		23,716		—
Total investment securities		142,588		12,992		129,596		—
Cash and cash equivalents		28,660		28,660		—		—
Fiduciary and restricted cash		342		342		—		—
Other invested assets		2,809		—		—		2,809
Total assets	$	174,399	$	41,994	$	129,596	$	2,809

The following table provides information as of December 31, 2010 about the Company’s financial assets and liabilities measured at fair value on a recurring basis (in thousands):

	December 31, 2010		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
U.S. Treasury and government agencies	$	25,680	$	25,680	$	—	$	—
Mortgage-backed securities		10,830		—		10,830		—
States and political subdivisions		22,388		—		22,388		—
Corporate debt securities		124,555		—		124,555		—
FDIC-insured certificates of deposit		26,810		—		26,810		—
Total investment securities		210,263		25,680		184,583		—
Cash and cash equivalents		46,364		46,364		—		—
Fiduciary and restricted cash		3,866		3,866		—		—
Other invested assets		2,564		—		—		2,564
Total assets	$	263,057	$	75,910	$	184,583	$	2,564
Liabilities:
Interest rate swaps (other liabilities)	$	1,453	$	—	$	—	$	1,453
Total liabilities	$	1,453	$	—	$	—	$	1,453

Level 1 Financial assets

Financial assets classified as Level 1 in the fair value hierarchy include U.S. Government bonds and certain government agencies securities and cash and cash equivalents. These securities are actively traded and the Company estimates the fair value of these securities using unadjusted quoted market prices. Cash equivalents primarily consist of highly liquid money market funds, which are reflected within Level 1 of the fair value hierarchy.

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Level 2 Financial assets

Financial assets classified as Level 2 in the fair value hierarchy include mortgage-backed securities, tax-exempt securities, corporate bonds and FDIC-insured certificates of deposit. The fair value of these securities is determined based on observable market inputs provided by independent third-party pricing services and the Company discloses the fair values of these investments in Level 2 of the fair value hierarchy. To date, the Company has not experienced a circumstance where it has determined that an adjustment is required to a quote or price received from independent third-party pricing sources. To the extent the Company determines that a price or quote is inconsistent with actual trading activity observed in that investment or similar investments, the Company would determine a fair value using this observable market information and disclose the occurrence of this circumstance. All of the fair values of securities disclosed in Level 2 are estimated based on independent third-party pricing services.

Level 3 Financial assets and liabilities

At September 30, 2011, the Company’s Level 3 financial assets include other invested assets related to an investment in a hedge fund, which is presented as a separate line item in the consolidated balance sheets. The Company measured the fair value of other invested assets on the basis of the net asset value of the fund as reported by the fund manager.

The Company’s Level 3 financial liabilities are interest rate swaps. The fair value of these swaps was determined by quotes from brokers that are not considered binding. The interest rate swaps expired during the first half of 2011.

Fair value measurements for assets in Level 3 for the three months ended September 30, 2011 were as follows (in thousands):

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3) Other Invested Assets
Balance at July 1, 2011	$	2,840
Transfers into Level 3		—
Total losses included in earnings		(31	)
Settlements		—
Balance at September 30, 2011	$	2,809

The Company did not have any transfers between Levels 1 and 2 during the period ended September 30, 2011.

Fair value measurements for assets in Level 3 for the nine months ended September 30, 2011 were as follows (in thousands):

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3) Other Invested Assets
Balance at January 1, 2011	$	2,564
Transfers into Level 3		—
Total gains included in earnings		245
Settlements		—
Balance at September 30, 2011	$	2,809

Fair value measurements for liabilities in Level 3 for the nine months ended September 30, 2011 were as follows (in thousands):

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3) Interest Rate Swaps
Balance at January 1, 2011	$	1,453
Transfers into Level 3		—
Total losses included in earnings		2
Settlements		(1,455	)
Balance at September 30, 2011	$	—

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Gains and losses (realized and unrealized) for Level 3 assets and liabilities included in earnings for the nine months ended September 30, 2011, are reported in net investment income and loss on interest rate swaps as follows (in thousands):

	Net Investment Income		Loss on Interest Rate Swaps
Assets
Total gains realized in earnings	$	245	$	—
Liabilities
Total losses realized in earnings		—		(2	)
Total for the period ended September 30, 2011	$	245	$	(2	)

Fair values represent the Company’s best estimates and may not be substantiated by comparisons to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. The following financial liabilities are not required to be recorded at fair value, but their fair value is disclosed.

Notes payable — The fair values of the notes payable were determined using a third-party valuation source and were estimated to be $18.4 million in the aggregate with a total carrying value of $76.9 million at September 30, 2011.

Senior secured credit facility — The fair value of the senior secured credit facility was determined using a third-party valuation source and was estimated to be $85.1 million with a carrying value of $94.0 million at September 30, 2011.

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

OVERVIEW

We are a distributor and producer of non-standard personal automobile insurance policies for individual consumers in targeted geographic markets. Non-standard personal automobile insurance policies provide coverage to drivers who find it difficult to obtain insurance from standard automobile insurance companies due to their lack of prior insurance, age, driving record, limited financial resources or other factors. Non-standard personal automobile insurance policies generally require higher premiums than standard automobile insurance policies for comparable coverage.

As of September 30, 2011, our subsidiaries included insurance companies licensed to write insurance policies in 40 states, underwriting agencies, retail agencies with 203 owned stores and a relationship with one unaffiliated underwriting agency. We are currently active in offering insurance directly to individual consumers through retail stores in 9 states (Louisiana, Texas, Illinois, Alabama, Missouri, Indiana, South Carolina, Kansas and Wisconsin) and distributing our own insurance policies through our owned retail stores and 4,900 independent agents or brokers in 8 states (Louisiana, Texas, Illinois, Alabama, California, Missouri, Indiana and South Carolina). In March 2011, we discontinued writing new business in the state of Michigan, and in June 2011 we discontinued writing renewals. In May 2010, we discontinued writing new and renewal policies in the state of Florida. In July 2010, we discontinued writing new and renewal insurance policies in New Mexico.

We believe that the delivery of non-standard personal automobile insurance policies to individual consumers requires the interaction of four basic operations, each with a specialized function:

• Insurance companies, which possess the regulatory authority and capital necessary to issue insurance policies;

• Underwriting agencies, which supply centralized infrastructure and personnel required to design and service insurance policies that are distributed through retail agencies;

• Retail agencies, which provide multiple points of sale under established local brands with personnel licensed and trained to sell insurance policies and ancillary products to individual consumers; and

• Premium finance companies, which provide payment alternatives to individual customers of our retail agencies.

Our four operating components often function as a vertically integrated unit, capturing the premium and associated risk and commission income and fees generated from the sale of an insurance policy. There are other instances, however, when each of our operations functions with unaffiliated entities on an unbundled basis, either independently or with one or two of the other operations. For example, our retail stores earn commission income and fees from sales of non-standard automobile insurance policies issued by third-party insurance carriers.

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.

CRITICAL ACCOUNTING POLICIES

There have been no changes of critical accounting policies since December 31, 2010.

We completed our annual goodwill and indefinite lived intangible asset impairment analyses as of September 30, 2011. We report as a single reporting segment and, as such, the goodwill analysis is measured under one reporting unit. Consistent with prior assessments, our fair value was determined using an internally developed discounted cash flow methodology and other relevant indicators of value available in the market place such as market transactions and trading values of similar companies. Based upon the results of the assessment, we concluded that the carrying values of goodwill and other intangible assets were not impaired as of September 30, 2011.

Key inputs in our valuation model are projected cash flows, future inflationary trends, future tax rates, and the risk-adjusted discount rates. The risk-adjusted discount rate was developed using a capital asset pricing model to estimate our weighted-average cost of capital and was estimated at 14.5%. The relative weight of capital for debt was estimated at approximately 20 percent based on observed industry averages.

Based on the valuation model results, management concluded that goodwill was not impaired as our fair value exceeded the carrying value. Further, the fair value obtained from the discounted cash flow model was subject to a stress test by decreasing forecasted cash flows by 15% and increasing the discount rate by 100 basis points to 15.5%. The indicated stress value was sufficient to cover our book value.

Management believes that the current market displacement caused by the continuing global financial market issues as well as the limited volume of its own shares that trade daily has resulted in the decrease in our market capitalization that is not representative of the long-term value.

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RECENTLY ISSUED ACCOUNTING STANDARDS

Refer to Note 2 to the unaudited Consolidated Financial Statements for a discussion of certain accounting standards that have been adopted during 2011 and certain accounting standards that we have not yet been required to adopt and may be applicable to the Company’s future Consolidated Financial Statements.

MEASUREMENT OF PERFORMANCE

We are an insurance holding company engaged in the underwriting, servicing and distributing of non-standard personal automobile insurance policies and related products and services. We distribute our products through three distinct distribution channels: our retail stores, independent agents and unaffiliated underwriting agencies. We generate earned premiums and fees from policyholders through the sale of our insurance products. In addition, through our retail stores, we sell insurance policies of third-party insurers and other products or services of unaffiliated third-party providers and thereby earn commission income from those third-party providers and insurers and fees from the customers.

As part of our corporate strategy, we treat our retail stores as independent agents, encouraging them to sell to their individual customers whatever products are most appropriate for and affordable to those customers. We believe that this offers our retail customers the best combination of service and value, developing stronger customer loyalty and improving customer retention. In practice, this means that in our retail stores, the relative proportion of the sales of our own insurance products as compared to the sales of the third-party policies will vary depending upon the competitiveness of our insurance products in the marketplace during the period. This reflects our intention of maintaining the margins in our insurance company subsidiaries, even at the cost of business lost to third-party carriers.

In the independent agency distribution channel and the unaffiliated underwriting agency distribution channel, the effect of competitive conditions is the same as in our retail store distribution channel. As in our retail stores, independent agents (either working directly with us or through unaffiliated underwriting agencies) not only offer our products but also offer their customers a selection of products by third-party carriers. Therefore, our insurance products must be competitive in pricing, features, commission rates and ease of sale or the independent agents will sell the products of those third parties instead of our products. We believe that we are generally competitive in the markets we serve, and we constantly evaluate our products relative to those of other carriers.

Premiums. One measurement of our performance is the level of gross premiums written and a second measurement is the relative proportion of premiums written through our three distribution channels. The following table displays our gross premiums written and assumed by distribution channel (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
Our underwriting agencies:
Retail agencies	$	39,043	$	47,104	$	125,262	$	144,213
Independent agencies		12,034		41,394		44,973		123,124
Subtotal		51,077		88,498		170,235		267,337
Unaffiliated underwriting agencies		3,443		4,796		11,664		15,999
Total	$	54,520	$	93,294	$	181,899	$	283,336

Total gross premiums written for the three months ended September 30, 2011 decreased $38.8 million, or 41.6%, compared with the prior year quarter. Total gross premiums written for the nine months ended September 30, 2011 decreased $101.4 million, or 35.8%, compared with the prior year period. This decrease was due to a number of actions taken during 2010 and into 2011 to increase prices and strengthen underwriting standards to improve the profitability of the gross premiums written. Improved processes and monitoring of pricing activity have been put in place. We suspended or constrained new business production for unprofitable independent agent relationships, which included our withdrawal from the Michigan market. We expect that these actions will continue to have a negative effect on premium production levels in 2011, but should improve the profitability of the business.

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In our retail distribution channel, gross premiums written consist of premiums written for our affiliated insurance carriers’ products only and do not include premiums written for third-party insurance carriers in our retail stores. We earn commission income and fees in our retail distribution channel for sales of third-party insurance policies. The following represents gross premiums written produced by our retail agencies (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
Our policies	$	39,043	$	47,104	$	125,262	$	144,213
Third-party carrier policies		15,163		11,970		42,718		36,056
Total	$	54,206	$	59,074	$	167,980	$	180,269

Gross premiums written of our policies in our retail distribution channel for the three and nine months ended September 30, 2011 decreased $8.1 million and $19.0 million, or 17.1% and 13.1%, respectively, compared with the prior year. This decrease is a result of the pricing and underwriting actions on our policies. However, third-party policies increased $3.2 million and $6.7 million, or 26.7% and 18.5%, respectively, for the three and nine months ended September 30, 2011.

In our independent agency distribution channel, gross premiums written for the three and nine months ended September 30, 2011 decreased $29.4 million and $78.2 million, or 70.9% and 63.5%, respectively, compared with the prior year.

Gross premiums written by our unaffiliated underwriting agencies for the three and nine months ended September 30, 2011 decreased $1.4 million and $4.3 million, or 28.2% and 27.1%, respectively, compared with the prior year.

We introduced a multivariate pricing product in May 2011 for new business in Louisiana, in June 2011 for new business in Alabama and Texas, and in September 2011 for new business in Illinois. The new product is expected to result in an improvement in profitability through better segment pricing.

The following table displays our gross premiums written and assumed by state (in thousands):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2011			2010		2011		2010
Louisiana	$	28,791		$	35,876	$	93,400	$	109,923
Texas		8,362			18,684		28,019		53,271
Illinois		5,980			10,565		19,816		31,812
Alabama		5,644			7,392		19,357		23,086
California		3,419			4,763		11,583		15,873
Indiana		1,497			2,662		4,983		7,946
South Carolina		756			1,381		2,503		4,295
Missouri		418			1,130		1,546		4,010
Michigan		(382	)		10,325		633		30,123
Other		35			516		59		2,997
Total	$	54,520		$	93,294	$	181,899	$	283,336

The following table displays our net premiums written by distribution channel (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Our underwriting agencies:
Retail agencies – gross premiums written	$	39,043		$	47,104		$	125,262		$	144,213
Ceded reinsurance		(11,152	)		—			(34,370	)		—
Subtotal retail agencies net premiums written		27,891			47,104			90,892			144,213
Independent agencies – gross premiums written		12,034			41,394			44,973			123,124
Ceded reinsurance		(3,515	)		(1,839	)		(12,479	)		(3,997	)
Subtotal independent agencies net premiums written		8,519			39,555			32,494			119,127
Unaffiliated underwriting agencies – gross premiums written		3,443			4,796			11,664			15,999
Ceded reinsurance		(969	)		(19	)		(3,253	)		(73	)
Subtotal unaffiliated underwriting agencies net premiums written		2,474			4,777			8,411			15,926
Excess of loss coverages with various reinsurers		(121	)		—			(1,496	)		—
Catastrophe coverages with various reinsurers		(161	)		(1,282	)		(486	)		(1,518	)
Total net premiums written	$	38,602		$	90,154		$	129,815		$	277,748

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Total net premiums written for the three months ended September 30, 2011 decreased $51.6 million, or 57.2%, compared with the prior year quarter. Total net premiums written for the nine months ended September 30, 2011 decreased $147.9 million, or 53.3%, compared with the prior year period. The decrease was primarily due to the decline in gross written premium production and the quota-share reinsurance agreements put in place for 2010 and 2011. Ceded premiums for the three and nine months ended September 30 were $15.9 million and $52.1 million, respectively, in 2011 and $3.1 million and $5.6 million, respectively, in 2010.

Effective October 1, 2010, the Company entered into a quota-share reinsurance agreement with a third-party reinsurance company ceding 40% of premiums and losses on policies in-force in all states other than Michigan on October 1, 2010 and policies written through December 31, 2010.

A separate quota-share reinsurance agreement was put in place effective January 1, 2011. Under the terms of the 2011 agreement, the Company cedes 28% of gross written premium in all states other than Michigan through December 31, 2011. The Company’s quota-share ceding commission rate structure for both quota-share agreements varies based on loss experience for both agreements.

In November 2011, we entered into a new quota-share reinsurance agreement that cedes 10% of Alabama, Illinois, Louisiana and Texas business from September 1, 2011 through year end and 40% of all business on an in-force basis from year end 2011 through the end of 2012 for those same states. This agreement is subject to Illinois Department of Insurance approval.

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RESULTS OF OPERATIONS

We had a net loss of $8.5 million and $23.1 million for the three months ended September 30, 2011 and 2010, respectively. We had a net loss of $18.9 million and $38.7 million for the nine months ended September 30, 2011 and 2010, respectively.

Comparison of the Three Months Ended September 30, 2011 to the Three Months Ended September 30, 2010

Total revenues for the three months ended September 30, 2011 decreased $51.2 million, or 46.3%, compared with the three months ended September 30, 2010. The decrease was due to decreases in net premiums earned, commission income and fees, net realized gains and net investment income, partially offset by an increase in other income.

The largest component of revenue is net premiums earned on insurance policies. Net premiums earned for the current quarter decreased $49.0 million, or 53.8%, compared with the prior year quarter primarily due to the decline in net written premium and the effects of reinsurance purchased in 2011. Since insurance premiums are earned over the service period of the policies, the revenue in the current quarter includes premiums earned on insurance products written through our three distribution channels in both current and previous periods.

Commission Income and Fees. Another measurement of our performance is the relative level of production of commission income and fees. Commission income and fees consist of (a) policy, installment, premium finance and agency fees earned for business written or assumed by our insurance companies both through independent agents and our retail agencies and (b) the commission, premium finance and agency fee income earned on sales of unaffiliated, third-party companies’ insurance policies or other products sold by our retail agencies. These various types of commission income and fees are impacted in different ways by the decisions we make in pursuing our corporate strategy.

Policy, installment, premium finance and agency fees are earned for business written or assumed by our insurance companies both through independent agents and our retail agencies. Generally, we can increase or decrease agency fees, installment fees, and interest rates subject to limited regulatory restrictions, but policy fees must be approved by the applicable state’s department of insurance. Premium finance fees are financing fees earned by our premium finance subsidiaries, and consist of origination and servicing fees as well as interest on premiums that customers choose to finance.

Commissions, premium finance and agency fees are earned on sales of third-party companies’ products sold by our retail agencies. As described above, in our owned stores, there can be a shift in the relative proportion of the sales of third-party insurance products as compared to sales of our own carriers’ products due to the relative competitiveness of our insurance products that could result in an increase in our commission income and fees from non-affiliated third-party insurers. We negotiate commission rates with the various third-party carriers whose products we agree to sell in our retail stores. As a result, the level of third-party commission income will also vary depending upon the mix by carrier of third-party products that are sold. In addition, we earn fees from the sales of other products and services such as auto club memberships and bond cards offered by unaffiliated companies.

The following sets forth the components of consolidated commission income and fees earned for the current quarter and the prior year quarter (in thousands):

	Three Months Ended September 30,
	2011		2010
Policyholder fees	$	5,660	$	7,491
Premium finance revenue		5,428		5,731
Commissions and fees		4,147		3,778
Agency fees		1,030		1,230
Other, net		—		1
Total commission income and fees	$	16,265	$	18,231

Total commission income and fees decreased $2.0 million, or 10.8%, compared with the prior year quarter. Policyholder fees decreased $1.8 million, or 24.4%, due to the lower overall volume of premiums written and a change in mix of states where these fees were realized. Premium finance revenue decreased $0.3 million, or 5.3%, compared with the prior year quarter. Commissions and fees increased $0.4 million, or 9.8%, compared with the prior year quarter due to the growth in the sale of third-party carrier policies.

Net Investment Income. Net investment income for the current quarter decreased $0.1 million, or 7.1%, compared with the prior year quarter. The decrease was primarily due to a 35.6% decrease in total average invested assets to $147.8 million during the current quarter from $229.4 million during the prior year quarter, which was partially offset by an increase in income from our investment in real estate. The average investment yield was 2.3% in the current quarter, compared with 2.2% in the prior year quarter. The $0.3 million net increase in income from our investment in real estate is due to a new long-term lease which commenced in the fourth quarter of 2010.

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At September 30, 2011, our fixed-income investments were invested in the following: corporate debt securities 53.4%; FDIC-insured certificates of deposit 16.6%; states and political subdivisions securities 12.6%; U.S. Treasury and government agencies securities 9.1%; and mortgage-backed securities 8.3%. The average quality of our portfolio was A+ at September 30, 2011. We attempt to mitigate interest rate risk by managing the duration of our fixed-income portfolio to the duration of our reserves. As of September 30, 2011, the effective duration of our fixed-income investment portfolio was 1.9 years.

Losses and Loss Adjustment Expenses. Since the largest expenses of an insurance company are the losses and loss adjustment expenses, another measurement of our insurance carriers’ performance is the level of such expenses, specifically as a ratio to earned premiums. Our losses and loss adjustment expenses are a blend of the specific estimated and actual costs of providing the coverage contracted by the purchasers of our insurance policies. We maintain reserves to cover our estimated ultimate liability for losses and related loss adjustment expenses for both reported and unreported claims on the insurance policies issued by our insurance companies. The establishment of appropriate reserves is an inherently uncertain process, involving actuarial and statistical projections of what we expect to be the cost of the ultimate settlement and administration of claims based on historical claims information, estimates of future trends in claims severity, changes in the mix of business/limits and other variable factors such as inflation. Due to the inherent uncertainty of estimating reserves, reserve estimates can be expected to vary from period to period. The claim initiatives that we started in the second half of 2009 shortened the claims payment cycle and reduced the number of claims outstanding. The acceleration of payment patterns has necessitated increased use of judgment by management to account for the deviation in trends. To the extent that our reserves prove to be inadequate in the future, we would be required to increase our reserves for losses and loss adjustment expenses and incur a charge to earnings in the period during which such reserves are increased. The historic development of our reserves for losses and loss adjustment expenses is not necessarily indicative of future trends in the development of these amounts.

Losses and loss adjustment expenses for the current quarter decreased $44.8 million, or 58.7%, compared with the prior year quarter. The percentage of losses and loss adjustment expense to net premiums earned (the loss ratio) was 75.1% in the current quarter, compared with 83.8% in the prior year quarter. The accident year decline in the loss ratio for the quarter compared with the 2010 accident year was due to the pricing and underwriting actions that were taken as well as additional process changes implemented in the handling of claims to mitigate the significant increases in severity that occurred due to the claims initiatives. The accident year decline was even more significant taking into account the impact of the quota-share treaties that were entered into for the fourth quarter of 2010 and for all of 2011. Loss adjustment expenses include all of the business subject to the quota-share treaties. As such, the quota-share treaties’ impact on the loss ratio was to increase it by 3.8 points for the third quarter of 2011.

The following table displays the impact of loss development related to prior periods’ business on our loss ratio for the current quarter and the prior year quarter:

	Three Months Ended September 30,
	2011			2010
Loss ratio – current quarter		75.1	%		82.7	%
(Favorable) adverse loss ratio development – prior period business		—			1.1
Reported loss ratio		75.1	%		83.8	%

Selling, General and Administrative Expenses. Another measurement of our performance that addresses our overall efficiency is the level of selling, general and administrative expenses. We recognize that our customers are primarily motivated by low prices. As a result, we strive to keep our costs as low as possible to be able to keep our prices affordable and thus to maximize our sales while still maintaining profitability. Our selling, general and administrative expenses include not only the cost of acquiring the insurance policies through our insurance carriers (the amortization of the deferred acquisition costs) and managing our insurance carriers and the retail stores, but also the costs of the holding company. The largest component of selling, general and administrative expenses is personnel costs, including payroll, benefits and accrued bonus expenses. Selling, general and administrative expenses decreased $20.8 million, or 42.7%, compared with the prior year quarter, primarily due to a decrease in policy acquisition expenses due to the decrease in premium production and the ceding commission from the quota-share reinsurance agreements.

Deferred policy acquisition costs represent the deferral of expenses that we incur in acquiring new business or renewing existing business. Policy acquisition costs, consisting of primarily commission, advertising, premium taxes, underwriting and retail agency expenses, are initially deferred and then charged against income ratably over the terms of the related policies through amortization of the deferred policy acquisition costs. Thus, the amortization of deferred acquisition costs is correlated with earned premium and the ratio of amortization of deferred acquisition costs to earned premium in an accounting period is another measurement of performance.

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Amortization of deferred policy acquisition costs is a major component of SG&A expenses. The following table sets forth the impact that amortization of deferred acquisition costs had on SG&A expenses and the change in deferred acquisition costs (in thousands):

	Three Months Ended September 30,
	2011			2010
Amortization of deferred acquisition costs	$	8,721		$	21,188
Other selling, general and administrative expenses		19,198			27,501
Total selling, general and administrative expenses	$	27,919		$	48,689
Total as a percentage of net premiums earned		66.4	%		53.5	%
Beginning deferred acquisition costs	$	10,386		$	24,276
Additions		7,842			21,158
Amortization		(8,721	)		(21,188	)
Ending deferred acquisition costs	$	9,507		$	24,246
Amortization of deferred acquisition costs as a percentage of net premiums earned		20.7	%		23.3	%

Loss on Interest Rate Swaps. Loss on interest rate swaps for the three months ended September 30, 2011 decreased $0.3 million compared with the same period in the prior year. The loss relates to the impact on the determination of fair value associated with the decline in short-term interest rates implied in the forward yield curve. One swap instrument expired in February 2011 and the remaining swap instrument expired in April 2011.

Interest Expense. Interest expense for the current quarter increased $0.1 million, or 1.3%, compared with the prior year quarter. This increase was due to an increase in the interest rate on the senior secured credit facility, which was partially offset by a decrease in the amortization of debt discount, a decrease in interest expense on the lease obligation entered into in May 2010 and a decrease in interest rates on the notes payable. Amortization of debt discount was $1.1 million in the current quarter as compared with $1.4 million for the prior year quarter.

Income Taxes. Income tax expense for the current quarter decreased $0.2 million, or 50.4%, compared with the prior year quarter. The income tax expense for both periods was primarily due to an increase in the deferred tax liability related to goodwill and state tax expense.

Our net deferred tax assets prior to recognition of valuation allowance were $60.5 million and $53.4 million at September 30, 2011 and December 31, 2010, respectively. In assessing the realizability of our deferred tax assets, we considered whether it was more likely than not that our deferred tax assets will be realized based upon all available evidence, including scheduled reversal of deferred tax liabilities, historical operating results, projected future operating results, tax carry-back availability, and limitations pursuant to Section 382 of the Internal Revenue Code, among others. Based on this assessment, we began recording a valuation allowance against deferred taxes in December 2009.

Comparison of the Nine Months Ended September 30, 2011 to the Nine Months Ended September 30, 2010

Total revenues for the nine months ended September 30, 2011 decreased $153.1 million, or 43.7%, compared with the nine months ended September 30, 2010. The decrease was due to decreases in net premiums earned, commission income and fees, and net realized gains, partially offset by an increase in other income and net investment income.

The largest component of revenue is net premiums earned on insurance policies. Net premiums earned for the current period decreased $140.9 million, or 50.3%, compared with the prior year period due to the decline in net written premium and the effects of reinsurance purchased in 2011. Since insurance premiums are earned over the service period of the policies, the revenue in the current period includes premiums earned on insurance products written through our three distribution channels in both current and previous periods.

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Commission Income and Fees.

The following sets forth the components of consolidated commission income and fees earned for the current period and the prior year period (in thousands):

	Nine Months Ended September 30,
	2011		2010
Policyholder fees	$	19,620	$	30,907
Premium finance revenue		17,716		17,427
Commissions and fees		12,810		11,994
Agency fees		3,447		3,763
Total commission income and fees	$	53,593	$	64,091

Total commission income and fees decreased $10.5 million, or 16.4%, compared with the prior year period. Policyholder fees decreased $11.3 million, or 36.5%, due to the lower overall volume of premiums written and a change in mix of states where these fees are realized. Premium finance revenue increased $0.3 million, or 1.7%, due to increases in the number of policies financed and revenue per policy. We experienced a steady increase in premium finance revenue since December 2007 when we began financing third-party premiums. Commissions and fees increased $0.8 million, or 6.8%, due to more of our retail customers choosing third-party products due to pricing and underwriting actions and an expansion of our ancillary product sales.

Net Investment Income. Net investment income for the current period increased $0.2 million, or 4.2%, compared with the prior year period. The increase was primarily due to an increase in income from our investment in real estate and from our investment in a hedge fund, which was partially offset by a 26.9% decrease in total average invested assets to $171.3 million during the current period from $234.3 million during the prior year period and a reduction in yields. The average investment yield was 2.3% (2.4% on a taxable equivalent basis) in the current period, compared with 2.3% (2.7% on a taxable equivalent basis) in the prior year period. The $1.0 million net increase in income from our investment in real estate is due to a new long-term lease which commenced in the fourth quarter of 2010. We entered into an investment in a hedge fund in the fourth quarter of 2010, which increased $0.2 million in fair value during the nine months ended September 30, 2011.

In the first quarter of 2010, we began to reposition our investment portfolio by decreasing our exposure to tax-exempt investments. The repositioning was completed in the second quarter of 2010. We sold $102.2 million of available-for-sale securities during the nine-month period ended September 30, 2010 for a net realized gain of $1.4 million.

Net Realized Gains (Losses) and Other Income (Loss). Net realized gains (losses) for the current period decreased $8.2 million, or 99.1%, compared with the prior year period. Other income (loss) for the current period increased $6.4 million, or 104.2%, compared with the prior year period. The 2010 activity was primarily due to the settlement of the auction-rate municipal securities.

For the nine-month period ended September 30, 2011, other income included $0.2 million for a business interruption insurance settlement related to Hurricane Gustav.

For the nine-month period ended September 30, 2010, other income included $0.6 million related to a settlement received from legal proceedings.

Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses for the current period decreased $126.9 million, or 55.6%, compared with the prior year period. The percentage of losses and loss adjustment expense to net premiums earned (the loss ratio) was 72.8% in the current period, compared with 81.5% in the prior year period. The accident year loss ratio for the current period decreased 150 basis points compared with the 2010 accident year loss ratio for the first nine months of 2010. A better comparison is to compare the 76.4% loss ratio for the current accident period to the 85.4% ratio for the full 2010 accident year. The decline in the loss ratio for 2011 compared with the 2010 accident year was due to the pricing and underwriting actions that were taken as well as additional process changes implemented in the handling of claims to mitigate the significant increases in severity that occurred due to the claims initiatives. Also, there was $5.0 million of favorable prior period development in the current period due to Vesta-related reserves, compared with the prior year period’s adverse loss development of $10.0 million primarily related to our 2009 Texas and Michigan business. The accident year decline was even more significant taking into account the impact of the quota-share treaties that were entered into for the fourth quarter of 2010 and for all of 2011. Loss adjustment expenses include all of the business subject to the quota-share treaties. As such, the quota-share treaties’ impact on the loss ratio was to increase it by 3.5 points for the first nine months of 2011.

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The following table displays the impact of loss development related to prior periods’ business on our loss ratio for the current period and the prior year period:

	Nine Months Ended September 30,
	2011			2010
Loss ratio – current period		76.4	%		77.9	%
(Favorable) adverse loss ratio development – prior period business		(3.6	)		3.6
Reported loss ratio		72.8	%		81.5	%

Selling, General and Administrative Expenses. The largest component of selling, general and administrative expenses is personnel costs, including payroll, benefits and accrued bonus expenses. Selling, general and administrative expenses decreased $43.9 million, or 32.8%, compared with the prior year period, primarily due to a decrease in premium production and ceding commission from the quota-share reinsurance agreements. The primary drivers of the decrease were a drop in independent agent expense with lower premium volume and ceding commission income in the first nine months of 2011 from the quota-share reinsurance agreements. There was no ceding commission income in the first nine months of 2010.

The following table sets forth the impact that amortization of deferred acquisition costs had on SG&A expenses and the change in deferred acquisition costs (in thousands):

	Nine Months Ended September 30,
	2011			2010
Amortization of deferred acquisition costs	$	28,479		$	63,873
Other selling, general and administrative expenses		61,415			69,902
Total selling, general and administrative expenses	$	89,894		$	133,775
Total as a percentage of net premiums earned		64.5	%		47.7	%
Beginning deferred acquisition costs	$	11,742		$	24,230
Additions		26,244			63,889
Amortization		(28,479	)		(63,873	)
Ending deferred acquisition costs	$	9,507		$	24,246
Amortization of deferred acquisition costs as a percentage of net premiums earned		20.4	%		22.8	%

Loss on Interest Rate Swaps. Loss on interest rate swaps for the current period decreased $0.9 million from the prior year period. The loss relates to the impact on the determination of fair value associated with the decline in short-term interest rates implied in the forward yield curve. One swap instrument expired in February 2011 and the remaining swap instrument expired in April 2011.

Interest Expense. Interest expense for the current period decreased $1.2 million, or 7.1%, compared with the prior year period. This decrease was due to a decrease in the amortization of debt discount, a decrease in the average debt outstanding and lower interest rates on the notes payable, which were partially offset by increases in the interest rate on the senior secured credit facility and interest expense on the lease obligation entered into in May 2010. Amortization of debt discount was $3.4 million in the current period as compared with $4.9 million in the prior year period.

Income Taxes. Income tax expense for the current period decreased $0.2 million, or 16.0%, compared with the prior year period. The income tax expense for both periods was primarily due to an increase in the deferred tax liability related to goodwill and state tax expense.

Our net deferred tax assets prior to recognition of valuation allowance were $60.5 million and $53.4 million at September 30, 2011 and December 31, 2010, respectively. In assessing the realizability of our deferred tax assets, we considered whether it was more likely than not that our deferred tax assets will be realized based upon all available evidence, including scheduled reversal of deferred tax liabilities, historical operating results, projected future operating results, tax carry-back availability, and limitations pursuant to Section 382 of the Internal Revenue Code, among others. Based on this assessment, we began recording a valuation allowance against deferred taxes in December 2009.

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.

28

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 have and expect to continue to use those revenues to service our corporate financial obligations, such as debt service and stockholder dividends. As of September 30, 2011, we had $0.1 million of cash and cash equivalents at the holding company level and $5.2 million of cash and cash equivalents 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. In most states, 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 year-end or the insurance company’s net income for the preceding year, in each case determined in accordance with statutory accounting practices. In addition, dividends may only be paid from unassigned earnings and an insurance company’s remaining surplus must be both reasonable in relation to its outstanding liabilities and adequate to its financial needs. As of September 30, 2011, our insurance companies could not pay ordinary dividends to us without prior regulatory approval due to a negative unassigned surplus position of Affirmative Insurance Company. However, as mentioned previously, our non-insurance company subsidiaries provide adequate cash flow to fund their own operations.

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 September 30, 2011, each of our insurance subsidiaries maintained a risk-based capital level that was in excess of an amount that would require any corrective actions.

The Illinois Insurance Code includes a reserve requirement that requires an insurer to maintain an amount of qualifying investments as defined at least equal to the lesser of $250.0 million or 100% of adjusted loss reserves and loss adjustment reserve expenses. As of December 31, 2010, Affirmative Insurance Company was deficient in qualifying assets by $32.1 million. The Illinois Department of Insurance approved our plan to cure the deficiency by June 30, 2011. The plan included a $3.8 million ordinary dividend and a $21.0 million extraordinary distribution from two of AIC’s insurance company subsidiaries, which were completed in March 2011 and an extraordinary dividend of $15.0 million from one of AIC’s insurance company subsidiaries, which was completed in June 2011. We are currently in compliance with the reserve requirement.

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.

We believe that existing cash and investment balances, as well as cash flows generated from operations, will be adequate to meet our liquidity needs, planned capital expenditures and the debt service requirements of the senior secured credit facility and notes payable, 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.

29

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are principally exposed to two types of market risk: interest rate risk and credit risk.

Interest rate risk. Our investment portfolio consists of investment-grade, fixed-income securities classified as available-for-sale investment securities. 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 less than three years. The fair value of our fixed-income securities as of September 30, 2011 was $142.6 million. The effective average duration of the portfolio as of September 30, 2011 was 1.9 years. If market interest rates increase 1.0%, our fixed-income investment portfolio would be expected to decline in market value by 1.9%, or $2.7 million, representing the effective average duration multiplied by the change in market interest rates. Conversely, a 1.0% decline in interest rates would result in a 1.9%, or $2.7 million, increase in the market value of our fixed-income investment portfolio.

Our senior secured credit facility is also subject to interest rate risk. In March 2011, we entered into an amendment that changed the pricing to be tiered based on the leverage ratio and includes a LIBOR floor of 3.0%. The interest rate is floating based on LIBOR plus increments tied to the Company’s leverage ratio. Effective April 1, 2011, the pricing under the agreement is changing to if the leverage ratio is greater than 2.3, the pricing is LIBOR plus 9.00%. If the leverage ratio is greater than 2.0 and less than or equal to 2.3, the pricing is LIBOR plus 7.50%. If the leverage ratio is greater than 1.8 and less than or equal to 2.0, the pricing is LIBOR plus 6.25%. The pricing for leverage ratios less than or equal to 1.8 was unchanged. The interest rate at September 30, 2011 was 12.0%.

Our notes payable are also subject to interest rate risk. The $30.9 million notes adjust quarterly to the three-month LIBOR rate plus 3.60%. The interest rate as of September 30, 2011 was 3.95%. The $25.8 million notes adjust quarterly to the three-month LIBOR rate plus 3.55%. The interest rate as of September 30, 2011 was 3.90%. The $20.2 million notes payable bear an interest rate of the three-month LIBOR rate plus 3.95%. The interest rate as of September 30, 2011 was 4.30%.

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. At September 30, 2011, and December 31, 2010, respectively, our fixed-income investments were invested in the following:

	September 30, 2011			December 31, 2010
Corporate debt securities		53.4	%		59.2	%
FDIC-insured certificates of deposit		16.6			12.8
States and political subdivisions		12.6			10.7
U.S. Treasury and government agencies		9.1			12.2
Mortgage-backed securities		8.3			5.1
Total		100.0	%		100.0	%

We invest our insurance portfolio funds in highly-rated, fixed-income securities. Information about our investment portfolio is as follows ($ in thousands):

	September 30, 2011			December 31, 2010
Total invested assets	$	142,588		$	210,263
Tax-equivalent book yield		2.40	%		2.61	%
Average duration in years		1.92			2.07
Average S&P rating		A+			A+

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.

30

The table below presents the total amount of receivables due from reinsurance as of September 30, 2011 and December 31, 2010, respectively (in thousands):

	September 30, 2011		December 31, 2010
Michigan Catastrophic Claims Association	$	112,580	$	65,727
Quota-share reinsurer for agreements effective in fourth quarter of 2010 and in 2011		49,168		53,743
Vesta Insurance Group		13,107		13,161
Excess of loss reinsurer		4,685		1,429
Excess of loss reinsurer		4,685		1,429
Other		4,435		4,722
Total reinsurance receivable	$	188,660	$	140,211

The quota-share reinsurer for the agreements effective in the fourth quarter of 2010 and in 2011 and excess of loss reinsurers all have A ratings from A.M. Best. Accordingly, the Company believes there is minimal risk related to these reinsurance receivables.

The Michigan Catastrophic Claims Association (MCCA) is the mandatory reinsurance facility that covers no-fault medical losses above a specific retention amount in Michigan. For policies effective in 2011 the required retention is $0.5 million. As a writer of personal automobile policies in the state of Michigan, we cede premiums and claims to the MCCA. Funding for MCCA comes from assessments against automobile insurers based upon their proportionate market share of the state’s automobile liability insurance market. Insurers are allowed to pass along this cost to Michigan automobile policyholders.

Under the reinsurance agreement with Vesta Insurance Group (VIG), including primarily Vesta Fire Insurance Corporation (VFIC), the Company’s wholly-owned subsidiaries Affirmative Insurance Company (AIC) and Insura Property and Casualty Insurance Company (Insura) had the right, under certain circumstances, to require VFIC to provide a letter of credit or establish a trust account to collateralize the gross amount due AIC and Insura from VFIC under the reinsurance agreement. Accordingly, AIC, Insura and VFIC entered into a Security Fund Agreement in September 2004. In August 2005, AIC received a letter from VFIC’s President that irrevocably confirmed VFIC’s duty and obligation under the Security Fund Agreement to provide security sufficient to satisfy VFIC’s gross obligations under the reinsurance agreement (the VFIC Trust). At September 30, 2011, the VFIC Trust held $16.8 million (after cumulative withdrawals of $8.7 million through September 30, 2011), consisting of a $13.1 million U.S. Treasury money market account and $3.7 million of corporate bonds rated BBB+ or higher, to collateralize the $13.1 million net recoverable from VFIC.

At September 30, 2011, $3.6 million was included in reserves for losses and loss adjustment expenses that represented the amounts owed by AIC and Insura under reinsurance agreements with the VIG affiliated companies, including Hawaiian Insurance and Guaranty Company, Ltd (Hawaiian). Affirmative established a trust account to collateralize this payable, which currently holds $20.7 million in securities (the AIC Trust). The Special Deputy Receiver (SDR) in Texas drew down the AIC Trust $0.4 million through September 2011, and the Special Deputy Receiver in Hawaii had cumulative withdrawals from the AIC Trust of $1.7 million through September 2011.

As part of the terms of the acquisition of AIC and Insura, VIG 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 September 30, 2011, all such unaffiliated reinsurers had A.M. Best ratings of “A-” or better.

Item 4. Controls and Procedures

The Company’s management performed an evaluation under the supervision and with the participation of the Company’s principal executive officer and the principal financial officer, and completed an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e), as adopted by the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934, as amended (the Exchange Act) as of September 30, 2011. Disclosure controls and procedures are the controls and other procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to management, including the principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosures.

Based on that evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures were effective.

31

During the Company’s last fiscal quarter there were no changes in internal control over financial reporting that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

See Note 11 of Notes to Consolidated Financial Statements, “Legal and Regulatory Proceedings.”

Item 1A. Risk Factors

There are no material changes with respect to those risk factors previously disclosed in Item 1A to Part I of our Form 10-K for the year ended December 31, 2010.

Item 6. Exhibits

31.1 Certification of Gary Y. Kusumi, Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2 Certification of Michael J. McClure, Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1 Certification of Gary Y. Kusumi, Chairman of the Board and Chief Executive Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2 Certification of Michael J. McClure, Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101 The following materials from Affirmative Insurance Holdings, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011, formatted in XBRL (Extensible Business Reporting Language): (1) the Consolidated Balance Sheets, (2) the Consolidated Statements of Income (Loss), (3) the Consolidated Statements of Stockholders’ Equity, (4) the Consolidated Statements of Comprehensive Income (Loss), (5) the Consolidated Statements of Cash Flows, and (6) Notes to Consolidated Financial Statements, tagged as blocks of text.

32

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: November 14, 2011	By:	/s/ Michael J. McClure
		Michael J. McClure
		Executive Vice President and Chief Financial Officer (and in his capacity as Principal Financial Officer)

33

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Gary Y. Kusumi, Chief Executive Officer of Affirmative Insurance Holdings, Inc., 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 and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

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

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

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

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

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

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting that 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: November 14, 2011

/s/ Gary Y. Kusumi

Gary Y. Kusumi

Chief Executive Officer

34

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Michael J. McClure, Executive Vice President and Chief Financial Officer of Affirmative Insurance Holdings, Inc., 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 and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

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

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

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

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

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

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting that 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: November 14, 2011

/s/ Michael J. McClure

Michael J. McClure

Executive Vice President and Chief Financial Officer

(Principal Financial Officer)

35

EX-32.1

Exhibit 32.1

CERTIFICATION

I, Gary Y. Kusumi, Chairman of the Board and Chief Executive Officer of Affirmative Insurance Holdings, Inc. (the Company), certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350 to the best of my knowledge, that:

(1) the Quarterly Report on Form 10-Q of the Company for the quarter ended September 30, 2011 (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.

This certificate is being furnished solely for purposes of Section 906.

Date: November 14, 2011

/s/ Gary Y. Kusumi

Gary Y. Kusumi

Chairman of the Board and Chief 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 U.S. Securities and Exchange Commission or its staff upon request.

36

EX-32.2

Exhibit 32.2

CERTIFICATION

I, Michael J. McClure, Executive Vice President and Chief Financial Officer of Affirmative Insurance Holdings, Inc. (the Company), certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350 to the best of my knowledge, that:

(1) the Quarterly Report on Form 10-Q of the Company for the quarter ended September 30, 2011 (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.

This certificate is being furnished solely for purposes of Section 906.

Date: November 14, 2011

/s/ Michael J. McClure

Michael J. McClure

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 U.S. Securities and Exchange Commission or its staff upon request.

37

XML

Consolidated Balance Sheets (Parenthetical) (USD $) In Thousands, except Share data	Sep. 30, 2011	Dec. 31, 2010
Consolidated Balance Sheets [Abstract]
Property and equipment, accumulated depreciation	$ 48,884	$ 41,678
Other intangible assets, accumulated amortization	7,622	7,495
Other assets, allowance for doubtful accounts	7,213	7,213
Other liabilities, interest rate swaps		$ 1,453
Common stock, par value	$ 0.01	$ 0.01
Common stock, shares authorized	75,000,000	75,000,000
Common stock, shares issued	18,202,221	17,768,721
Common stock, shares outstanding	15,408,358	15,408,358
Treasury stock, shares	2,793,863	2,360,363

XML

Consolidated Statements Of Income (Loss) (USD $) In Thousands, except Per Share data	3 Months Ended		9 Months Ended
	Sep. 30, 2011	Sep. 30, 2010	Sep. 30, 2011	Sep. 30, 2010
Revenues
Net premiums earned	$ 42,042	$ 91,075	$ 139,264	$ 280,212
Commission income and fees	16,265	18,231	53,593	64,091
Net investment income	1,078	1,160	3,891	3,735
Net realized gains (losses)	(45)	1,115	71	8,295
Other income (loss)	8	(1,077)	257	(6,110)
Total revenues	59,348	110,504	197,076	350,223
Expenses
Net losses and loss adjustment expenses	31,562	76,345	101,376	228,257
Selling, general and administrative expenses	27,919	48,689	89,894	133,775
Depreciation and amortization	2,533	2,381	7,340	7,196
Total expenses	62,014	127,415	198,610	369,228
Operating loss	(2,666)	(16,911)	(1,534)	(19,005)
Loss on interest rate swaps		(252)	(2)	(862)
Interest expense	5,561	5,491	16,291	17,527
Loss before income tax expense	(8,227)	(22,654)	(17,827)	(37,394)
Income tax expense	231	466	1,093	1,301
Net loss	$ (8,458)	$ (23,120)	$ (18,920)	$ (38,695)
Basic loss per common share:
Net loss	$ (0.55)	$ (1.50)	$ (1.23)	$ (2.51)
Diluted loss per common share:
Net loss	$ (0.55)	$ (1.50)	$ (1.23)	$ (2.51)
Weighted average common shares outstanding:
Basic	15,408	15,415	15,408	15,415
Diluted	15,408	15,415	15,408	15,415

XML

Document And Entity Information	9 Months Ended
	Sep. 30, 2011	Nov. 11, 2011
Document And Entity Information [Abstract]
Document Type	10-Q
Amendment Flag	false
Document Period End Date	Sep. 30, 2011
Document Fiscal Period Focus	Q3
Document Fiscal Year Focus	2011
Entity Registrant Name	AFFIRMATIVE INSURANCE HOLDINGS INC
Entity Central Index Key	0001282543
Current Fiscal Year End Date	--12-31
Entity Filer Category	Smaller Reporting Company
Entity Common Stock, Shares Outstanding		15,408,358

XML

Premium Finance Receivables, Net

9 Months Ended

Sep. 30, 2011

Premium Finance Receivables, Net [Abstract]

Premium Finance Receivables, Net

5. Premium Finance Receivables, Net

Premium finance receivables (related to policies of both the Company and third-party carriers) are secured by unearned premiums from the underlying insurance policies and consisted of the following at September 30, 2011 and December 31, 2010 (in thousands):

	September 30, 2011			December 31, 2010
Premium finance contracts	$	44,662		$	45,866
Unearned finance charges		(2,266	)		(2,286	)
Allowance for credit losses		(387	)		(437	)
Total	$	42,009		$	43,143

Premium finance receivables are secured by the underlying unearned insurance premiums for which the Company obtains assignment from the policyholder in the event of non-payment. When a payment becomes past due, the Company cancels the underlying policy with the insurance carrier and receives the unearned premium to clear unpaid principal and interest. The loan is closed by writing off any uncollected amounts or refunding any overpayment to the customer. Therefore, no finance receivables are past due in excess of thirty days. Losses due to non-realization of premium finance receivables were $0.2 million and 0.5% of total premiums financed for the three months ended September 30, 2011, and $0.2 million and 0.4% of total premiums financed for the three months ended September 30, 2010. Losses due to non-realization of premium finance receivables were $0.5 million and 0.4% of total premiums financed for the nine months ended September 30, 2011, and $0.5 million and 0.4% of total premiums financed for the nine months ended September 30, 2010.

XML

Income Taxes

9 Months Ended

Sep. 30, 2011

Income Taxes [Abstract]

Income Taxes

10. Income Taxes

The provision for income taxes for the three and nine months ended September 30, 2011 and 2010 consisted of the following (in thousands):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2011			2010		2011		2010
Current tax expense (benefit)	$	(88	)	$	147	$	137	$	345
Deferred tax expense		319			319		956		956
Net income tax expense	$	231		$	466	$	1,093	$	1,301

The Company's effective tax rate differed from the statutory rate of 35% for the three and nine months ended September 30, 2011 and 2010 as follows (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Loss before income taxes	$	(8,227	)	$	(22,654	)	$	(17,827	)	$	(37,394	)
Tax provision computed at the federal statutory income tax rate		(2,879	)		(7,929	)		(6,239	)		(13,088	)
Increases (reductions) in tax resulting from:
Tax-exempt interest		(32	)		(48	)		(106	)		(357	)
State income taxes		(427	)		75			(457	)		140
Valuation allowance		3,701			8,430			7,954			14,586
Other		(132	)		(62	)		(59	)		20
Income tax expense	$	231		$	466		$	1,093		$	1,301
Effective tax rate		(2.8	)%		(2.1	)%		(6.1	)%		(3.5	)%

Net deferred tax assets prior to recognition of the valuation allowance were $60.5 million and $53.4 million at September 30, 2011 and December 31, 2010, respectively. In assessing the realizability of our deferred tax assets, we considered whether it was more likely than not that our deferred tax assets will be realized based upon all available evidence, including scheduled reversal of deferred tax liabilities, historical operating results, projected future operating results, tax carry-back availability, and limitations pursuant to Section 382 of the Internal Revenue Code, among others.

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General

9 Months Ended

Sep. 30, 2011

General [Abstract]

General

1. General

Affirmative Insurance Holdings, Inc. (the Company), formerly known as Instant Insurance Holdings, Inc., was incorporated in Delaware in June 1998. The Company is a distributor and producer of non-standard personal automobile insurance policies and related products and services for individual consumers in targeted geographic areas. The Company currently offers insurance directly to individual consumers through retail stores in 9 states (Louisiana, Texas, Illinois, Alabama, Missouri, Indiana, South Carolina, Kansas and Wisconsin) as well as through 4,900 independent agents or brokers in 8 states (Louisiana, Texas, Illinois, Alabama, California, Missouri, Indiana and South Carolina).

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Goodwill And Other Intangible Assets

9 Months Ended

Sep. 30, 2011

Goodwill And Other Intangible Assets [Abstract]

Goodwill And Other Intangible Assets

7. Goodwill and Other Intangible Assets

The Company completed its annual goodwill and indefinite lived intangible asset impairment analyses as of September 30, 2011. The Company reports under a single reporting segment and, as such, the goodwill analysis is measured under one reporting unit. Consistent with prior assessments, the fair value of the Company's reporting unit was determined using an internally developed discounted cash flow methodology and other relevant indicators of value available in the market place such as market transactions and trading values of similar companies. Based upon the results of the assessment, the Company concluded that the carrying values of goodwill and other intangible assets were not impaired as of September 30, 2011.

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Net Loss Per Common Share

9 Months Ended

Sep. 30, 2011

Net Loss Per Common Share [Abstract]

Net Loss Per Common Share

12. Net Loss Per Common Share

Net loss per common share is based on the weighted average number of shares outstanding. Diluted weighted average shares is calculated by adjusting basic weighted average shares outstanding by all potentially dilutive stock options and restricted stock. Stock options outstanding of 1,772,500 and 1,245,900 as of September 30, 2011 and 2010, respectively, were not included in the computation of diluted earnings per share because the exercise price of the options was greater than the average market price of the common stock and thus the inclusion would have been anti-dilutive.

The following table sets forth the reconciliation of numerators and denominators for the basic and diluted earnings per share computation for the three and nine months ended September 30, 2011 and 2010 (in thousands, except per share amounts):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Numerator:
Loss from continuing operations	$	(8,458	)	$	(23,120	)	$	(18,920	)	$	(38,695	)
Denominator:
Weighted average common shares outstanding		15,408			15,415			15,408			15,415
Weighted average diluted shares outstanding		15,408			15,415			15,408			15,415
Basic loss per common share from continuing operations:	$	(0.55	)	$	(1.50	)	$	(1.23	)	$	(2.51	)
Diluted loss per common share from continuing operations:	$	(0.55	)	$	(1.50	)	$	(1.23	)	$	(2.51	)

On March 18, 2011, 433,500 shares of Affirmative's common stock were issued on a restricted basis, and the voting rights for all of the shares were assigned to New Affirmative, LLC via a written irrevocable proxy at the time the stock awards were made. These shares were not included in the computation of basic or diluted earnings per share due to the performance conditions not being met. On August 10, 2011, the restricted shares were repurchased at par and 1,272,500 stock options were awarded to various executives.

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Debt

9 Months Ended

Sep. 30, 2011

Debt [Abstract]

Debt

8. Debt

The Company's long-term debt instruments and balances outstanding at September 30, 2011 and December 31, 2010 were as follows (in thousands):

	September 30, 2011		December 31, 2010
Notes payable due 2035	$	30,928	$	30,928
Notes payable due 2035		25,774		25,774
Notes payable due 2035		20,159		20,171
Total notes payable		76,861		76,873
Senior secured credit facility		94,014		95,974
Total long-term debt	$	170,875	$	172,847

The $30.9 million notes payable due 2035 are redeemable in whole or in part by the Company. The notes bore an initial interest rate of 7.545% until March 15, 2010. Since March 15, 2010, the securities adjust quarterly to the three-month LIBOR rate plus 3.60%. The interest rate as of September 30, 2011 was 3.95%.

The $25.8 million notes payable due 2035 are redeemable in whole or in part by the Company. The notes bore an initial interest rate of 7.792% until June 15, 2010. Since June 15, 2010, the securities adjust quarterly to the three-month LIBOR rate plus 3.55%. The interest rate as of September 30, 2011 was 3.90%.

The $20.2 million notes payable due 2035 are redeemable by the Company in whole or in part. The notes bore an initial interest rate of the three-month LIBOR rate plus 3.95% not exceeding 12.50% through March 2010 with no limit thereafter. The interest rate as of September 30, 2011 was 4.30%.

In March 2011, the Company entered into an amendment to the facility. The amendment included the following significant items:

• A waiver of any defaults or events of default for the period prior to the effective date of the amendment related to the risk-based capital ratio and loss ratio covenants under the prior terms of the agreement.

• The permitted dividend leverage ratio was changed from 1.5 to 1.0.

• Indebtedness under the baskets for qualified additional subordinated debt and Affirmative Premium Finance Company was eliminated. The Company did not have any such debt.

• A provision was added allowing for the acquisition of $30 million of subordinated debt if the proceeds are used as a capital contribution to the regulated insurance entities.

• The assets and stock of Affirmative Premium Finance Company will be pledged and this entity will become a guarantor of the debt.

• The quarterly requirements for the leverage ratio covenant calculation were changed for the first three quarters of 2011.

• The quarterly requirements for the interest coverage ratio covenant calculation were changed for the first two quarters of 2011.

• The quarterly requirements for the loss ratio covenant calculation were changed from December 31, 2010 through March 31, 2012.

• The annual requirements for the risk-based capital covenant calculation were changed for December 31, 2010 and December 31, 2011.

• At every quarter end, the Company will make a payment to the lenders equal to the excess of cash at the non-regulated entities of $12 million at December 31 and March 31 and $10 million at June 30 and September 30.

• Effective April 1, 2011, the pricing under the agreement changed to if the leverage ratio is greater than 2.3, the pricing is LIBOR plus 9.00%. If the leverage ratio is greater than 2.0 and less than or equal to 2.3, the pricing is LIBOR plus 7.50%. If the leverage ratio is greater than 1.8 and less than or equal to 2.0, the pricing is LIBOR plus 6.25%. The pricing for leverage ratios less than or equal to 1.8 was unchanged.

• The Company has the option to capitalize interest that is in excess of the prior payment terms to the loan balance.

In addition, the Company paid a 0.25% fee to all lenders that approved the amendment.

In accordance with ASC 470-50 Debt Modifications and Extinguishments, the Company evaluated the present value of the cash flows under the terms of the amended credit agreement to determine if they were at least 10 percent different from the present value of the remaining cash flows under the terms of the existing credit agreement. It was determined that the terms were not substantially different and therefore should not be accounted for as a debt extinguishment. Accordingly, lender consent fees of approximately $0.3 million were capitalized and will be amortized, along with remaining unamortized debt issuance costs from the March 2009 debt modification, over the remaining term of the senior secured credit facility. Fees paid to other parties of approximately $0.7 million were expensed as incurred in the first nine months of 2011.

During the first nine months of 2011, the Company made principal payments of $5.4 million on the senior secured credit facility. As of September 30, 2011, the principal balance of the senior secured credit facility was $103.0 million with an interest rate of 12.0%.

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Deferred Policy Acquisition Costs

9 Months Ended

Sep. 30, 2011

Deferred Policy Acquisition Costs [Abstract]

Deferred Policy Acquisition Costs

6. Deferred Policy Acquisition Costs

Policy acquisition costs, consisting of primarily commissions, advertising, premium taxes, underwriting and agency expenses, net of ceding commission income, are deferred and charged against income ratably over the terms of the related policies. The components of deferred policy acquisition costs and the related amortization expense were as follows (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Beginning balance	$	10,386		$	24,276		$	11,742		$	24,230
Additions		7,842			21,158			26,244			63,889
Amortization		(8,721	)		(21,188	)		(28,479	)		(63,873	)
Ending balance	$	9,507		$	24,246		$	9,507		$	24,246

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Consolidated Statements Of Comprehensive Income (Loss) (USD $) In Thousands	3 Months Ended		9 Months Ended
	Sep. 30, 2011	Sep. 30, 2010	Sep. 30, 2011	Sep. 30, 2010
Consolidated Statements Of Comprehensive Income (Loss) [Abstract]
Net loss	$ (8,458)	$ (23,120)	$ (18,920)	$ (38,695)
Other comprehensive income (loss):
Unrealized gains (losses) on available-for-sale investment securities arising during period	(472)	1,137	(360)	521
Reclassification adjustment for gains (losses) included in net loss	45	(43)	(71)	(1,400)
Other comprehensive income (loss), net	(427)	1,094	(431)	(879)
Total comprehensive loss	$ (8,885)	$ (22,026)	$ (19,351)	$ (39,574)

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Summary Of Significant Accounting Policies

9 Months Ended

Sep. 30, 2011

Summary Of Significant Accounting Policies [Abstract]

Summary Of Significant Accounting Policies

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements of the Company. In the opinion of management, all adjustments necessary for a fair presentation have been included and are of a normal recurring nature. Interim results are not necessarily indicative of the results that may be expected for the year. The consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2010 included in the Company's Annual Report on Form 10-K.

The consolidated balance sheet at December 31, 2010 was derived from the audited financial statements at that date but does not include all of the information and notes required by GAAP. All material intercompany transactions and balances have been eliminated in consolidation.

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the 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 reserves for losses and loss adjustment expenses, deferred policy acquisition costs, reinsurance receivables, valuation of available-for-sale securities, goodwill and other intangible assets, and deferred income taxes.

Recently Issued Accounting Standards

ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS, provides identical guidance with concurrently issued international financial reporting standard (IFRS) 13, Fair Value Measurements. Most of the changes in the new standard are clarifications of existing guidance, but it expands the disclosures about fair value measurements, and will require the categorization by level of the fair value hierarchy for items that are not measured at fair value in the statement of financial position, but for which the fair value is required to be disclosed, which would consist of the Company's debt. In addition, for fair value measurements categorized as Level 3 within the fair value hierarchy, the valuation processes and sensitivity of the fair value measurements to changes in unobservable inputs shall be disclosed. This standard is effective for interim and annual periods beginning after December 15, 2011, and should be applied prospectively. Early adoption is not permitted. The adoption of this standard will not impact the Company's consolidated financial position, results of operations or cash flows.

ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, will require companies to present the components of net income and comprehensive income in either one or two consecutive financial statements. Companies will no longer be permitted to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. Reclassifications from other comprehensive income must be presented in both the consolidated statement of income and the consolidated statement of other comprehensive income. This standard is effective for interim and annual periods beginning after December 15, 2011, and should be applied retrospectively. Early adoption is permitted. The adoption of this standard will not impact the Company's consolidated financial position, results of operations or cash flows.

ASU 2010-26, Financial Services-Insurance (Topic 944), modifies the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal insurance contracts. The Task Force reached a final Consensus that requires costs to be incremental or directly related to the successful acquisition of new or renewal contracts to be capitalized as a deferred acquisition cost. This standard is effective for interim and annual periods beginning after December 15, 2011 and may be early adopted as of the beginning of an annual reporting period using either the prospective or retrospective method. Adoption of the new standard could have a material impact on the Company's consolidated financial position or results of operations. Management is evaluating the impact.

ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (Topic 310), an amended guidance for disclosures about the credit quality of financing receivables and the allowance for credit losses. This update amends existing guidance by requiring more robust and disaggregated disclosures by an entity about the credit quality of its financing receivables and its allowance for credit losses. These disclosures will provide additional information about the nature of credit risks inherent in a company's financing receivables, how a company analyzes and assesses credit risk in determining its allowance for credit losses, and the reasons for any changes a company may make in its allowance for credit losses. This update is generally effective for interim and annual reporting periods ending on or after December 15, 2010; however, certain aspects of the update pertaining to activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. The adoption of the new guidance had no significant effect on the Company's consolidated financial statements.

ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820), requires additional disclosures about fair value measurements, including transfers in and out of Levels 1 and 2 and activity in Level 3 on a gross basis, and clarifies certain other existing disclosure requirements including level of disaggregation and disclosures around inputs and valuation techniques. The provisions of the new standard are effective for interim or annual reporting periods beginning after December 15, 2009, except for the additional Level 3 disclosures which became effective for fiscal years beginning after December 15, 2010. This standard is disclosure-only in nature and does not change accounting requirements. Accordingly, adoption of the new standard had no impact on the Company's consolidated financial position, results of operations or cash flows.

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Available-For-Sale Investment Securities

9 Months Ended

Sep. 30, 2011

Available-For-Sale Investment Securities [Abstract]

Available-For-Sale Investment Securities

3. Available-for-Sale Investment Securities

The Company's available-for-sale investment securities are carried at fair value with unrealized gains and losses, net of income taxes, reported in accumulated other comprehensive income, a separate component of stockholders' equity. Gains and losses realized on the disposition of investment securities are determined on the specific-identification basis and credited or charged to income.

The amortized cost, gross unrealized gains (losses), and estimated fair value of the Company's available-for-sale securities at September 30, 2011, and December 31, 2010, were as follows (in thousands):

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
September 30, 2011
U.S. Treasury and government agencies	$	12,813	$	181	$	(2	)	$	12,992
Mortgage-backed securities		11,674		290		(148	)		11,816
States and political subdivisions		17,619		369		(1	)		17,987
Corporate debt securities		75,361		898		(182	)		76,077
FDIC-insured certificates of deposit		23,568		151		(3	)		23,716
Total	$	141,035	$	1,889	$	(336	)	$	142,588
December 31, 2010
U.S. Treasury and government agencies	$	25,611	$	142	$	(73	)	$	25,680
Mortgage-backed securities		10,554		295		(19	)		10,830
States and political subdivisions		22,245		280		(137	)		22,388
Corporate debt securities		123,182		1,505		(132	)		124,555
FDIC-insured certificates of deposit		26,687		126		(3	)		26,810
Total	$	208,279	$	2,348	$	(364	)	$	210,263

Expected maturities may differ from contractual maturities because certain borrowers may have the right to call or prepay obligations with or without penalties. The Company's amortized cost and estimated fair values of fixed-income securities at September 30, 2011 by contractual maturity were as follows (in thousands):

	Amortized Cost		Fair Value
Due in one year or less	$	45,021	$	45,250
Due after one year through five years		77,679		78,769
Due after five years through ten years		6,661		6,753
Mortgage-backed securities		11,674		11,816
Total	$	141,035	$	142,588

Gross realized gains and losses on available-for-sale investments for the nine months ended September 30 were as follows (in thousands):

	2011			2010
Gross gains	$	237		$	1,455
Gross losses		(166	)		(55	)
Total	$	71		$	1,400

The following table summarizes the Company's available-for-sale securities in an unrealized loss position at September 30, 2011, and December 31, 2010, the fair value and amount of gross unrealized losses, aggregated by investment category and length of time those securities have been continuously in an unrealized loss position (in thousands):

	September 30, 2011
	Less Than Twelve Months					Twelve Months or Greater					Total
	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
U.S. Treasury and government agencies	$	571	$	(2	)	$	—	$	—		$	571	$	(2	)
Mortgage-backed securities		6,151		(148	)		—		—			6,151		(148	)
States and political subdivisions		551		—			75		(1	)		626		(1	)
Corporate debt securities		9,343		(146	)		1,561		(36	)		10,904		(182	)
FDIC-insured certificates of deposit		749		(1	)		399		(2	)		1,148		(3	)
Total	$	17,365	$	(297	)	$	2,035	$	(39	)	$	19,400	$	(336	)
	December 31, 2010
	Less Than Twelve Months					Twelve Months or Greater					Total
	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
U.S. Treasury and government agencies	$	12,707	$	(73	)	$	—	$	—		$	12,707	$	(73	)
Mortgage-backed securities		3,770		(19	)		—		—			3,770		(19	)
States and political subdivisions		8,619		(137)			—		—			8,619		(137)
Corporate debt securities		23,801		(132	)		—		—			23,801		(132	)
FDIC-insured certificates of deposit		2,183		(3	)		—		—			2,183		(3	)
Total	$	51,080	$	(364	)	$	—	$	—		$	51,080	$	(364	)

The Company's portfolio contains approximately 37 and 64 individual investment securities that were in an unrealized loss position as of September 30, 2011 and December 31, 2010, respectively.

The unrealized losses at September 30, 2011 were attributable to changes in market interest rates since the securities were purchased. Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include (1) duration and magnitude of the decline in value, (2) the financial condition of the issuer or issuers, (3) structure of the security and (4) the Company's intent to sell the security or whether its more likely than not that the Company would be required to sell the security before its anticipated recovery in market value. At September 30, 2011, management performed its quarterly analysis of all securities with an unrealized loss and concluded no individual securities were other-than-temporarily impaired.

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Legal And Regulatory Proceedings

9 Months Ended

Sep. 30, 2011

Legal And Regulatory Proceedings [Abstract]

Legal And Regulatory Proceedings

11. Legal and Regulatory Proceedings

The Company and its subsidiaries are named from time to time as parties in various legal actions arising in the ordinary course of the Company's business and arising out of or related to claims made in connection with the Company's insurance policies and claims handling. Except as noted below and in the Company's prior Forms 10-Q for the 2011 fiscal year, there are no material changes with respect to legal and regulatory proceedings previously disclosed in Note 16 to the consolidated financial statements included in the Company's Form 10-K for the year ended December 31, 2010. The Company believes that the resolution of these legal actions will not have a material adverse effect on the Company's consolidated financial position or results of operations. However, the ultimate outcome of these matters is uncertain.

On October 26, 2010, the Chapter 7 Trustee for Brooke Corporation, Brooke Capital Corporation and Brooke Investments, Inc., along with Brooke Agency Services Company, LLC ("BASC"), filed an adversary proceeding in the U.S. Bankruptcy Court for the District of Kansas against Affirmative Insurance Holdings, Inc., Affirmative Insurance Services, Inc., Affirmative Insurance Services of Illinois, Inc., and Affirmative Insurance Company. On September 15, 2011, the parties reached a settlement of this matter which, subject to final court approval, will resolve all matters in controversy. The settlement will not have a material adverse effect on the Company's consolidated financial position or results of operations.

On August 17, 2009, plaintiff Toni Hollinger filed a putative class action in the U.S. District Court for the Eastern District of Texas against several county mutual insurance companies and reinsurance companies, including Affirmative Insurance Company. The complaint alleges that defendants engaged in unfair discrimination and violated the Texas Insurance Code by charging different policy fees for the same class and hazard of insurance written through county mutual insurance companies. On August 5, 2010, the Court issued an order dismissing plaintiff's claims for lack of subject matter jurisdiction, and Plaintiff appealed the dismissal of her claims. On September 6, 2011, the Fifth Circuit Court of Appeals affirmed the District Court's dismissal of this action.

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Reinsurance

9 Months Ended

Sep. 30, 2011

Reinsurance [Abstract]

Reinsurance

4. Reinsurance

In the ordinary course of business, the Company places reinsurance with other insurance companies in order to provide greater diversification of its business and limit the potential for losses arising from large risks. In addition, the Company assumes reinsurance from other insurance companies.

Effective October 1, 2010, the Company entered into a quota-share reinsurance agreement with a third-party reinsurance company ceding 40% of premiums and losses on policies in-force in certain states on October 1, 2010 and policies written through December 31, 2010 on a run-off basis. The Company receives provisional ceding commission which may be adjusted based on the fully-developed loss ratio of the reinsured policies. Written premiums ceded under this agreement totalled $114.6 million as of September 30, 2011.

A separate quota-share reinsurance agreement was put in place effective January 1, 2011. Under the terms of the 2011 agreement, the Company cedes 28% of gross written premium in all states other than Michigan through December 31, 2011. Written premiums ceded under this agreement totalled $15.6 million and $49.5 million during the three and nine months ended September 30, 2011, respectively.

The Company's quota-share ceding commission rate structure varies based on loss experience for both quota-share agreements. The estimates of loss experience are continually reviewed and adjusted, and the resulting adjustments to ceding commissions are reflected in current operations.

In June 2011, the Company entered into a reinsurance agreement with third-party reinsurers which provides $7.0 million in excess of the first $3.0 million of losses coverage for catastrophic events that may involve multiple insured losses.

In August 2010, the Company entered into an excess of loss reinsurance contract with third-party reinsurers which provides coverage for individual losses in excess of $100,000 up to $1 million. This contract terminated July 31, 2011 on a run-off basis.

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

	Three Months Ended September 30,
	2011									2010
	Written Premium			Earned Premium			Loss and Loss Adjustment Expenses			Written Premium			Earned Premium			Loss and Loss Adjustment Expenses
Direct	$	46,296		$	50,672		$	88,983		$	74,963		$	75,099		$	105,455
Reinsurance assumed		8,224			9,127			9,299			18,331			19,082			18,221
Reinsurance ceded		(15,918	)		(17,757	)		(66,720	)		(3,140	)		(3,106	)		(47,331	)
Total	$	38,602		$	42,042		$	31,562		$	90,154		$	91,075		$	76,345
	Nine Months Ended September 30,
	2011									2010
	Written Premium			Earned Premium			Loss and Loss Adjustment Expenses			Written Premium			Earned Premium			Loss and Loss Adjustment Expenses
Direct	$	154,363		$	173,983		$	184,557		$	231,365		$	228,763		$	224,502
Reinsurance assumed		27,536			33,185			18,569			51,971			57,018			55,502
Reinsurance ceded		(52,084	)		(67,904	)		(101,750	)		(5,588	)		(5,569	)		(51,747	)
Total	$	129,815		$	139,264		$	101,376		$	277,748		$	280,212		$	228,257

Under certain of the Company's reinsurance transactions, the Company has received ceding commissions. The ceding commission rate structure varies based on loss experience. The estimates of loss experience are continually reviewed and adjusted, and the resulting adjustments to ceding commissions are reflected in current operations. Ceding commissions recognized were reflected as a reduction of selling, general and administrative expenses as follows (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Selling, general and administrative expenses	$	(5,367	)	$	(10	)	$	(14,386	)	$	(20	)

The amount of loss reserves and unearned premium the Company would remain liable for in the event its reinsurers are unable to meet their obligations were as follows (in thousands):

	September 30, 2011		December 31, 2010
Losses and loss adjustment expense reserves	$	153,164	$	93,084
Unearned premium reserve		18,329		34,149
Total	$	171,493	$	127,233

The Michigan Catastrophic Claims Association (MCCA) is the mandatory reinsurance facility that covers no-fault medical losses above a specific retention amount in Michigan. For policies effective in 2011 and 2010, the required retention is $0.5 million. As a writer of personal automobile policies in the state of Michigan, the Company cedes premiums and claims to the MCCA. Funding for MCCA comes from assessments against automobile insurers based upon their proportionate market share of the state's automobile liability insurance market. Insurers are allowed to pass along this cost to Michigan automobile policyholders.

The table below presents the ceded premiums written and ceded loss and loss adjustment expenses to the MCCA for the three and nine months ended September 30, 2011 and 2010 (in thousands):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2011			2010		2011		2010
Ceded premiums written	$	(21	)	$	1,839	$	527	$	3,997
Ceded loss and loss adjustment expenses	$	48,467		$	46,718	$	50,591	$	51,065

The table below presents the total amount of receivables due from reinsurers as of September 30, 2011 and December 31, 2010 (in thousands):

	September 30, 2011		December 31, 2010
MCCA	$	112,580	$	65,727
Quota-share reinsurer for agreements effective in fourth quarter of 2010 and in 2011		49,168		53,743
Vesta Insurance Group		13,107		13,161
Excess of loss reinsurer		4,685		1,429
Excess of loss reinsurer		4,685		1,429
Other		4,435		4,722
Total reinsurance receivable	$	188,660	$	140,211

The quota-share reinsurer for the agreements effective in the fourth quarter of 2010 and in 2011, and the excess of loss reinsurers all have A ratings from A.M. Best. Accordingly, the Company believes there is minimal credit risk related to these reinsurance receivables. Under the reinsurance agreement with Vesta Insurance Group (VIG), including primarily Vesta Fire Insurance Corporation (VFIC), the Company's wholly-owned subsidiaries, Affirmative Insurance Company (AIC) and Insura Property and Casualty Insurance Company (Insura), had the right, under certain circumstances, to require VFIC to provide a letter of credit or establish a trust account to collateralize gross amounts due from VFIC under the reinsurance agreement. Accordingly, AIC, Insura and VFIC entered into a Security Fund Agreement effective September 2004. In August 2005, AIC received a letter from VFIC's President that irrevocably confirmed VFIC's duty and obligation under the Security Fund Agreement to provide security sufficient to satisfy VFIC's gross obligations under the reinsurance agreement (the VFIC Trust). At September 30, 2011, the VFIC Trust held $16.8 million (after cumulative withdrawals of $8.7 million through September 30, 2011), consisting of a $13.1 million U.S. Treasury money market account and $3.7 million of corporate bonds rated BBB+ or higher, to collateralize the $13.1 million net recoverable (net of $2.9 million payable) from VFIC.

The Company assumes reinsurance from a Texas county mutual insurance company (the county mutual) whereby the Company has assumed 100% of the policies issued by the county mutual for business produced by the Company's owned MGAs. The county mutual does not retain any of this business and there are no loss limits other than the underlying policy limits. AIC has established a trust to secure the Company's obligation under this reinsurance contract with a balance of $54.3 million and $52.0 million as of September 30, 2011 and December 31, 2010, respectively.

At September 30, 2011, $3.6 million was included in reserves for losses and loss adjustment expenses that represented the amounts owed by AIC and Insura under reinsurance agreements with the VIG affiliated companies, including Hawaiian Insurance and Guaranty Company, Ltd (Hawaiian). Affirmative established a trust account to collateralize this payable, which currently holds $20.7 million in securities (the AIC Trust). The Special Deputy Receiver in Texas had cumulative withdrawals from the AIC Trust of $0.4 million through September 2011, and the Special Deputy Receiver in Hawaii had cumulative withdrawals from the AIC Trust of $1.7 million through September 2011.

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Fair Value Of Financial Instrument

9 Months Ended

Sep. 30, 2011

Fair Value Of Financial Instrument [Abstract]

Fair Value Of Financial Instrument

14. Fair Value of Financial Instruments

The Company utilizes a hierarchy of valuation techniques for the disclosure of fair value estimates based on whether the significant inputs into the valuation are observable. In determining the level of hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect the Company's significant market assumptions. The Company measures certain assets and liabilities at fair value on a recurring basis, including investment securities classified as available-for-sale, cash equivalents, other invested assets, other receivables and interest rate swaps. Following is a brief description of the type of valuation information that qualifies a financial asset or liability for each level:

Level 1 — Unadjusted quoted market prices for identical assets or liabilities in active markets which are accessible by the Company.

Level 2 — Observable prices in active markets for similar assets or liabilities. Prices for identical or similar assets or liabilities in markets that are not active. Directly observable market inputs for substantially the full term of the asset or liability, e.g., interest rates and yield curves at commonly quoted intervals, volatilities, prepayment speeds, default rates, and credit spreads. Market inputs that are not directly observable, but are derived from or corroborated by observable market data.

Level 3 — Unobservable inputs based on the Company's own judgment as to assumptions a market participant would use, including inputs derived from extrapolation and interpolation that are not corroborated by observable market data.

The Company evaluates the various types of financial assets and liabilities to determine the appropriate fair value hierarchy based upon trading activity and the observability of market inputs. The Company employs control processes to validate the reasonableness of the fair value estimates of its assets and liabilities, including those estimates based on prices and quotes obtained from independent third-party sources. The Company's procedures generally include, but are not limited to, initial and ongoing evaluation of methodologies used by independent third-parties and monthly analytical reviews of the prices against current pricing trends and statistics.

Where possible, the Company utilizes quoted market prices to measure fair value. For assets and liabilities that have quoted market prices in active markets, the Company uses the quoted market prices as fair value and includes these prices in the amounts disclosed in Level 1 of the hierarchy. When quoted market prices in active markets are unavailable, the Company determines fair values based on independent external valuation information, which utilizes various models and valuation techniques based on a range of inputs including pricing models, quoted market prices of publicly traded securities with similar duration and yield, time value, yield curve, prepayment speeds, default rates and discounted cash flows. In most cases, these estimates are determined based on independent third-party valuation information, and the amounts are disclosed as Level 2 or Level 3 of the fair value hierarchy depending on the level of observable market inputs.

Financial assets and financial liabilities measured at fair value on a recurring basis

The following table provides information as of September 30, 2011 about the Company's financial assets measured at fair value on a recurring basis (in thousands):

	September 30, 2011		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
U.S. Treasury and government agencies	$	12,992	$	12,992	$	—	$	—
Mortgage-backed securities		11,816		—		11,816		—
States and political subdivisions		17,987		—		17,987		—
Corporate debt securities		76,077		—		76,077		—
FDIC-insured certificates of deposit		23,716		—		23,716		—
Total investment securities		142,588		12,992		129,596		—
Cash and cash equivalents		28,660		28,660		—		—
Fiduciary and restricted cash		342		342		—		—
Other invested assets		2,809		—		—		2,809
Total assets	$	174,399	$	41,994	$	129,596	$	2,809

The following table provides information as of December 31, 2010 about the Company's financial assets and liabilities measured at fair value on a recurring basis (in thousands):

	December 31, 2010		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
U.S. Treasury and government agencies	$	25,680	$	25,680	$	—	$	—
Mortgage-backed securities		10,830		—		10,830		—
States and political subdivisions		22,388		—		22,388		—
Corporate debt securities		124,555		—		124,555		—
FDIC-insured certificates of deposit		26,810		—		26,810		—
Total investment securities		210,263		25,680		184,583		—
Cash and cash equivalents		46,364		46,364		—		—
Fiduciary and restricted cash		3,866		3,866		—		—
Other invested assets		2,564		—		—		2,564
Total assets	$	263,057	$	75,910	$	184,583	$	2,564
Liabilities:
Interest rate swaps (other liabilities)	$	1,453	$	—	$	—	$	1,453
Total liabilities	$	1,453	$	—	$	—	$	1,453

Level 1 Financial assets

Financial assets classified as Level 1 in the fair value hierarchy include U.S. Government bonds and certain government agencies securities and cash and cash equivalents. These securities are actively traded and the Company estimates the fair value of these securities using unadjusted quoted market prices. Cash equivalents primarily consist of highly liquid money market funds, which are reflected within Level 1 of the fair value hierarchy.

Level 2 Financial assets

Financial assets classified as Level 2 in the fair value hierarchy include mortgage-backed securities, tax-exempt securities, corporate bonds and FDIC-insured certificates of deposit. The fair value of these securities is determined based on observable market inputs provided by independent third-party pricing services and the Company discloses the fair values of these investments in Level 2 of the fair value hierarchy. To date, the Company has not experienced a circumstance where it has determined that an adjustment is required to a quote or price received from independent third-party pricing sources. To the extent the Company determines that a price or quote is inconsistent with actual trading activity observed in that investment or similar investments, the Company would determine a fair value using this observable market information and disclose the occurrence of this circumstance. All of the fair values of securities disclosed in Level 2 are estimated based on independent third-party pricing services.

Level 3 Financial assets and liabilities

At September 30, 2011, the Company's Level 3 financial assets include other invested assets related to an investment in a hedge fund, which is presented as a separate line item in the consolidated balance sheets. The Company measured the fair value of other invested assets on the basis of the net asset value of the fund as reported by the fund manager.

The Company's Level 3 financial liabilities are interest rate swaps. The fair value of these swaps was determined by quotes from brokers that are not considered binding. The interest rate swaps expired during the first half of 2011.

Fair value measurements for assets in Level 3 for the three months ended September 30, 2011 were as follows (in thousands):

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3) Other Invested Assets
Balance at July 1, 2011	$	2,840
Transfers into Level 3		—
Total losses included in earnings		(31	)
Settlements		—
Balance at September 30, 2011	$	2,809

The Company did not have any transfers between Levels 1 and 2 during the period ended September 30, 2011.

Fair value measurements for assets in Level 3 for the nine months ended September 30, 2011 were as follows (in thousands):

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3) Other Invested Assets
Balance at January 1, 2011	$	2,564
Transfers into Level 3		—
Total gains included in earnings		245
Settlements		—
Balance at September 30, 2011	$	2,809

Fair value measurements for liabilities in Level 3 for the nine months ended September 30, 2011 were as follows (in thousands):

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3) Interest Rate Swaps
Balance at January 1, 2011	$	1,453
Transfers into Level 3		—
Total losses included in earnings		2
Settlements		(1,455	)
Balance at September 30, 2011	$	—

Gains and losses (realized and unrealized) for Level 3 assets and liabilities included in earnings for the nine months ended September 30, 2011, are reported in net investment income and loss on interest rate swaps as follows (in thousands):

	Net Investment Income		Loss on Interest Rate Swaps
Assets
Total gains realized in earnings	$	245	$	—
Liabilities
Total losses realized in earnings		—		(2	)
Total for the period ended September 30, 2011	$	245	$	(2	)

Fair values represent the Company's best estimates and may not be substantiated by comparisons to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. The following financial liabilities are not required to be recorded at fair value, but their fair value is disclosed.

Notes payable — The fair values of the notes payable were determined using a third-party valuation source and were estimated to be $18.4 million in the aggregate with a total carrying value of $76.9 million at September 30, 2011.

Senior secured credit facility — The fair value of the senior secured credit facility was determined using a third-party valuation source and was estimated to be $85.1 million with a carrying value of $94.0 million at September 30, 2011.

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Consolidated Statements Of Stockholders' Equity (USD $) In Thousands, except Share data	Common Stock [Member]	Additional Paid-In Capital [Member]	Retained Earnings (Deficit) [Member]	Treasury Stock [Member]	Accumulated Other Comprehensive Income (Loss) [Member]	Total
Balance at Dec. 31, 2009	$ 178	$ 164,752	$ 48,446	$ (32,880)	$ 2,859
Balance, shares at Dec. 31, 2009	17,768,721			2,353,363
Stock-based compensation		982
Net loss			(38,695)			(38,695)
Change in net unrealized loss on available-for-sale investment securities					(879)
Balance at Sep. 30, 2010	178	165,734	9,751	(32,880)	1,980	144,763
Balance, shares at Sep. 30, 2010	17,768,721			2,353,363
Balance at Dec. 31, 2010	178	165,776	(40,485)	(32,906)	445	93,008
Balance, shares at Dec. 31, 2010	17,768,721			2,360,363		15,408,358
Issuance of restricted stock awards	4
Issuance of restricted stock awards, shares	433,500
Stock-based compensation		359
Repurchase of restricted stock awards, shares				433,500
Repurchase of restricted stock awards				(4)
Net loss			(18,920)			(18,920)
Change in net unrealized loss on available-for-sale investment securities					(431)
Balance at Sep. 30, 2011	$ 182	$ 166,135	$ (59,405)	$ (32,910)	$ 14	$ 74,016
Balance, shares at Sep. 30, 2011	18,202,221			2,793,863		15,408,358

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Consolidated Statements Of Cash Flows (USD $) In Thousands	9 Months Ended
	Sep. 30, 2011	Sep. 30, 2010
Cash flows from operating activities
Net loss	$ (18,920)	$ (38,695)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	7,340	7,196
Stock-based compensation expense	316	1,165
Amortization of debt modification costs	310	359
Amortization of debt discount	3,428	4,883
Net realized gains from sales of available-for-sale securities	(71)	(1,400)
Realized gain on trading securities		(6,897)
Fair value loss on settlement rights for auction-rate securities		6,707
Fair value gain on investment in hedge fund	(245)
Amortization of premiums on investments, net	2,306	2,535
Provision for doubtful premiums receivable	(180)	342
Loss on interest rate swaps	2	862
Proceeds from insurance recoveries	(212)
Change in operating assets and liabilities:
Fiduciary and restricted cash	3,524	8,458
Premiums, fees and commissions receivable, net	15,764	10,377
Reserves for losses and loss adjustment expenses	10,413	29,699
Amounts due from reinsurers	(66,537)	(41,631)
Premium finance receivable, net (related to our insurance premiums)	3,794	(9,715)
Deferred revenue	(2,201)	(1,612)
Unearned premium	(26,425)	(1,391)
Deferred acquisition costs	2,235	(16)
Deferred tax liability	956	956
Income taxes receivable	902	1,290
Other	(3,788)	2,137
Net cash used in operating activities	(67,289)	(24,391)
Cash flows from investing activities
Proceeds from sales of available-for-sale securities	56,277	102,231
Proceeds from maturities of available-for-sale securities	27,163	48,510
Proceeds from sales of trading securities		35,470
Purchases of available-for-sale securities	(18,431)	(160,688)
Premium finance receivable, net (related to third-party insurance premiums)	(2,660)	3,763
Purchases of property and equipment	(2,335)	(4,922)
Investment in real property	(550)	(5,630)
Net cash provided by investing activities	59,464	18,734
Cash flows from financing activities
Proceeds from financing under capital lease obligations		28,189
Principal payments under capital lease obligations	(3,718)	(1,748)
Principal payments on senior secured credit facility	(5,388)	(18,360)
Debt modification costs paid	(769)
Repurchase of restricted stock	(4)
Net cash provided by (used in) financing activities	(9,879)	8,081
Net increase (decrease) in cash and cash equivalents	(17,704)	2,424
Cash and cash equivalents at beginning of year	46,364	60,928
Cash and cash equivalents at end of period	28,660	63,352
Supplemental disclosure of cash flow information:
Cash paid for interest	10,911	11,795
Cash paid for income taxes	$ 335	$ 364

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Capital Lease Obligation

9 Months Ended

Sep. 30, 2011

Capital Lease Obligation [Abstract]

Capital Lease Obligation

9. Capital Lease Obligation

In May 2010, the Company entered into a capital lease obligation related to certain computer software, software licenses, and hardware used in the Company's insurance operations. The Company received cash proceeds from the financing in the amount of $28.2 million. As required by the lease agreements, the Company purchased $28.2 million of FDIC-insured certificates of deposit held in brokerage accounts and pledged such securities as collateral against all of the Company's obligations under the lease. The dollar amount of collateral pledged is set to decline over the term of the lease as the Company makes the scheduled lease payments. The lease term is 60 months with monthly rental payments totaling approximately $0.6 million. At the end of the initial term, the Company will have the right to purchase the software for a nominal fee, after which all rights, title and interest would transfer to the Company.

Property under capital lease at September 30, 2011 was as follows (in thousands):

	Cost		Accumulated Depreciation		Net
Computer software, software licenses and hardware	$	28,189	$	7,651	$	20,538

Estimated future lease payments for the years ending December 31 (in thousands):

2011	$	1,684
2012		6,736
2013		6,736
2014		6,736
2015		2,807
Total estimated future lease payments		24,699
Less: Amount representing interest		3,115
Present value of future lease payments	$	21,584

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Related Party Transactions

9 Months Ended

Sep. 30, 2011

Related Party Transactions [Abstract]

Related Party Transactions

13. Related Party Transactions

The Company has entered into certain transactions with a partnership that is affiliated with J. Christopher Flowers. Mr. Flowers is affiliated with New Affirmative LLC, the majority shareholder of the Company. In the fourth quarter of 2010, the Company committed to invest $2.5 million in Varadero, a hedge fund, and $10.0 million in a related liquidity-focused product. The investment manager of Varadero is Varadero Capital, L.P., of which Varadero GP, LLC is the general partner. Both the investment manager and general partner are partially-owned by an entity affiliated with Mr. Flowers. As of September 30, 2011, the Company had funded $2.5 million in the hedge fund and approximately $9.3 million in the related liquidity-focused product. At September 30, 2011, the fair value of the hedge fund was approximately $2.8 million, based on net asset value and recorded as other invested assets, and the fair value of the liquidity-focused product was approximately $9.1 million, included in available-for-sale securities in the consolidated balance sheets.

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Consolidated Balance Sheets (USD $) In Thousands	Sep. 30, 2011	Dec. 31, 2010
Assets
Available-for-sale securities, at fair value	$ 142,588	$ 210,263
Other invested assets	2,809	2,564
Cash and cash equivalents	28,660	46,364
Fiduciary and restricted cash	342	3,866
Accrued investment income	1,501	1,829
Premiums and fees receivable, net	26,368	43,313
Premium finance receivable, net	42,009	43,143
Commissions receivable	2,320	1,652
Receivable from reinsurers	188,660	140,211
Deferred acquisition costs	9,507	11,742
Income taxes receivable	901	1,803
Investment in real property, net	11,913	11,896
Property and equipment (net of accumulated depreciation of $48,884 for 2011 and $41,678 for 2010)	34,096	39,197
Goodwill	163,570	163,570
Other intangible assets (net of accumulated amortization of $7,622 for 2011 and $7,495 for 2010)	16,340	16,468
Prepaid expenses	6,211	5,295
Other assets (net of allowance for doubtful accounts of $7,213 for 2011 and 2010)	2,007	2,545
Total assets	679,802	745,721
Liabilities and Stockholders' Equity
Reserves for losses and loss adjustment expenses	262,497	252,084
Unearned premium	65,777	92,202
Amounts due to reinsurers	19,391	38,172
Deferred revenue	5,693	7,894
Capital lease obligation	21,584	25,302
Senior secured credit facility	94,014	95,974
Notes payable	76,861	76,873
Deferred tax liability	13,052	12,095
Other liabilities (includes interest rate swaps of $1,453 for 2010)	46,917	52,117
Total liabilities	605,786	652,713
Stockholders' equity:
Common stock, $0.01 par value; 75,000,000 shares authorized, 18,202,221 shares issued and 15,408,358 shares outstanding at September 30, 2011 and 17,768,721 shares issued and 15,408,358 shares outstanding at December 31, 2010	182	178
Additional paid-in capital	166,135	165,776
Treasury stock, at cost (2,793,863 shares at September 30, 2011 and 2,360,363 shares at December 31, 2010)	(32,910)	(32,906)
Accumulated other comprehensive income	14	445
Retained deficit	(59,405)	(40,485)
Total stockholders' equity	74,016	93,008
Total liabilities and stockholders' equity	$ 679,802	$ 745,721