10-K/A

Bermuda

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer Identification No.)

Bermuda Commercial Bank Building

19 Par-la-Ville Road Hamilton, HM 11

(Address of principal executive offices)

(Zip Code)

10-K/A 1 d627089d10ka.htm 10-K/A 10-K/A

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K/A

(Amendment No. 2 To Form 10-K)


(Mark One)
x		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
		EXCHANGE ACT OF 1934
		For the fiscal year ended December 31, 2012
		Or
¨		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
		SECURITIES ACT OF 1934
		For the transition period from to
		Commission File Number: 001-35834
		Tower Group International, Ltd.
		Filed on behalf of and as successor to Tower Group, Inc.
		(Exact name of registrant as specified in its charter)


				(441) 279-6610
				(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:


		Title of each class		Name of each exchange on which registered
		Common Stock, $0.0l par value per share		NASDAQ Global Select Market

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of Securities

Act. Yes ¨ No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the

Act. Yes ¨ No þ

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 ¨ No þ

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

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


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

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

This Amendment No. 2 to the Annual Report on Form 10-K is being filed by the registrant on behalf of and as successor to Tower Group, Inc. The aggregate market value of Tower Group, Inc.’s common stock held by non-affiliates on June 30, 2012 (based on the closing price on the NASDAQ Global Select Market on such date) was $720,706,000.

As of February 26, 2013, Tower Group, Inc. had 38,401,626 shares of common stock outstanding. As of such date, Tower Group, Inc. was not a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

EXPLANATORY NOTE

This Amendment No. 2 (the “Amendment”) to the Annual Report on Form 10-K for the year ended December 31, 2012, which was filed with the Securities and Exchange Commission (the “SEC”) on March 4, 2013 and amended by Amendment No. 1 to the Annual Report on Form 10-K, which was filed with the SEC on March 13, 2013 (as amended by Amendment No. 1, the “Original Amended Report”) is being filed by the registrant on behalf of and as successor to Tower Group, Inc. The registrant is deemed to be the successor to Tower Group, Inc. pursuant to Rule 12g-3(a) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). On March 13, 2013, the registrant and Tower Group, Inc. consummated the merger contemplated by the Agreement and Plan of Merger that the registrant entered into with Tower Group, Inc. and certain other parties on July 30, 2012, as amended. Tower Group, Inc. was treated as the acquiring company in the merger for accounting purposes and the transaction is accounted for as a reverse acquisition under the acquisition method of accounting for business combinations. As a result, the consolidated financial statements of Tower Group, Inc. for the periods through March 13, 2013 became the registrant’s consolidated financial statements for the same respective periods. This Amendment is being filed to restate the consolidated balance sheets as of December 31, 2012 and 2011, the consolidated statements of operations and comprehensive income, changes in stockholders’ equity and cash flows for the years ended December 31, 2012 and 2011, and certain footnote disclosures thereto, and to reflect revisions, where necessary, to the consolidated statements of operations and comprehensive income for the year ended December 31, 2010, and to certain footnote disclosures relating to 2010.

Management is restating the Original Amended Report for the loss reserve and premium receivables errors discussed below and is also correcting other immaterial adjustments that were initially recorded in the period they were identified. These immaterial adjustments are being recast into the periods in which they originated.

On November 14, 2013, Tower issued a Current Report on Form 8-K stating that it had reached a determination to restate Tower’s audited annual consolidated financial statements as of and for the years ended December 31, 2011 and 2012 contained in the Original Amended Report, and that such financial statements should no longer be relied upon. In addition, Tower will revise its (i) audited annual consolidated financial statements for the year ended December 31, 2010 contained in the Original Amended Report and (ii) unaudited interim consolidated financial statements as of and for the three months ended March 31, 2013 and 2012 contained in its Quarterly Report on Form 10-Q for the quarter ended March 31, 2013, which was filed with the SEC on May 10, 2013 (the “First Quarter 2013 Form 10-Q”). Following management review of the matter with the Audit Committee of Tower’s Board of Directors (the “Audit Committee”), and upon management’s recommendation, the Audit Committee reached a conclusion on November 7, 2013 that previously issued financial statements of the Company covering one or more periods for which the Company is required to provide financial statements need to be revised or restated and may no longer be relied upon because of the inadvertent mistakes described below. At such meeting, the Audit Committee authorized the Company’s Chief Financial Officer and Chief Accounting Officer to determine, in consultation with the Company’s independent registered public accounting firm, the specific financial statements that should be revised or restated and should no longer be relied upon. Acting upon such authority, on November 12, 2013, these officers reached a conclusion, and advised Tower’s Board of Directors, as to the specific financial statements that need to be so revised or restated and should no longer be relied upon, as described above. The Company had previously determined and announced on October 7, 2013 that its June 30, 2013 loss reserves were strengthened by approximately $365 million. The Company then undertook to review its reserve analyses for prior years. During this evaluation, the Company considered its historical loss reserve analyses and the analyses of its independent actuaries and reviewed and discussed its conclusions with its independent registered public accounting firm. Upon completion of this evaluation, the Company determined that inadvertent mistakes in classification of insurance premiums by line of business used in the loss reserving process resulted in (1) an increase in the loss and loss adjustment expenses of $9.6 million, $21.7 million and $5.7 million, for the years ended December 31, 2012, 2011 and 2010, respectively, and (2) a decrease in the reinsurance recoverables on unpaid losses asset balance by $37.0 million, $27.4 million and $5.7 million as of December 31, 2012, 2011 and 2010, respectively.

In addition, subsequent to the announcement on October 7, 2013, the Company identified errors in its historical premiums receivable balances due to inadvertent mistakes in its premiums receivable reconciliation process. This resulted in (1) a decrease of premiums receivable asset balance of $11.0 million, $10.0 million, $5.6 million and $7.2 million as of the years ended December 31, 2012, 2011, 2010 and 2009, respectively, and (2) an increase (decrease) of other operating expenses of $1.0 million, $4.4 million, ($1.6) million and $7.2 million for the years ended December 31, 2012, 2011, 2010 and 2009, respectively. The Company also will correct other immaterial adjustments that were initially recorded in the period they were identified.

Management has concluded, as a result of the items discussed above, that material weaknesses exist in internal controls over financial reporting related to the Company’s loss reserving and premiums receivable reconciliation processes and as a result has now concluded the Company’s internal control over financial reporting was not effective as of December 31, 2012 and its disclosure controls procedures were not effective as of December 31, 2012. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.

The effects of these restatements and revisions to our consolidated financial statements are described in Note 2 to the consolidated financial statements. In addition, we have updated the financial statement disclosures for significant events that have occurred subsequent to the filing of the Original Annual Report. See “Note 1 – Nature of Business” and “Note 24 - Subsequent Events” to the consolidated financial statements contained in this Amendment for further description.

The following sections have been amended from the Original Annual Report as a result of the revisions described above:

ŸPart I—Item 1. Business;

ŸPart I—Item 3. Legal Proceedings;

ŸPart II—Item 6. Selected Financial Data;

ŸPart II—Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations;

ŸPart II—Item 8. Financial Statements and Supplementary Data;

ŸPart II—Item 9A. Controls and Procedures; and

ŸPart IV—Item 15. Exhibits.

This Amendment also includes as exhibits certifications from our Chief Executive Officer and Chief Financial Officer dated as of the date of this filing.

Except as described above, no other sections have been amended from the Original Annual Report. Accordingly, this Amendment should be read in conjunction with the Original Annual Report. As stated above, the registrant is deemed to be the successor to Tower Group, Inc. pursuant to Rule 12g-3(a) under the Exchange Act and, following the consummation of the merger described above by the registrant and Tower Group, Inc., the consolidated financial statements of Tower Group, Inc. for the periods through March 13, 2013, closing date of the merger, became the registrant’s consolidated statements for the same periods. Accordingly, as used in this Amendment, unless the context requires otherwise, references to “Tower”, the “Company”, “we”, “us”, or “our” (i) with respect to any period, event or occurrence prior to March 13, 2013, are to Tower Group, Inc. and (ii) with respect to any subsequent period, event or occurrence, are to Tower Group International, Ltd., and, in each case include the Company’s insurance subsidiaries, managing general agencies and management companies.

TABLE OF CONTENTS


PART I
Item 1.	Business	1
Item 3.	Legal Proceedings	25
PART II
Item 6.	Selected Consolidated Financial Information	26
Item 7.	Management’s Discussion And Analysis Of Financial Condition And Results Of Operations	27
Item 8.	Financial Statements And Supplementary Data	F-1
Item 9A.	Controls And Procedures	F-61
PART IV
Item 15.	Exhibits, Financial Statement Schedules	F-62

Item 1. Business

Overview

This Amendment No. 2 to the Annual Report on Form 10-K is being filed by the registrant on behalf of and as successor to Tower Group, Inc. As stated above, the registrant is deemed to be the successor to Tower Group, Inc. pursuant to Rule 12g-3(a) under the Exchange Act and, following the consummation of the merger described above by the registrant and Tower Group, Inc., the consolidated financial statements of Tower Group, Inc. for the periods through March 13, 2013, closing date of the merger, became the registrant’s consolidated statements for the same periods. Accordingly, as used in this Form 10-K/A, unless the context requires otherwise, references to “Tower”, the “Company”, “we”, “us”, or “our” (i) with respect to any period, event or occurrence prior to March 13, 2013, are to Tower Group, Inc. and (ii) with respect to any subsequent period, event or occurrence, are to Tower Group International, Ltd., and, in each case, include the Company’s insurance subsidiaries, managing general agencies and management companies. Tower is also the attorney-in-fact (“AIF”) for Adirondack Insurance Exchange, a New York reciprocal insurer, and New Jersey Skylands Insurance Association, a New Jersey reciprocal insurer (together, the “Reciprocal Exchanges”). The Company does not have an ownership interest in the Reciprocal Exchanges but is required to consolidate their results for financial reporting purposes. A full listing of the subsidiaries of Tower Group, Inc. is included as Exhibit 21.1 to this Form 10-K/A.

Through our insurance subsidiaries, we offer a broad range of general commercial, specialty commercial and personal property and casualty insurance products and services to businesses in various industries and to individuals throughout the United States. We provide these products on both an admitted and an excess and surplus (“E&S”) lines basis. Insurance companies writing on an admitted basis are licensed by the states in which they sell policies and are required to offer policies using premium rates and forms that are filed with state insurance regulators. Non-admitted carriers writing in the E&S market are not bound by most of the rate and form regulations imposed on standard market companies, allowing them the flexibility to change the coverage offered and the rate charged without the time constraints and financial costs associated with the filing process.

Significant Business Developments and Risks and Uncertainties Resulting from Events Occurring in 2013

In the preparation of Tower’s June 30, 2013 consolidated financial statements, subsequent to December 31, 2012, the Company recorded an increase in its loss and loss adjustment expense reserves of approximately $365 million relating to reserve strengthening associated with losses from prior accident years. This reserve strengthening arose primarily from accident years 2008-2011 within the workers’ compensation, commercial multi-peril liability (“CMP”), other liability and commercial auto liability lines of business. In the second quarter of 2013, the Company performed a comprehensive update to its internal reserve study in response to continued observance in the second quarter of 2013 of higher than expected reported loss development. In conjunction with its comprehensive internal review, the Company also retained its consulting actuary to perform an independent reserve study covering lines of business comprising over 90% of the Company’s loss reserves. Since 2010, the Company has changed the mix of business by reducing the amount of program and middle market workers’ compensation and liability business that it underwrites.

The reserve strengthening was viewed by the Company as an event or circumstance that required the Company to perform, in the second quarter of 2013, a detailed quantitative analysis of whether its recorded goodwill was impaired. After performing the quantitative analysis as of June 30, 2013, it was determined that $214.0 million of goodwill, which represents all of the goodwill allocated to the Commercial Insurance reporting unit at that date, was impaired. Accordingly, the consolidated statement of operations as of June 30, 2013 includes a non-cash charge of $214.0 million.

As a result of the reserve strengthening, the Company is expecting its U.S. based operations to have a pre-tax loss for 2013, which would result in a three-year cumulative loss position on its U.S. subsidiaries. After considering this negative evidence and uncertainty regarding the Company’s ability to generate sufficient future taxable income in the United States, the Company concluded that it should not recognize any net deferred tax assets (comprised principally of net operating loss carryforwards) as of June 30, 2013. The Company, therefore provided a full valuation allowance against its deferred tax asset at June 30, 2013.

Reinsurance Agreements

On October 1, 2013, Tower announced that it entered into agreements with three reinsurers, Arch Reinsurance Ltd. (“Arch”), Hannover Re (Ireland) Plc. (“Hannover”) and Southport Re (Cayman), Ltd. (“Southport Re”). These agreements provided for surplus enhancement and improved certain financial leverage ratios, while increasing the Company’s financial flexibility. The agreements with Arch and Hannover each consist of one reinsurance agreement while the arrangement with Southport Re consists of several reinsurance agreements. Each of these is described below.

and policies written or renewed from July 1, 2013 to December 31, 2013. The agreement has a special termination clause whereby either party may terminate the agreement upon the occurrence of certain circumstances, including an A.M. Best financial strength rating downgrade to below A-. As noted below, A.M. Best downgraded Tower’s financial strength rating to B++. Neither party has provided notice to terminate the agreement.

The second agreement was between TICNY, on its behalf and on behalf of each of its pool participants, and Hannover. Under this multi-line quota share agreement, TICNY will cede 14% on a quota share of certain brokerage commercial automobile liability, brokerage commercial multi-peril property, brokerage commercial multi-peril liability, brokerage other liability (mono line liability) and brokerage workers’ compensation businesses. The agreement covers losses occurring on or after July 1, 2013 for policies in-force as at June 30, 2013 and policies written or renewed from July 1, 2013 to December 31, 2013. The agreement has a special termination clause whereby either party may terminate the agreement upon the occurrence of certain circumstances, including an A.M. Best financial strength rating downgrade to below A-. As noted below, A.M. Best downgraded Tower’s financial strength rating to B++. Neither party has provided notice to terminate the agreement.

The third reinsurance arrangement with Southport Re consisted of two separate reinsurance agreements with TICNY, on its behalf and on behalf of each of its pool participants, and a third reinsurance agreement with Tower Reinsurance, Ltd. (“TRL”). Under the first of the agreements with TICNY, TICNY ceded to Southport Re a 30% quota share of its workers’ compensation and employer’s liability business. The agreement covers losses occurring on or after July 1, 2013 for policies in force at June 30, 2013 and policies written or renewed during the term of the agreement. Under the second of these agreements with TICNY, an aggregate excess of loss agreement, Southport Re assumed a portion of the losses incurred by TICNY on its workers’ compensation and employer’s liability business between January 1, 2011 and June 30, 2013, but paid by TICNY on or after June 1, 2013. Finally, TRL, a wholly-owned Bermuda-domiciled reinsurance subsidiary of Tower, also entered into an aggregate excess of loss agreement with Southport Re, in which Southport Re assumed a portion of the losses incurred by TRL on its assumed workers’ compensation and employer’s liability business between January 1, 2011 and June 30, 2013, but paid by TRL on or after June 1, 2013. The agreement has a special termination clause whereby either party may terminate the agreement upon the occurrence of certain circumstances, including an A.M. Best financial strength rating downgrade to below A-. As noted below, A.M. Best downgraded Tower’s financial strength rating to B++. Neither party has provided notice to terminate the agreement.

A.M. Best, Fitch and Demotech Downgrade the Company’s Financial Strength and Issuer Credit Ratings

On October 7, 2013, Fitch Ratings (“Fitch”), downgraded Tower’s Issuer Default Rating from “BBB” to “B” and Tower’s insurance subsidiaries’ Insurer Financial Strength ratings from “A-” to “BB”. The ratings will continue to remain on negative watch until, at the earliest, the completion of Tower’s exploration of strategic alternatives.

On October 8, 2013, A.M. Best Company (“A.M. Best”), lowered Tower’s issuer credit, as well as its financial strength ratings, from “A-” (Excellent) to “B++” (Good). The ratings remain under review with negative implications pending further discussions between A.M. Best and Tower’s management.

On October 7, 2013, Demotech, Inc. (“Demotech”) lowered its rating on TICNY and three other U.S. based insurance subsidiaries (Kodiak Insurance Company, Massachusetts Homeland Insurance Company and York Insurance Company of Maine) from A’ (A prime) to A (A exceptional). In addition, Demotech removed its previous A’ (A prime) rating on six other U.S. based insurance subsidiaries (CastlePoint Florida Insurance Company, CastlePoint Insurance Company, CastlePoint National Insurance Company, Hermitage Insurance Company, North East Insurance Company and Preserver Insurance Company). Demotech also affirmed its A ratings on Adirondack Insurance Exchange, New Jersey Skylands Insurance Association, New Jersey Skylands Insurance Company, and Mountain Valley Indemnity Company.

Management expects these rating actions, in combination with the other items that have impacted the Company in the second quarter of 2013, to result in a decrease in the amount of premiums the insurance subsidiaries are able to write. Business written through certain program underwriting agents requires an A.M. Best rating of A- or greater.

In addition, one of Tower’s ceding companies requested as a result of contractual provisions that $26.3 million of additional collateral be provided to support the recoverability of their reinsurance receivable from Tower. The $26.3 million was funded in October 2013. Tower’s U.S. based insurance subsidiaries are also required to post collateral for various statutory purposes, and such requests are received from time to time from various regulatory authorities.

Statutory Capital

The Company is required to maintain minimum capital and surplus for each of its insurance subsidiaries.

U.S. based insurance companies are required to maintain capital and surplus above Company Action Level, which is a calculated capital and surplus number using a risk-based formula adopted by the state insurance regulators. The basis for this formula is the National Association of Insurance Commissioners’ (“NAIC’s”) risk-based capital (“RBC”) system and is designed to measure the adequacy of a U.S. regulated insurer’s statutory capital and surplus compared to risks inherent in its business. If an insurance entity falls into Company Action Level, its management is required to submit a comprehensive financial plan that identifies the conditions that contributed to the financial condition. This plan must contain proposals to correct the financial problems and provide projections of the financial condition, both with and without the proposed corrections. The plan must also outline the key assumptions underlying the projections and identify the quality of, and problems associated with, the underlying business. Depending on the level of actual capital and surplus in comparison to the Company Action Level, the state insurance regulators could increase their regulatory oversight, restrict the placement of new business, or place the company under regulatory control. Bermuda based insurance entities minimum capital and surplus requirements are calculated from a solvency formula prescribed by the Bermuda Monetary Authority (the “BMA”).

The Company has discussed with the BMA its intention to combine a substantial portion of the business and the capital of CastlePoint Reinsurance Company (“CastlePoint Re”), the Company’s other Bermuda based reinsurer, with TRL. Through this combination, management believes that the combined entity’s capital would meet the minimum capital and surplus thresholds determined by the BMA. The Company is currently developing this plan and expects to deliver this plan to its Bermuda regulators in the next several weeks. The Company cannot provide assurance that it will be successful in pursuing this alternative. Should the business combination not be approved, TRL would be operating at a capital level that is below the regulatory minimums as designated by the BMA. As such, TRL could be subject to significant additional regulatory oversight or, in the event that such oversight did not satisfy the BMA, placed into liquidation.

Tower has in place several intercompany reinsurance transactions between its U.S. based insurance subsidiaries and its Bermuda based insurance subsidiaries. The U.S. based insurance subsidiaries have historically reinsured on a quota share basis obligations to CastlePoint Re. The 2013 obligations that CastlePoint Re assumes from the U.S. based insurance subsidiaries are then retroceded to TRL. In addition, CastlePoint Re also entered into a loss portfolio transaction with TRL where its reserves associated with the U.S. insurance subsidiary business for underwriting years prior to 2013 were all transferred to TRL. Therefore, TRL recorded $175 million of reserve strengthening on its balance sheet as of June 30, 2013 and, consequently, the financial result of such development was a reduction in the capital of TRL to $8.3 million at June 30, 2013. In addition TRL is required to collateralize the additional $175 million of assumed reserves in a trust for the benefit of TICNY, the lead pool company of the U.S. insurance companies. TRL had unencumbered liquid assets of $96 million at June 30, 2013, and during October of 2013, TRL commuted two reinsurance treaties which provided an additional $79 million in unencumbered assets.

The funding of the trust to support TICNY’s reinsurance recoverable has not yet occurred and requires approval by the BMA. The Company provides no assurance that it will be successful in finalizing the business combination or in funding the trust. If the trust funding is not approved, 1) the statutory capital of TICNY would be at a level that could result in the New York Department of Financial Services placing TICNY under regulatory control; and 2) Tower Group, Inc. could violate the revised debt covenants of the bank credit facility at December 31, 2013, which violation, if not waived, would result in a cross default of our convertible notes. Statutory capital and surplus would be further reduced by whatever amounts are due from CastlePoint Re or from TRL that are not supported by assets held in trust. At June 30, 2013, all other U.S. based insurance subsidiaries maintained capital and surplus above company action level.

Two insurance subsidiaries that do not constitute “significant subsidiaries” of the Company under Regulation S-X are in discussions with the insurance regulatory authority in their state of domicile with respect to the imposition of restrictions on the operation of their businesses. These discussions may result in such subsidiaries’ agreeing to provide the regulatory authority with increased information with respect to their business, operations and financial condition, as well as limitations on payments and transactions outside the ordinary course of business and material changes in their management and related matters.

Liquidity

TGI is the obligor under the bank credit facility agreement dated as of February 15, 2012, as amended, with Bank of America, N.A. and other lenders mentioned therein ($70 million outstanding as of June 30, 2013) and the Convertible Senior Notes (“Notes”) due September 2014 ($150 million par amount outstanding as of June 30, 2013). The indebtedness of TGI is guaranteed by Tower Group International, Ltd. (“TGIL”).

TGI amended its credit facility on October 11, 2013, and agreed to several restrictions under the credit facility, including:

•

To not enter into any new borrowings under the credit facility;

•

To pledge to the lending banks any proceeds of new capital raises by TGI or TGIL until such time as the credit facility is paid in full;

•

To pledge to the lending banks proceeds from any sales of assets occurring at TGI; and

•

To submit to regulatory authorities, as appropriate, a request for approval to pledge the capital stock of the U.S. based and Bermuda based insurance subsidiaries.

In addition, the following financial covenants are included in the credit facility:

•

Minimum consolidated Net Worth is the greater of $553,400,000 or 90 % of Consolidated Net Worth as of June 30, 2013; this covenant increases by 90% of any new capital plus 50% of Net Income above $20,000,000;

•

Debt to capitalization ratio limit of 46%;

•

Minimum risk based capital ratio of 175% at December 31, 2013 for Tower Insurance Company of New York and any other insurance subsidiary that exceeds 10% of the consolidated statutory surplus of all insurance subsidiaries;

•

Bermuda enhanced minimum capital requirement of 150% for CastlePoint Re at December 31, 2013 and 110% for TRL;

•

Minimum statutory surplus for all insurance companies of the greater of $419,000,000 or 85% of Combined Surplus at June 30, 2013; and

•

Independent accountant’s annual report shall not be subject to any “going concern” or like qualification or exception. This financial covenant will remain in effect for the year ending December 31, 2013. Although the independent accountant’s report on the consolidated financial statements for the years ended December 31, 2010, 2011 and 2012 contains a “going concern” explanatory paragraph, on November 14, 2013, the Company received a waiver from the lenders under the credit facility in respect of such “going concern” paragraph.

Tower currently is in compliance with all covenants contained in the credit facility.

The credit facility matures on May 30, 2014, at which point any unpaid balance becomes due.

The Company’s plan to repay the Notes includes a combination of using proceeds from the sale of assets held at TGI as well as using proceeds generated by future strategic alternatives being evaluated by TGIL’s Board of Directors, and to the extent necessary, issuing debt and/or equity securities to pay down the principal of the Notes. To the extent that such asset sales and debt securities issuances are not executed or are not successful, the Company may seek to sell certain of its operating assets to satisfy this obligation. The Company cannot currently provide assurance that it will be successful in finalizing the liquidation of the assets held at TGI, issuing new debt and/or equity securities or selling certain of its operating assets.

As of June 30, 2013, there are $235 million of subordinated debentures outstanding. The subordinated debentures do not have financial covenants that would cause an acceleration of their stated maturities. The earliest stated maturity date is on a $10 million debenture, with a stated maturity in May 2033. The Company has the ability to defer interest payments on its subordinated debentures for up to twenty quarters.

There are currently no commitments or assurances to raise additional capital, execute on any strategic alternatives or to liquidate certain investments at prices sufficient to liquidate the credit facility. In addition, there can be no guarantees that the Company will be able to remedy current statutory capital deficiencies in certain insurance subsidiaries or maintain adequate levels of statutory capital in the future. Consequently, there is substantial doubt about the Company’s ability to continue as a going concern. Should the Company no longer continue to support its capital or liquidity needs, or should the Company be unable to successfully execute the above mentioned initiatives, the above items would have a material adverse effect on its business, results of operations and financial position.

The Company and certain of its senior officers have been named as defendants in several class action lawsuits instituted against them by certain shareholders.

Merger Transaction with Canopius Holdings Bermuda Limited

On August 20, 2012, TGI closed on its previously announced $74.9 million acquisition of a 10.7% stake in Canopius Group Limited (“Canopius Group”), a privately owned Lloyd’s insurance holding company domiciled in Guernsey, Channel Islands. In connection with this acquisition, TGI also entered into an agreement dated April 25, 2012 (the “Master Transaction Agreement”) under which Canopius Group committed to assist TGI with the establishment of a presence at Lloyd’s of London through a special purpose syndicate (“SPS Transaction Right and Acquisition Right”) (subject to required approvals) and granted TGI an option (the “Merger Option”) to combine with Canopius Bermuda. On July 30, 2012, TGI announced that it had exercised the Merger Option and executed an Agreement and Plan of Merger (the “Original Merger Agreement”) with Canopius Bermuda pursuant to which a wholly-owned subsidiary of Canopius Bermuda would acquire all of TGI’s common stock. TGI paid Canopius Group a fee of $1,000,000 to exercise the Merger Option. On November 8, 2012, the Original Merger Agreement was amended by Amendment No. 1 to the Agreement and Plan of Merger to reflect changes to the merger consideration to be received by TGI stockholders (the Original Merger Agreement as so amended, the “Merger Agreement”).

Prior to the Merger Transaction date, Canopius Group priced on March 6, 2013, a private sale of 100% of the shares of Canopius Bermuda to third party investors for net consideration for $205,862,755. This investment resulted in 14,025,737 shares being issued in the private placement immediately preceding the merger.

On March 13, 2013, Canopius Bermuda and TGI consummated the transaction contemplated by the Merger Agreement (the “Merger Transaction”). Canopius Bermuda was re-named Tower Group International, Ltd. and became the ultimate parent company of TGI, with TGI becoming its indirect wholly-owned subsidiary. Pursuant to the terms of the Merger Agreement, among other things, (i) 100% of the issued and outstanding shares of TGI common stock was cancelled and automatically converted into the right to receive 1.1330 common shares of the Company, par value $0.01 per share (the “Common Shares”), (ii) each outstanding option to acquire TGI common stock, whether vested or unvested and whether granted under TGI’s 2008 Long-Term Equity Compensation Plan or otherwise, automatically vested, free of any forfeiture conditions, and constituted a fully vested option to acquire that number of Common Shares (rounded down to the nearest whole number) equal to the number of shares of TGI common stock subject to such option multiplied by 1.1330, on the same terms and conditions (other than vesting and performance conditions) as were applicable to such TGI stock option immediately prior to the Merger Transaction, with the exercise price of such option adjusted to be the original exercise price divided by 1.1330, and (iii) substantially all issued and outstanding shares of TGI restricted stock, whether granted under TGI’s 2008 Long-Term Equity Compensation Plan or otherwise, automatically vested, free of any forfeiture conditions, and was converted into the right to receive, as soon as reasonably practicable after the effective time, 1.1330 Common Shares.

Immediately after giving effect to the issuance of Common Shares to the former TGI stockholders in the Merger Transaction, approximately 57,432,150 Common Shares were outstanding, of which 76% was held by the former TGI stockholders. The remaining 24% of Common Shares outstanding immediately after giving effect to the Merger Transaction was held by third party investors. As the Company is the successor issuer to TGI, succeeding to the attributes of TGI as registrant, including TGI’s SEC file number, its Common Shares trade on the same exchange, the NASDAQ Global Select Market, and under the same trading symbol, “TWGP,” that the shares of TGI common stock traded on and under prior to the Merger Transaction.

Business Segments

The Company presents its business results through three business segments: Commercial Insurance, Personal Insurance and Insurance Services. Each of these segments is described below.

For a summary of the Company’s revenue, expenses and underwriting income (pre-tax income for Insurance Services) by reportable business segment, see “Note 22 – Segment Information” of the notes to the Company’s consolidated financial statements.

Commercial Insurance Segment

Our Commercial Insurance segment offers property and casualty insurance products through several business units that serve customers in general commercial and specialty commercial markets. Using our broad product line offering, we are able to provide a comprehensive product solution to our producers and allow them to place more business with us. In addition, our diversified business platform allows us to allocate our capital to profitable markets and de-emphasize unprofitable markets. We provide commercial lines products comprised of commercial package, general liability, workers’ compensation, commercial automobile, fire and allied, inland marine and commercial umbrella policies to businesses across different industries.

These products are underwritten and serviced through our 20 offices and distributed through approximately 900 retail agents, approximately 220 wholesale agents and 15 program underwriting agents (“PUA”). Approximately 55% of the direct premiums written by the Commercial Insurance segment in 2012 were from the northeastern United States. However, in the past several years we have expanded our commercial business beyond the northeastern United States through acquisitions and by appointing retail and wholesale agents in other regions, primarily the west and southeast.

Through our general commercial business units, we offer a broad and diversified range of property and casualty insurance products and services primarily to small to mid-sized businesses throughout the United States. We classify our business into different pricing and coverage tiers to meet the specific needs of our customers. We offer our products on an admitted basis in the preferred, standard, and non-standard pricing and coverage tiers and on a non-admitted basis using our E&S coverage and pricing tier. For each of the preferred, standard, non-standard and E&S coverage and pricing tiers, we have developed different coverage and underwriting guidelines. For example, the pricing for the preferred risk sector is generally the lowest, followed by the pricing for the standard, non-standard and E&S lines of business. Underwriting guidelines are correspondingly stricter for preferred risks in order to justify the lower premium rates charged for these risks with guidelines becoming progressively less restrictive for standard, non-standard and E&S risks. We generally distribute policies for risks with preferred and standard underwriting characteristics through our retail agents and policies for risks with non-standard and E&S underwriting characteristics through our wholesale agents. In addition to categorizing our products into various pricing and coverage tiers, we further classify our products into the following premium size classes: under $25,000 (small), $25,000 to $150,000 (medium) and over $150,000 (large). We currently provide coverage for businesses in the real estate, retail, wholesale and service industries such as retail and wholesale stores, residential and commercial buildings, restaurants and artisan contractors, but are expanding our product offerings to other industry groups.

Through our specialty commercial business units, we also offer insurance covering narrowly defined, homogeneous classes of business including Transportation, Professional Employers Organizations, Temporary Staffing Firms, Commercial Construction and Auto Dealerships produced through a select number of program underwriting agents, who have specialized underwriting expertise in the classes they underwrite and have established books of business with proven track records. We rely on our program underwriting agents for industry insight, regional underwriting knowledge and understanding of the specific risks in the niche markets we serve. We couple that knowledge with disciplined underwriting practices, technology and systems capabilities to provide insurance programs and products customized to the needs of specialty markets customers. Our focus in the specialty market is on those classes of business traditionally underserved by standard property and casualty insurers due to the complex business knowledge, awareness of regional market conditions and investment required to achieve attractive underwriting profits. We believe this portion of the market is attractive because competition is based primarily on customer service, availability and continuity of insurance capacity, specialized policy forms, efficient claims handling and other value-added considerations, rather than just price. We maintain a disciplined underwriting approach to this business through conservative authority delegation and regular audits of underwriting and operational performance.

Through our Assumed Reinsurance business, we generally provide coverage on a “quota share” basis to our customers, who are other insurance carriers or reinsurers. Under this type of arrangement, we generally receive an agreed upon proportion of premiums written by the insurance carrier, and share in all losses in the same proportion as the premiums received.

Personal Insurance Segment

We offer a broad range of personal lines products including package, mono line homeowners, mono line automobile insurance, and ancillary personal lines coverage (renters, condo, dwelling fire, scheduled articles, umbrella and boats). Package policies include homeowners and auto and may also include ancillary coverage.

The Personal Insurance segment is designed to fit the insurance needs of most personal lines customers. Our products are distributed through a network of approximately 500 retail agents, wholesale agents, national brokers and other insurance companies. Our customers are concentrated in the northeastern United States with 86% of the premium volume produced by agents in this region, including NY (41%), NJ (15%), and MA (11%). Mono line homeowners in CA make up 8.4% of our premium. Personal lines includes the business written in the Reciprocal Exchanges and Tower stock companies.

For our retail agency business, we offer three levels of coverage under our OneChoice® product including OneChoice Security Plus, Security Plus Elite, and our new Premier product for affluent customers. In addition, customers can also purchase our CustomPac® package product which provides additional policyholder benefits.

Our wholesale mono line homeowners business is primarily written in NY, NJ, and CA. The product for wholesale agents is designed to accommodate customers in underserved markets and provides broad underwriting eligibility and processing simplicity for distributors. We offer standard and non-standard policies through wholesale agents.

Insurance Services Segment

In our Insurance Services segment, we generate fees from performing various aspects of insurance company functions for other insurance companies, including underwriting, claims administration, operational and technology services. We provide these services through our managing general agencies and management companies.

Our primary source of fee income is from the Reciprocal Exchanges for which we manage the day-to-day operations in exchange for a management fee. This model allows us to use capital more efficiently and provides the company with a steady flow of fee income.

The following shows fee income for the years ended December 31, 2012, 2011 and 2010:


		Year Ended December 31,
($ in millions)		2012		2011		2010

Management fee income	$		30.2	$	29.3	$	17.8
Other revenue			3.4		1.6		2.1

Products and Services

Our diversified business platform allows us to provide a broad range of products. Our products include the following:

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Commercial Multiple-peril Packages. Coverage offered under our commercial package and business owners policies combines property, liability (including general liability and products and completed operations), business interruption, equipment breakdown, fidelity and inland marine coverages tailored for commercial businesses and enterprises. Commercial packages and business owners policies are offered by our Commercial Insurance segment.

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Other Liability. In our Commercial Insurance and Personal Insurance segments, we write liability policies for individuals and business owners including mono line commercial general liability (generally for risks that do not have property exposure or whose property exposure is insured elsewhere) and commercial umbrella policies. Also, in our Commercial Insurance segment, we write General Liability policies for businesses in programs that are tailored to narrowly defined industry classes.

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Workers’ Compensation. In our Commercial Insurance segment, we write workers’ compensation policies, which are a statutory coverage requirement in almost every state to protect employees in case of injury on

the job, and the employers from liability for an accident involving an employee. We write workers’ compensation policies generally for small and medium-sized businesses as well as in programs targeted to specific industry classes.

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Commercial Automobile. In our Commercial Insurance segment, we write coverage for automobiles by providing automobile liability, physical damage insurance including commercial and personal automobile policies for both fleet and non-fleet risks (our personal automobile business is described in the bullet below). We write commercial automobile policies that focus on business automobiles and small trucks for businesses other than transportation companies as well as for trucking businesses and other specialty transportation businesses.

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Fire and Allied Lines and Inland Marine. We write fire and allied lines policies for individuals and businesses. Individual dwelling policies generally include personal property with optional liability coverage that provides an alternative to the homeowners policy for the personal lines customer. Commercial fire and allied lines policies provide protection for damage to commercial buildings and their contents, and these policies may be utilized in selected circumstances as an alternative to a commercial package policy. We write inland marine insurance protection for the property of businesses that is not at a fixed location, for items of personal property that are easily transportable, and for properties that are under construction. Coverages offered typically include builders risk, contractors’ equipment and installation, domestic transit and transportation, fine arts, property floaters and leased property. These products are offered by our Commercial Insurance and Personal Insurance segments through their respective distribution systems.

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Personal Package. The personal package policy provides our agents with a differentiated product and provides our customers with the convenience and security of covering their home, automobile, umbrella and supplemental coverages with one insurance policy and one bill.

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Homeowners and Personal Dwellings. Our homeowners policy is a multiple-peril policy, providing property and liability coverages for one- and two-family, owner-occupied residences. We provide additional coverage to the homeowner for personal umbrella and personal inland marine.

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Personal Automobile. Our personal automobile policies provide coverage for liability and physical damage. Auto Liability covers Bodily Injury to others, damage to others’ property and the legal defense costs resulting from an accident caused by our insured. Physical Damage provides coverage to vehicles that have suffered losses from collision, theft, fire, vandalism or other causes.

Gross premiums written by product line for the years ended December 31, 2012, 2011 and 2010 are as follows:


		Year ended December 31,
($ in millions)		2012		2011		2010

Tower
Commercial multiple-peril	$		477.9	$	418.7	$	366.6
Commercial other liability			139.6		179.6		157.0
Workers’ compensation			419.0		359.4		283.4
Commercial automobile			193.1		229.9		204.7
Fire and allied lines and inland marine			64.7		48.7		38.9
Homeowners and umbrella			336.0		267.3		234.2
Personal automobile			125.4		98.0		99.8

Total Tower			1,755.7		1,601.6		1,384.6

Reciprocals
Fire and allied lines and inland marine			14.2		12.7		-
Homeowners and umbrella			90.1		86.7		52.0
Personal automobile			111.1		109.9		59.8

Total Reciprocals			215.4		209.3		111.8

Consolidated totals	$		1,971.1	$	1,810.9	$	1,496.4

Acquisitions

The Company completed the following acquisitions during the three year period ended December 31, 2012.

NAV PAC Division of Navigators Group, Inc. (“NAV PAC”)

On January 14, 2011, Tower obtained the renewal rights to the middle market commercial package and commercial automobile business underwritten through the NAV PAC division of Navigators Group, Inc. Tower pays Navigators Insurance Company a commission equal to 2% of the direct premiums written under this renewal rights arrangement. This business allowed us to expand our middle market commercial product offering into certain niche classes of business. This renewal rights acquisition represents the ability to write future insurance business and does not include the acquisition of any assets or liabilities of NAV PAC. Accordingly, this transaction was not accounted for as a business combination.

Renewal Rights of AequiCap Commercial Automobile (“AequiCap II”)

On November 2, 2010, Tower acquired the renewal rights to the commercial automobile liability and physical damage business of AequiCap Program Administrators Inc. (“AequiCap”), an underwriting agency based in Fort Lauderdale, Florida, for $12 million. The business subject to the agreement covers both trucking and taxi risks that are consistent with Tower’s current underwriting guidelines.

OneBeacon Personal Lines Division (“OBPL”)

On July 1, 2010 the Company completed the acquisition of OBPL. The Company acquired Massachusetts Homeland Insurance Company, York Insurance Company of Maine and two management companies. The management companies are the attorneys-in-fact for Adirondack Insurance Exchange, a New York reciprocal insurer, and New Jersey Skylands Insurance Association, a New Jersey reciprocal insurer (collectively, the “Reciprocal Exchanges”). The consideration for this transaction was $164.3 million. Effective July 1, 2010, the Company entered into transition service agreements with OneBeacon Insurance Group, LLC (“OneBeacon”) whereby OneBeacon provides certain information technology and operational support to the Company for a certain period of time. This acquisition expanded the Company’s suite of personal lines insurance products to include private passenger automobile, homeowners, personal umbrella, and the signature package product, OneChoice CustomPac, which provides customers with one policy for all of their homeowners, automobile and umbrella needs.

Organizational Structure

Our organizational structure is divided into three strategic centers: a corporate center, a service center and a profit center. The corporate center functions are performed from our headquarters located in New York and are comprised of Corporate Legal and Audit, Corporate Marketing and Communications, Finance, Human Resources and Corporate Administration, and Actuarial and Risk Management. The service center functions encompass Operations, Technology and Claims and Legal Defense. The profit center functions include the three business centers: Underwriting, Distribution and Operations.

In 2010, we established East and West zones to provide business development, underwriting, policyholders services and claims functions to the Commercial Insurance and Personal Insurance segments. The East zone is comprised of New England, the Mid-Atlantic and Southeast regions. The West zone includes our West, Southwest and Midwest regions. The following table shows the states that comprise each of our zones and regions:

East Zone

New England Region

Mid-Atlantic Region

Southeast Region

Connecticut

New Hampshire

Delaware

New Jersey

Alabama

North Carolina

Maine

Rhode Island

District of

Columbia

New York

Florida

South Carolina

Massachusetts

Vermont

Maryland

Pennsylvania

Georgia

Tennessee

Mississippi

Virginia

West Virginia

West Zone

Midwest Region

Southwest Region

West Region

Illinois

Minnesota

Arkansas

New Mexico

Alaska

Idaho

Indiana

Missouri

Colorado

Oklahoma

Arizona

Montana

Iowa

North Dakota

Kansas

Texas

California

Nevada

Kentucky

Ohio

Louisiana

Utah

Hawaii

Oregon

Michigan

South Dakota

Nebraska

Wyoming

Washington

Wisconsin

The East zone is headquartered in New York and has ten branches. The West zone is headquartered in Irvine, California, and has four branches. Claims processing functions are located in New York, New Jersey, Maine, Massachusetts, Illinois, California, Texas and Florida, and service both the East and West zones. In addition, we have five legal defense offices located in the East zone.

The following table shows the direct premiums written by region, premiums assumed and gross premiums written for the years ended December 31, 2012, 2011 and 2010:


	Year Ended December 31,
($ in millions)	2012		Percent		2011		Percent		2010		Percent

East zone direct premiums written
New England	$	228.0		11.6%	$	217.8		12.0%	$	138.4		9.2%
Mid-Atlantic		917.9		46.6%		905.0		50.0%		786.3		52.5%
Southeast		138.1		7.0%		135.8		7.5%		125.2		8.4%
West zone direct premiums written
Midwest		39.4		2.0%		45.8		2.5%		25.3		1.7%
Southwest		85.3		4.3%		37.7		2.1%		50.5		3.4%
West		346.5		17.5%		349.9		19.3%		306.5		20.5%
Assumed premiums		215.9		11.0%		118.9		6.6%		64.2		4.3%

Total gross premiums written	$	1,971.1		100.0%	$	1,810.9		100.0%	$	1,496.4		100.0%

Distribution

We generate business through independent retail, wholesale and program underwriting agents (collectively, our “producers”). These producers sell policies for us as well as for other insurance companies. We carefully select our producers by evaluating several factors such as their need for our products, premium production potential, loss history with other insurance companies that they represent, product and market knowledge, and the size of the agency. We generally appoint producers with a total annual insurance premium volume greater than $10 million and we expect a new producer to be able to produce at least $500,000 in annual premiums for us during the first year and $1 million or more in annual premiums after three years. We select our program underwriting agents based upon their underwriting expertise in specific niche markets, type of business, size and profitability of the existing book of business.

Commissions expense in 2012 and 2011 averaged 18.5% and 17.3% (excluding the Reciprocal Exchanges) of gross premiums earned, respectively. Our commission schedules are 1 to 2.5 points higher for wholesale compared to retail agents. Our commissions are also higher for program underwriting agents that perform additional underwriting and processing services on our behalf, including premium collection, policy issuance and data collection and from other insurance companies and Lloyd’s syndicates from which we have been assuming business. In our Commercial Insurance segment we also have a profit sharing plan that added 1/2 of 1 percent to overall commission based on the loss ratio performance of qualifying agencies. In our Personal Insurance segment, we have a profit sharing plan that added 3/4 of 1 percent to overall commission rates in the past several years.

To ensure that we obtain profitable business from our producers, we attempt to position ourselves as our producers’ primary provider within the product segments that we offer. We manage the results of our producers through periodic reviews to monitor premium volume and profitability. We have access to online premium and loss ratio reports by producer, and we estimate each producer’s profitability at least annually using actuarial techniques. We continuously monitor the performance of our producers by assessing leading indicators and metrics that signal the need for corrective action. Corrective action may include increased frequency of producer meetings and more detailed business planning. If loss ratio issues arise, we increase the monitoring of individual risks and consider reducing that producer’s binding authority. Review and enforcement of the agency agreement requirements can be used to address inadequate adherence to administrative duties and responsibilities. Noncompliance can lead to reduction of authority and potential termination.

In 2012, 37.0% of the Company’s total business was generated by wholesale agents, 36.0% by retail producers 18.5% by program underwriting agents and 8.5% from international assumed reinsurance.

Our largest producers in 2012 were Northeast Agencies, Guy Carpenter, Risk Transfer, NSM, Morstan General Agency and NBIS. In the year ended December 31, 2012, these producers accounted for 7%, 6%, 5%, 5%, 3% and 3%, respectively, of the

total of our gross premiums written. Guy Carpenter production was solely for our assumed reinsurance business. No other producer was responsible for more than 3% of our gross premiums written. Approximately 48% of the 2012 gross premiums written in the Commercial Insurance segment were produced by our top 43 active producers representing 3% of our active agents, brokers and program underwriting agents. These producers each have annual written premiums of $5 million or more. As we build a broader geographic distribution base, we are increasing the number of program underwriting agents who write significant premium volume for Tower, particularly with the addition of producers through acquisitions and territorial expansion in the northeastern United States and Southeast and Midwest regions.

The number of agencies and program underwriting agents from which we receive business is shown in the following table:


	December 31,
	2012		2011		2010

Retail Agencies		1,017		1,128		1,151
Wholesale Agencies		220		221		173
Program Underwriting Agents		15		8		13

Total		1,252		1,357		1,337

Underwriting

Our underwriting strategy is to seek diversification in our products and an appropriate business mix for any given year that will emphasize profitable business and de-emphasize business that is not meeting profit targets. At the beginning of each year, we establish target premium levels and loss ratios for each line of business, which we monitor throughout the year on a regular basis. If any line of business fails to meet its target loss ratio, a cross-functional team comprised of personnel from segment underwriting, corporate underwriting, actuarial, claims and loss control will generally meet to develop corrective action plans that may involve revising underwriting guidelines, non-renewing unprofitable segments or entire lines of business and/or implementing rate increases. During the period of time that a corrective action plan is being implemented with respect to any product line that fails to meet its target loss ratio, premium for that product line is reduced or maintained depending upon its effect on our total loss ratio. To offset the reduction or lack of growth in premium volume for the products that are undergoing corrective action, we seek to expand our premium writings in existing profitable business or add new business with better underwriting profit potential.

For lines of business other than workers’ compensation, we generally use actuarial loss costs developed by the Insurance Services Office (ISO), a company providing statistical, actuarial and underwriting and claims information and related services to insurers, as a benchmark in the development of pricing for our products. For workers’ compensation policies, we use loss costs or rates developed by the National Council on Compensation Insurance, Inc. (NCCI) or state-administered rates or loss costs. We further tailor pricing to each specific product we underwrite, taking into account our historical loss experience and individual risk and coverage characteristics. This may result in proprietary rates and forms for select classes and territories.

Commercial Insurance business

With respect to the business written on a direct basis through our Commercial Insurance segment, we establish underwriting guidelines for all the products that we underwrite to ensure a uniform approach to risk selection, pricing and risk evaluation among our underwriters and to achieve underwriting profitability. The rules and guidelines may be customized for a particular region to recognize territorial differences. Our underwriting process involves securing an adequate level of underwriting information from our producers, inspections and surveys to identify and evaluate risk exposures, which provides information necessary for pricing the risks we choose to accept. For certain approved classes of commercial risks, we allow our producers to initially bind these risks utilizing rating criteria that we provide to them. Our web-based platforms, webPlus^® (“webPlus”) and Preserver Online, provide our producers with the capability to submit and receive quotes over the Internet and contain our risk selection and pricing logic, thereby enabling us to streamline our initial submission and screening process. If the individual risk does not meet the initial submission and screening parameters contained within webPlus or Preserver Online, the risk is automatically referred to an assigned underwriter for specific offline review.

New business is subject to post-bind inspection and is evaluated based on size, hazard and territory. These inspections generally take place within 60 days from the effective date of the policy, and are generally reviewed by underwriting within that period. If the inspection reveals that the risk insured under the policy does not meet our established underwriting guidelines, the policy is typically cancelled. If the inspection reveals that the risk meets our established underwriting guidelines but the policy was bound with incorrect rating information, the policy is amended through an endorsement based upon the correct information. We supplement the inspection by using online data sources to further evaluate the building value, claim experience, financial history and catastrophe exposures of the insured. In addition, we specifically tailor coverage to match the insured’s exposure and premium requirements. We complete internal file reviews and audits on a monthly, quarterly and annual basis to confirm that underwriting standards and pricing programs are being consistently followed. Our property risks are generally comprised of residential buildings, retail stores and restaurants covered under policies with low building and content limits. We carefully

underwrite potential risks to limit our exposure to terrorism losses. Our underwriting guidelines are designed to avoid properties designated as, or in close proximity to, high profile or target risks, individual buildings over 25 stories and any site within 500 feet of major transportation centers, bridges, tunnels and other governmental or institutional buildings. In addition, we monitor the concentration of employees insured under our workers’ compensation policies and avoid writing risks with more than 100 employees in any location at a given time. Please see “Risk Factors-Risks Related to Our Business.” We may face substantial exposure to losses from terrorism, and we are currently required by law to offer coverage against such losses.

We underwrite our products through our underwriting business units that are each headed by an underwriting manager. These underwriting units are supported by professionals in the corporate underwriting, actuarial, operations, business development and loss control departments. The corporate underwriting department is responsible for managing and analyzing the profitability of our entire book of business, supporting segment underwriting with technical assistance, developing underwriting guidelines, granting underwriting authority, training, developing new products and monitoring underwriting quality control through audits. The underwriting operations department is responsible for developing workflows, conducting operational audits and providing technical assistance to the underwriting teams. The loss control department manages the inspection and risk improvement process on commercial and personal lines business written, utilizing in-house loss control representatives and outside vendors. The business development department works with the underwriting teams to manage relationships with our producers.

The underwriting process utilized for the Commercial Insurance segment’s program business is based on our understanding of best industry practices. We consider the appropriateness of delegating authority to the Program Underwriting Agent by evaluating the quality of its management, risk management strategy and track record. In addition, we require each program that we underwrite to include significant information regarding the nature of the perils to be included and detailed aggregate information pertaining to the location(s) of the risks covered. We obtain available information on the client’s loss history for the perils being insured or reinsured, together with relevant underwriting considerations. In conjunction with testing each proposed program against our underwriting criteria, our underwriters evaluate the proposal in terms of its risk/reward profile to assess the adequacy of the proposed pricing and its potential impact on our overall return on capital and corporate risk objectives. Our underwriting process integrates the actuarial, finance, operations, information technology, claims, legal and underwriting disciplines. We utilize our in-house actuarial staff as well as outside consultants, as necessary. The actuarial and underwriting estimates that we develop in our pricing analyses are explicitly tracked by program on a continuous basis through our underwriting audit and actuarial reserving processes. We require significant amounts of data from our clients and only accept business for which the data provided to us is sufficient for us to make an appropriate analysis. We may supplement the data provided to us by our clients with information from the ISO, the NCCI, other advisory rate-making associations and other organizations that provide projected loss cost data to their members.

Personal Insurance business

Our broad range of personal lines products are developed using multivariate rating plans, allowing us to calculate adequate prices for a broad range of customers. We invest in external data and services to insure our business is correctly classified for rating and underwriting including motor vehicle reports, household driver reports, CLUE reports, credit reports, protection class, brush underwriting, property inspections, and catastrophe modeling.

We have market-leading expertise in catastrophe management. We underwrite and price each new business application using exposure-level average annual loss estimates, reinsurance costs, and capital costs. If a new business policy does not allow us to achieve our target returns, the business is declined by our underwriting platform. As we expand to new states, our portfolio of homeowner exposures will be priced and underwritten to cover reinsurance and capital costs and to achieve our accumulation targets.

We have made a significant investment to modernize our personal lines technology platform, Advantage Policy Processing System (“APPS”), which includes policy administration, billing, claims, and data warehouse systems. With our new APPS technology platform, we are able to reduce costs by eliminating legacy systems and related service agreements, improving distributor engagement through broader functionality and more efficient transactions and providing real-time quote and policy issuance. This real-time underwriting platform validates and integrates data from external sources, determines eligibility, develops final rate, provides agency and policyholder documentation, and provides the agency with a once-and-done transaction.

We offer different products, coverage levels, underwriting eligibility, and rating plans through varying company structure depending on the state, distribution channel, and customer segment we are serving.

As Attorney-in-Fact (“AIF”) for the Reciprocal Exchanges, we work with the Reciprocal Exchanges to expand their business. We expect the majority of new premium growth to occur within Reciprocal Exchanges (versus growth within stock underwriting companies). Growing our business through our management agreement with the Reciprocal Exchanges offers us significant advantages. First, income from premium written in the Reciprocal Exchanges will generate management fees (rather than underwriting income). This management fee income is more predictable year-to-year versus underwriting income. Second,

because we can operate at higher premium to surplus ratios in the Reciprocal Exchanges, our target combined ratio can be higher in the Reciprocal Exchanges resulting in more competitive rates. Finally, placing homeowners business in Reciprocal Exchanges leverages our partnerships with reinsurers who have benefited from our consistent track record of underwriting income in the Reciprocal Exchanges.

Claims Management

We manage the claims function through our regional claims offices throughout the U.S. On a limited basis, we also utilize third party administrators who specialize in handling certain types of claims, generally for our program business.

Our claims adjustors are assigned to cases based upon their expertise for various types of claims, and we monitor the results of the adjusters handling the claims using peer reviews and claim file audits. We monitor claims adjusting performed by third-party administrators similarly to how we monitor claims adjusting conducted by our own personnel. We maintain databases of the claims experience of each of our products, territories and programs results, and our claims managers work with our underwriters and actuaries to assess results and trends.

We establish case loss reserves for each claim based upon all of the facts available at the time to record our best estimate of the ultimate loss exposure for each claim. For third-party claims, we also establish reserves on a case-by-case basis for estimated defense and cost containment expenses, sometimes referred to as allocated loss adjustment expense reserves.

In 2013, for programs that we have terminated, we are assigning claims to a special unit within the claims department. This department will review claims audits that will be performed on all terminated programs, and will also revalidate on a claim by claim basis the sufficiency of case reserves. As the Company experienced reserve strengthening associated with many of its terminated programs in 2012, the Company is initiating this run-off claims unit to mitigate future reserve strengthening.

Competition

The insurance industry is highly competitive. Each year we attempt to assess and project market conditions when we develop prices for our products, but we cannot fully know our profitability until all claims have been reported and settled.

We compete with many insurance companies in each segment in which we write business, and we compete within our producers’ offices to write the types of business that we desire. Some of our competitors have more, and in some cases substantially more, capital and greater marketing and management resources than we have, and some of our competitors have greater name and brand recognition than we have, especially outside of the northeastern United States where we have more experience.

Competition in the types of business that we underwrite and intend to underwrite is based on many factors, including:

•

reputation;

•

multiple solution capability;

•

strength of client and distribution relationships;

•

perceived financial strength and financial ratings assigned by independent rating agencies;

•

management’s experience in the product, territory, or program;

•

premiums charged and other terms and conditions offered;

•

services provided, products offered and scope of business, both by size and geographic location; and

•

claims handling.

Increased competition could result in fewer applications for coverage, lower premium rates and less favorable policy terms, which could adversely affect us. We are unable to predict the extent to which new, proposed or potential initiatives may affect the demand for our products or the risks that may be available for us to consider underwriting.

Within our admitted commercial and personal lines business, we compete with major U.S. insurers and certain underwriting syndicates, including large national companies such as Travelers Companies, Inc., Hartford, CNA, Liberty Mutual, AIG, Allstate Insurance Company, GEICO, Progressive Corporation and State Farm Insurance; regional insurers such as Philadelphia Insurance Companies, Selective Insurance Company, Erie and Hanover Insurance and smaller, more local competitors such as Greater New York Mutual, Magna Carta Companies, MMG Insurance Company, Arbella, Quincy Mutual Fire Insurance Company and Utica First Insurance Company. Our non-admitted binding authority and submit business with general agents competes with Scottsdale Insurance Company, Navigators Group, Inc., Essex Insurance Company, Colony Insurance Company, Century Insurance Group, RLI Corp., United States Liability Insurance Group, Burlington Insurance Group, Inc., W.R. Berkley

Corporation, Western World and Lloyds. In our program business, we compete against companies that write program business such as QBE Insurance Group Limited, Am Trust Financial Services, Inc., RLI Corp., W.R. Berkley Corporation, Markel Corporation and Great American Insurance Group.

Loss and Loss Adjustment Expense Reserves

We are required to establish reserves for incurred losses that are unpaid, including reserves for claims and loss adjustment expenses, which represent the expenses of settling and adjusting those claims. These reserves are balance sheet liabilities representing estimates of future amounts required to pay losses and loss expenses for insured and/or reinsured claims that have occurred at or before the balance sheet date, whether already known to us or not yet reported. Our policy is to establish these losses and loss reserves after considering all information known to us as of the date they are recorded.

Loss reserves fall into two categories: case reserves for reported losses and loss expenses associated with a specific reported insured claim, and reserves for incurred but not reported (“IBNR”) losses and loss adjustment expenses. We establish these two categories of loss reserves as follows:

•

Reserves for reported losses - When a claim is received from an insured, broker or ceding company, or claimant we establish a case reserve for the estimated amount of its ultimate settlement and its estimated loss expenses. We establish case reserves based upon the known facts about each claim at the time the claim is reported and may subsequently increase or reduce the case reserves as our claims department deems necessary based upon the development of additional facts about the claim.

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IBNR reserves - We also estimate and establish reserves for loss and loss adjustment expense (“LAE”) amounts incurred but not yet reported, including expected development of reported claims. IBNR reserves are calculated as ultimate losses and LAE less reported losses and LAE. Ultimate losses are projected by using generally accepted actuarial techniques.

Loss reserves represent our best estimate, at a given point in time, of the unpaid ultimate settlement and administration cost of claims incurred. For workers’ compensation, our reserves are discounted for claims that are settled or expected to be settled as long-term annuity payments, and as of December 31, 2012 the total amount of this discount was $8.4 million, which relates to $393.9 million in total net reserves for workers’ compensation. To estimate loss reserves, we utilize information from our pricing analyses, actuarial analysis of claims experience by product and segment, and relevant insurance industry information such as loss settlement patterns for the type of business being reserved.

Since the process of estimating loss reserves requires significant judgment about a number of variables, such as fluctuations in inflation, judicial trends and changes in claims handling procedures, our ultimate liability may exceed or be less than these estimates. We revise reserves for losses and loss expenses as additional information becomes available and reflect adjustments, if any, in earnings in the periods in which they are determined.

We engage independent external actuarial specialists at least annually, to review specific pricing and reserving methods and results. We also engage an independent external actuarial specialist annually to opine on the statutory reserves that are recorded at our insurance subsidiaries.

A reconciliation of loss and LAE reserves from the beginning of the year to the end of the year for the three years ended December 31, 2012, 2011 and 2010 is included in the footnotes to the financial statements included in this Form 10-K/A.

Loss and loss adjustment expenses

Our claims reserving practices are designed to set reserves that in the aggregate are adequate to pay all claims at their ultimate settlement value. Shown below is the loss reserve development for business written each year from 2002 through 2012. The table portrays the changes in our loss and LAE reserves in subsequent years from the prior loss estimates based on experience as of the end of each succeeding year.

The first line of the table shows, for the years indicated, our net reserve liability including the reserve for incurred but not reported losses as originally estimated. For example, as of December 31, 2002 we estimated that $15.5 million would be a sufficient reserve to settle all claims not already settled that had occurred prior to December 31, 2002 whether reported or unreported to us. The next section of the table shows, by year, the cumulative amounts of losses and loss adjustment expenses paid as of the end of each succeeding year. For example, with respect to the net losses and loss expense reserve of $15.5 million as of December 31, 2002, by December 31, 2012 (ten years later) $19.6 million had actually been paid in settlement of the claims (including the impact of reinsurance commutations).

The next section of the table sets forth the re-estimations in later years of incurred losses, including payments, for the years indicated. For example, as reflected in that section of the table, the original reserve of $15.5 million was re-estimated to be $21.6

million at December 31, 2012. The increase from the original estimate is caused by a combination of factors, including: (1) claims being settled for amounts different than originally estimated, (2) reserves being increased or decreased for claims remaining open as more information becomes known about those individual claims, (3) more or fewer claims being reported after December 31, 2002 than anticipated and (4) the impact of commuting existing reinsurance coverage.

The “cumulative redundancy/ (deficiency)” represents, as of December 31, 2012, the difference between the latest re-estimated liability and the reserves as originally estimated. A redundancy means the original estimate was higher than the current estimate; a deficiency means that the current estimate is higher than the original estimate. For example, as of December 31, 2012 and based upon updated information, we re-estimated that the reserves which were established as of December 31, 2011 had a $79.4 million deficiency as compared to the original net liability estimated at December 31, 2011.

The bottom part of the table shows the impact of reinsurance reconciling the net reserves shown in the upper portion of the table to gross reserves.


	Year ended December 31,
($ in millions)	2002			2003			2004			2005			2006		2007		2008			2009			2010 (revised)			2011 (restated)		2012 (restated)

Original Net Liability		15.5			24.4			36.9			101.7			192.5		311.7		312.8			932.3			1,333.4			1,339.9		1,436.2
Cumulative payments as of:
One year later		4.1			7.5			10.9			13.7			49.5		102.4		111.4			415.6			674.2			637.3
Two years later		6.7			11.9			4.5			36.7			90.9		163.8		178.4			492.6			868.2
Three years later		9.1			2.9			16.8			60.6			120.0		205.7		210.1			769.6
Four years later		4.5			11.7			30.2			73.9			137.7		229.1		262.3
Five years later		8.9			17.8			34.9			82.1			144.9		258.2
Six years later		11.7			20.8			39.1			87.2			158.5
Seven years later		13.4			24.4			39.5			95.3
Eight years later		14.9			24.9			41.8
Nine years later		15.5			30.0
Ten years later		19.6

Net liability re-estimated as of:
One year later		15.6			24.2			36.6			101.0			191.1		303.9		312.5			943.0			1,333.5			1,419.2
Two years later		14.7			24.8			40.7			101.5			178.3		288.1		326.0			983.3			1,325.8
Three years later		16.5			29.0			48.3			99.5			171.4		293.0		347.5			980.1
Four years later		19.6			36.2			45.3			96.6			173.4		303.5		333.8
Five years later		25.1			33.6			40.2			97.9			176.0		296.9
Six years later		23.0			27.9			41.6			102.6			173.4
Seven years later		17.0			29.8			43.6			103.0
Eight years later		18.1			31.9			44.8
Nine years later		20.6			33.0
Ten years later		21.6
Cumulative Net redundancy/ (deficiency)		(6.1	)		(8.6	)		(7.9	)		(1.3	)		19.1		14.8		(21.0	)		(47.8	)		7.7			(79.4)
Reinsurance Commutations		8.0			10.3			10.2			10.3			-		-		-			-			-			-
Cumulative net redundancy/ (deficiency) excluding
Reinsurance Commutations		1.8			1.7			2.4			9.0			19.1		14.8		(21.0	)		(47.8	)		7.7			(79.4)

Net reserves		15.5			24.4			36.9			101.7			192.5		311.7		312.8			932.3			1,333.4			1,339.9		1,436.2
Ceded reserves		50.2			75.1			91.8			97.0			110.0		189.5		222.2			199.7			277.0			292.2		459.5

Gross reserves		65.7			99.5			128.7			198.7			302.5		501.2		535.0			1,132.0			1,610.4			1,632.1		1,895.7

Net re-estimated		21.6			33.0			44.8			103.0			173.4		296.9		333.8			980.1			1,325.8			1,419.2
Ceded re-estimated		48.7			70.6			85.6			85.1			93.7		173.5		230.5			211.9			343.1			353.1

Gross re-estimated		70.3			103.6			130.4			188.1			267.1		470.4		564.3			1,192.0			1,668.8			1,772.3

Cumulative gross redundancy/ (deficiency)		(4.6	)		(4.1	)		(1.7	)		10.6			35.5		30.8		(29.3	)		(60.0	)		(58.4	)		(140.2)

(1)

The cumulative payments, net liabilities and net deficiencies are affected by commutations. We commuted several reinsurance treaties in 2002. These commutations had the effect of lowering the cumulative payments by $8.0 million in 2002, $10.3 million in 2003, $10.2 million in 2004 and $10.3 million in 2005

(2)

The net reserve increases reflected in the above table for 2008, 2009 and 2012 resulted primarily from reserve strengthening in the workers’ compensation, commercial multi-peril liability, other liability, and auto liability lines partially offset by favorable development in the property lines and by favorable changes to unallocated loss adjustment expense reserves. The net reserve decrease for 2010 is primarily due to favorable development in personal lines, partially offset by reserve strengthening in commercial lines. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further discussion.

(3)	Reciprocal Exchanges net reserves of $125.0 million and $83.4 million are included in the ending reserves at December 31, 2011 and 2012, respectively.

Analysis of Reserves

The following table shows our estimated net outstanding case loss reserves and IBNR for loss and LAE by line of business as of December 31, 2012 and 2011:


	2012						2011
	Case Loss Reserves		IBNR		Total		Case Loss Reserves		IBNR		Total
($ in millions)			(restated)		(restated)				(restated)		(restated)

Tower
Commercial multiple-peril	$	210.4	$	139.3	$	349.7	$	192.2	$	111.3	$	303.5
Commercial other liability		134.3		84.7		219.0		115.7		106.0		221.7
Workers’ compensation		228.8		165.1		393.9		168.5		110.5		279.0
Commercial automobile		114.7		102.8		217.5		109.3		73.9		183.2
Fire and allied lines		16.2		1.1		17.3		8.0		2.7		10.7
Homeowners and umbrella		38.8		38.5		77.3		69.9		33.4		103.3
Personal automobile		54.3		23.8		78.1		82.2		31.3		113.5

Total Tower		797.5		555.3		1,352.8		745.8		469.1		1,214.9

Reciprocal Exchanges
Fire and allied lines		1.4		2.0		3.4		4.0		4.2		8.2
Homeowners and umbrella		2.5		6.2		8.7		10.8		18.6		29.4
Personal automobile		49.7		21.6		71.3		59.5		27.9		87.4

Total Reciprocal Exchanges		53.6		29.8		83.4		74.3		50.7		125.0

Consolidated total, all lines	$	851.1	$	585.1	$	1,436.2	$	820.1	$	519.8	$	1,339.9

In 2012, we recognized reserve strengthening in our net losses from prior accident years of $79.2 million, comprised of $88.1 million reserve strengthening excluding the reciprocals and $8.9 million favorable development in the Reciprocal Exchanges. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further discussion.

We carefully monitor our gross, ceded and net loss reserves by segment and line of business to ensure that they are adequate, since a deficiency in reserves may result in or indicate inadequate pricing on our products and may impact our financial condition.

The following table shows the net loss and LAE ratios by line of business for the years ended December 31, 2012, 2011 and 2010:


	2012						2011						2010
	Tower		Reciprocal Exchanges		Total		Tower		Reciprocal Exchanges		Total		Tower		Reciprocal Exchanges		Total
	(restated)		Reciprocal Exchanges		(restated)		(restated)		Reciprocal Exchanges		(restated)		(revised)		Reciprocal Exchanges		(revised)

Commercial multiple-peril		70.1%		n/a		70.1%		64.6%		n/a		64.6%		59.6%		n/a		59.6%
Commercial other liability		45.8%		n/a		45.8%		63.2%		n/a		63.2%		59.4%		n/a		59.4%
Workers’ compensation		82.4%		n/a		82.4%		74.4%		n/a		74.4%		55.8%		n/a		55.8%
Commercial automobile		86.5%		n/a		86.5%		71.9%		n/a		71.9%		75.8%		n/a		75.8%
Fire and allied lines		76.1%		-14.8%		71.4%		78.6%		34.2%		76.0%		40.6%		18.6%		28.6%
Homeowners and umbrella		69.9%		57.6%		67.8%		65.0%		64.8%		65.0%		47.4%		59.1%		51.4%
Personal automobile		78.5%		77.9%		78.2%		62.7%		52.6%		58.2%		68.5%		79.2%		74.4%

All lines		74.1%		66.7%		73.4%		69.1%		55.8%		67.6%		60.7%		66.3%		61.1%

Our actuaries utilize standard methods common in the insurance industry to project losses and corresponding reserves, which predominantly consist of loss ratio projections, loss development methods and the Bornhuetter-Ferguson (“B-F”) method. Our actuaries also discuss and review their analyses with our underwriting and claims management, so that cross functional input is considered in the loss and LAE analyses. Based upon these inputs and methods, our actuaries determine a best estimate of the loss and LAE reserves. Loss development factors are derived from our data, as well as in some cases from claims experience obtained from other carriers or based upon industry experience, and the loss development factors are utilized in each of the actuarial methods. The loss ratio projection method applies loss development factors to older accident years and projects the loss ratio to the most recent periods based upon trend factors for inflation and pricing changes. Generally, the loss ratio projection method is given the most weight for the recent accident year when there is high volatility in the development patterns, since this method gives little or no weight to immature claims experience that may be unrepresentative of ultimate loss activity. The B-F method combines the loss ratio method and the loss development method to determine loss reserves by adding an expected development (loss ratio times premium times percent unreported) to the reported reserves, and is generally given less weight as each accident year matures. The loss development methods utilize reported paid and incurred claims experience and loss development factors, and these methods are given increasing weight as each accident year matures.

The table below shows the range of the reserves estimates by line of business. The ranges were derived based upon the use of alternative actuarial methods for each line of business, which we believe reflects reasonably likely outcomes, although even further variation could result based upon other changes in loss development patterns, variation in expected loss ratios or variation from external impacts that might affect claims payouts. We believe the results of the range analysis, which are summarized in the table below, constitute a reasonable range of expected outcomes of our reserves for net loss and LAE at December 31, 2012:


		Range of Reserve Estimates
($ in millions)	High (restated)			Low (restated)		Carried (restated)

Tower
Commercial multiple-peril	$		432.1	$	327.3	$	349.7
Commercial other liability			285.4		196.8		219.0
Workers’ compensation			530.7		374.9		393.9
Commercial automobile			271.4		200.0		217.4
Fire and allied lines			21.3		16.5		17.3
Homeowners and umbrella			104.0		71.8		77.4
Personal automobile			83.9		63.0		78.1

Total Tower	$		1,728.8	$	1,250.3	$	1,352.8

Reciprocal Exchanges
Fire and allied lines			4.2		3.2		3.4
Homeowners and umbrella			10.5		8.2		8.7
Personal automobile			75.4		57.5		71.3

Total Reciprocal Exchanges			90.1		68.9		83.4

Consolidated total	$		1,818.9	$	1,319.2	$	1,436.2

If the Company had recorded reserves at the high end of the range, net reserves would have increased by $382.7 million, or 26.6%. If the Company had recorded reserves at the low end of the range, net reserves would have decreased by $116.9 million, or 8.1%.

While our reserves are set based upon our current best estimates, there are no assurances that future loss development and trends will be consistent with our past loss development history or those estimates, and so reserve strengthening remains a risk factor to our business. See “Risk Factors—Risks Related to Our Business—If our actual loss and LAE exceed our loss and LAE reserves, our financial condition and results of operations could be significantly adversely affected.” See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies—Loss and Loss Adjustment Expense Reserves.”

Investments

Our investment policy and guidelines specify minimum criteria for overall credit quality of our investment portfolio and include limitations on the size of particular holdings, as well as restrictions on investments in different asset classes. We utilize several independent investment advisors to effect investment transactions and provide investment advice. We also have retained and may retain other investment advisors to manage or advise us regarding portions of our overall investment portfolio.

The Company’s investment strategy is intended to manage investment risk based on the organization’s ability to accept such risk. The investment strategy is intended to:

—

Maintain adequate liquidity and capital to meet the organization’s responsibility to policyholders;

—

Provide a consistent level of income to support the Company’s profitability and contribute to the growth of capital;

—

Seek to grow the value of assets over time, thereby increasing the Company’s capital strength; and

—

Mitigate investment risk, including managing duration, credit quality, market and currency risk and issuer and industry concentrations.

We monitor the quality of investments, duration, sector mix, and actual and expected investment returns. Investment decision-making is guided by general economic conditions as well as management’s forecast of our cash flows, including the nature and timing of our expected liability payouts and the possibility that we may have unexpected cash demands, for example, to satisfy claims due to catastrophic losses. We expect our investment portfolio will continue to consist mainly of highly rated and liquid fixed-income securities; however, we may invest a portion of our funds in other asset types including common equity investments, real estate, preferred securities, partnerships, hedge funds, other pooled investments and non-investment grade bonds.

Our investment guidelines require compliance with applicable government regulations and laws. Without the approval of our board of directors, we cannot purchase financial futures, options or other derivatives. We expect the majority of our investment holdings to continue to be denominated in U.S. dollars. Upon completion of the proposed merger, we will evaluate the need to introduce foreign denominated investments into our investment strategy in order to align investments results with acquired business. We report overall investment results to the board of directors on a quarterly basis.

Ratings

Ratings by independent agencies are an important factor in establishing the competitive position of insurance and reinsurance companies and are important to our ability to market and sell our products. Rating organizations continually review the financial positions of insurers. A.M. Best is one of the most important rating agencies for insurance and reinsurance companies. A.M. Best maintains a letter scale rating system ranging from A++ (Superior) to F (In liquidation). In evaluating a company’s financial strength, A.M. Best reviews the company’s profitability, leverage and liquidity, as well as its book of business, the adequacy and soundness of its reinsurance, the quality and estimated market value of its assets, the adequacy of its loss and loss expense reserves, the adequacy of its surplus, its capital structure, the experience and competence of its management and its market presence. The objective of A.M. Best’s ratings system is to provide an opinion of an insurer’s or reinsurer’s financial strength and ability to meet ongoing obligations to its policyholders. These ratings reflect the ability to pay policyholder claims and are not a recommendation to buy, sell or hold the shares of a particular company. These ratings are subject to periodic review by, and may be revised or revoked at the sole discretion of A.M. Best.

On October 8, 2013, A.M. Best lowered Tower’s issuer credit, as well as its financial strength ratings, from “A-” (Excellent) to “B++” (Good). The ratings remain under review with negative implications pending further discussions between A.M. Best and Tower’s management.

Our insurance subsidiaries and our holding company are also rated by Fitch Ratings Ltd. On October 7, 2013, Fitch downgraded Tower’s Issuer Default Rating from “BBB” to “B” and Tower’s insurance subsidiaries’ Insurer Financial Strength ratings from “A-” to “BB”. The ratings will continue to remain on negative watch until, at the earliest, the completion of Tower’s exploration of strategic alternatives. Insurer Financial Strength Ratings assess the ability of an insurer to meet policyholder and related obligations, relative to the “best” credit risk in a given country across all industries and obligation types. Fitch Ratings’ Issuer Default Ratings provide an opinion on the relative ability of an entity to meet financial commitments, such as interest, preferred dividends, repayment of principal, insurance claims or counterparty obligations.

Our insurance subsidiaries and the Reciprocal Exchanges are also rated by Demotech, Inc. (“Demotech”). On October 7, 2013, Demotech lowered its rating on TICNY and three other U.S. based insurance subsidiaries (Kodiak Insurance Company, Massachusetts Homeland Insurance Company and York Insurance Company of Maine) from A’ (A prime) to A (A exceptional). In addition, Demotech removed its previous A’ (A prime) rating on six other U.S. based insurance subsidiaries (CastlePoint Florida Insurance Company, CastlePoint Insurance Company, CastlePoint National Insurance Company, Hermitage Insurance Company, North East Insurance Company and Preserver Insurance Company). Demotech also affirmed its A ratings on Adirondack Insurance Exchange, New Jersey Skylands Insurance Association, New Jersey Skylands Insurance Company and Mountain Valley Indemnity Company. Demotech’s rating process is designed to provide an objective baseline for assessing solvency which in turn provides insight into changes in financial stability. Demotech’s Financial Stability Ratings are based upon a series of quantitative ratios and qualitative considerations which together comprise a Financial Stability Analysis Model.

Regulatory Matters

Our insurance subsidiaries are subject to extensive governmental regulation and supervision in the U.S., and our reinsurance subsidiary, CastlePoint Reinsurance Company, Ltd. (“CastlePoint Re”), is subject to governmental regulation in Bermuda. Most insurance regulations are designed to protect the interests of policyholders rather than shareholders and other investors. These regulations, generally administered by a department of insurance in each jurisdiction relate to, among other things:

•

approval of policy forms and premium rates for our primary insurance operations;

•

standards of solvency, including risk-based capital measurements;

•

licensing of insurers and their agents;

•

restrictions on the nature, quality and concentration of investments;

•

restrictions on the ability to pay dividends to us;

•

restrictions on transactions between insurance company subsidiaries and their affiliates;

•

restrictions on the size of risks insurable under a single policy;

•

requiring deposits for the benefit of policyholders;

•

requiring certain methods of accounting;

•

periodic examinations of our operations and finances;

•

establishment of trust funds for the protection of policyholders;

•

prescribing the form and content of records of financial condition required to be filed; and

•

requiring reserves for unearned premium, losses and other purposes.

Our insurance subsidiaries also are subject to state laws and regulations that require diversification of investment portfolios and that limit types of permitted investments and the amount of investments in certain investment categories. Failure to comply with these laws and regulations may cause non-conforming investments to be treated as non-admitted assets for purposes of measuring statutory capital and surplus and, in some instances, would require divestiture.

Insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to financial condition, holding company issues and other matters.

In addition, regulatory authorities have relatively broad discretion to deny or revoke insurance licenses for various reasons, including the violation of regulations. We base some of our practices on our interpretations of regulations or practices that we believe are generally followed by the industry. These practices may turn out to be different from the interpretations of regulatory authorities. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or otherwise penalize us. This could adversely affect us. Further, changes in the level of regulation of the insurance or reinsurance industry or changes in laws or regulations themselves or interpretations by regulatory authorities could adversely affect us.

On February 21, 2013, the New York Department of Financial Services (the “DFS”) announced that it was investigating certain insurers, including Tower’s largest insurance company subsidiary, Tower Insurance Company of New York (“TICNY”), for unacceptable claims practices in New York related to Superstorm Sandy. In connection with such investigation, the DFS previously issued an Insurance Law Section 308 letter to TICNY, which directed TICNY to provide information and supporting documentation and to which TICNY, as a New York-domiciled insurer, is legally required to respond. Tower is cooperating with the DFS in connection with such inquiry. Tower has responded to the DFS that the allegations in this matter do not constitute a pattern or practice of Tower.

Regulation

U.S. Insurance Holding Company Regulation of Tower

Tower, as the parent of the insurance subsidiaries, is subject to the insurance holding company laws of New York, Florida, Illinois, Maine, Massachusetts, New Hampshire and New Jersey, the domestic jurisdictions of the insurance subsidiaries, and California, in which two of such insurance subsidiaries is considered to be commercially domiciled under the laws of that state. These laws generally require the insurance subsidiaries to register with their respective domiciliary state Insurance Department (“Insurance Department”) and to furnish annually financial and other information about the operations of companies within the holding company system. Generally under these laws, all material transactions among companies in the holding company system to which an insurance subsidiary is a party, including sales, loans, reinsurance agreements and service agreements, must be fair and reasonable and, if material or of a specified category, require prior notice and approval or non-disapproval by the Insurance Department.

In December of 2010, the National Association of Insurance Commissioners (“NAIC”) adopted final revisions to a proposed model act and a model regulation for governing insurance holding company systems (the “Amended Model Act”). The Amended Model Act requires insurers or reinsurers licensed in such state to submit greater information to state regulators about parent companies or other affiliates within the holding company system and to permit regulators to assess the “enterprise risk” within a holding company system. The Model Act has been adopted in California, where two of our companies are commercially domiciled. It has not been adopted in any other of our domestic jurisdictions, although adoption is possible in all our domestic jurisdictions in the coming years.

Changes of Control

Before a person can acquire control of an insurance subsidiary, prior written approval must be obtained from the Superintendent or the Commissioner of the Insurance Department (“Superintendent”) of the insurance subsidiary’s domestic jurisdiction or jurisdiction of commercial domicile. Prior to granting approval of an application to acquire control of an insurer, the Superintendent considers such factors as: the financial strength of the applicant, the integrity and management of the applicant’s Board of Directors and executive officers, the acquirer’s plans for the future operations of the domestic insurer and any anti-competitive results that may arise from the consummation of the acquisition of control. Pursuant to insurance holding company laws, “control” means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of the company, whether through the ownership of voting securities, by contract (except a commercial contract for goods or non-management services) or otherwise. Control is presumed to exist if any person, directly or indirectly, owns, controls or holds with the power to vote a certain threshold percentage of the voting securities of the company. In the domestic jurisdictions of all but one of the insurance subsidiaries, the threshold percentage of voting securities that triggers a presumption of control is 10% or more. In Florida, the threshold percentage that triggers a presumption of control is 5% of the voting securities. The Insurance Department, after notice and a hearing, may determine that a person or entity which, directly or indirectly, owns, controls or holds with the power to vote less than the threshold percentage of the voting securities of the company, “controls” the company. Because a person acquiring 10% or more of our common stock would indirectly control the same percentage of the stock of the insurance subsidiaries, the insurance company change of control laws of New York, California, Illinois, New Jersey, New Hampshire, Maine and Massachusetts would likely apply to such a transaction. The insurance company change of control laws of Florida would likely apply to an acquisition of 5% or more of our voting stock.

These laws may discourage potential acquisition proposals and may delay, deter or prevent a change of control of Tower, including through transactions, and in particular unsolicited transactions, that some or all of the stockholders of Tower might consider to be desirable.

Legislative Changes

From time to time, various regulatory and legislative changes have been proposed in the insurance industry. Among the proposals that have in the past been or are at present being considered are the possible introduction of Federal regulation in addition to, or in lieu of, the current system of state regulation of insurers and proposals in various state legislatures (some of which proposals have been enacted) to conform portions of their insurance laws and regulations to various model acts adopted by the NAIC. We are unable to predict whether any of these laws and regulations will be adopted, the form in which any such laws and regulations would be adopted, or the effect, if any, these developments would have on our operations and financial condition.

In 2002, the Federal government enacted legislation designed to ensure the availability of insurance coverage for terrorist acts in the United States of America and established a Federal assistance program. Subsequent laws were enacted in 2005 and 2007 extending and modifying the prior legislation. For a discussion of this legislation, see “Business—Reinsurance—Terrorism Reinsurance.” As a result of this legislation, potential losses from a terrorist attack could be substantially larger than previously expected, could also adversely affect our ability to obtain reinsurance on favorable terms, including pricing, and may affect our underwriting strategy, rating, and other elements of our operation.

On July 21, 2010, the U.S. Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act of 20l0 (the “Dodd-Frank Act”). Certain sections of the Dodd-Frank Act relate to the business of insurance. The Dodd-Frank Act provides that only the domestic state of a primary insurer may regulate the financial statement credit for reinsurance taken by that primary insurer. Non-domestic states will no longer be able to require additional collateral from unauthorized reinsurers or impose their own credit for reinsurance rules on primary insurers that are licensed in such other states. The Dodd-Frank Act also creates the Federal Insurance Office (“FIO”). Initially, the FIO will have limited authority and will mainly gather information and report to Congress on the business of insurance. The Dodd-Frank Act also includes the Nonadmitted and Reinsurance Reform Act of 2010 (the “NRRA”). The NRRA is intended to streamline and simplify the payment and collection of surplus lines premium taxes. Many sections of the Dodd-Frank Act become effective over time, and certain provisions of the Dodd-Frank Act require the implementation of regulations that have not yet been drafted. We are unable to predict how or when these changes may be implemented, or the effect, if any, these developments would have on our operations and financial condition.

State Insurance Regulation

State insurance authorities have broad regulatory powers with respect to various aspects of the business of U.S. insurance companies. The primary purpose of such regulatory powers is to protect individual policyholders. The extent of such regulation varies, but generally has its source in statutes that delegate regulatory, supervisory and administrative power to state insurance departments. Such powers relate to, among other things, licensing to transact business, accreditation of reinsurers, admittance of assets to statutory surplus, regulating unfair trade and claims practices, establishing reserve requirements and solvency standards, regulating investments and dividends, approving policy forms and related materials in certain instances and approving premium rates in certain instances. State insurance laws and regulations require an insurance company to file financial statements with Insurance Departments everywhere it will be licensed to conduct insurance business, and its operations are subject to examination by those departments.

Our insurance subsidiaries prepare statutory financial statements in accordance with Statutory Accounting Principles (“SAP”) and procedures prescribed or permitted by their state of domicile. As part of their regulatory oversight process, Insurance Departments conduct periodic detailed examinations of the books and records, financial reporting, policy filings and market conduct of insurance companies domiciled in their states, generally once every three to five years. Examinations are generally carried out in cooperation with the Insurance Departments of other states under guidelines promulgated by the NAIC.

The terms and conditions of reinsurance agreements generally are not subject to regulation by any U.S. state Insurance Department with respect to rates or policy terms. As a practical matter, however, the rates charged by primary insurers do have an effect on the rates that can be charged by reinsurers.

Insurance Regulatory Information System Ratios

The Insurance Regulatory Information System (“IRIS”) was developed by the NAIC and is intended primarily to assist state Insurance Departments in executing their statutory mandates to oversee the financial condition of insurance companies operating in their respective states. IRIS identifies thirteen industry ratios and specifies “Usual Values” for each ratio. Departure from the usual values on four or more of the ratios can lead to inquiries from individual state insurance commissioners as to certain aspects of an insurer’s business.

In 2012, six of Tower’s insurance subsidiaries and one of the Reciprocal Exchange entities had three or more ratios departing from the Usual Values. All other Tower insurance subsidiaries had none, one or two ratios departing from the Usual Values.

The common ratios outside the Usual Values for Tower’s insurance subsidiaries were the following: (i) two-year overall operating ratio, (ii) gross change in policyholders’ surplus, (iii) change in adjusted policyholders’ surplus, (iv) adjusted liabilities to liquid assets, and (v) estimated current reserve deficiency to policyholders’ surplus. These insurance subsidiaries’ ratios outside the Usual Values were driven primarily by the reserve strengthening the Company recorded in the first and second quarters of 2012 and losses from Superstorm Sandy in the fourth quarter of 2012.

Two Reciprocal Exchange entities experienced catastrophe losses from Superstorm Sandy, which resulted in the following ratios to be outside the Usual Values: (i) two-year overall operating ratio, and (ii) change in adjusted policyholders’ surplus. The third Reciprocal Exchange entity’s ratios outside the Usual Values include: (i) change in net premiums written, (ii) two-year overall operating ratio, (iii) investment yield, and (iv) estimated current reserve deficiency to policyholders’ surplus.

Risk-Based Capital Regulations

The Insurance Departments require domestic property and casualty insurers to report their risk-based capital based on a formula developed and adopted by the NAIC that attempts to measure statutory capital and surplus needs based on the risks in the insurer’s mix of products and investment portfolio. The formula is designed to allow the Insurance Departments to identify potential weakly-capitalized companies. Under the formula, a company determines its risk-based capital by taking into account certain risks related to the insurer’s assets (including risks related to its investment portfolio and ceded reinsurance) and the insurer’s liabilities (including underwriting risks related to the nature and experience of its insurance business). At December 31, 2012, risk-based capital levels of our insurance subsidiaries exceeded the minimum level that would trigger regulatory attention.

Statutory Accounting Principles

Each U.S. insurance company is required to file quarterly and annual statements that conform to SAP. SAP is a basis of accounting developed to assist insurance regulators in monitoring and regulating the solvency of insurance companies. It is primarily concerned with measuring an insurer’s surplus as regards policyholders. Accordingly, statutory accounting focuses on valuing assets and liabilities of insurers at financial reporting dates in accordance with appropriate insurance law and regulatory provisions applicable in each insurer’s domiciliary state.

U.S. generally accepted accounting principles (“GAAP”) are concerned with a company’s solvency, but it is also concerned with other financial measurements, such as income and cash flows. Accordingly, GAAP gives more consideration to appropriate matching of revenue and expenses than does SAP. As a direct result, different assets and liabilities and different amounts of assets and liabilities will be reflected in financial statements prepared in accordance with GAAP as opposed to SAP.

Statutory accounting practices established by the NAIC and adopted, in part, by the state regulators determine, among other things, the amount of statutory surplus and statutory net income of the insurance subsidiaries and thus determine, in part, the amount of funds that are available to pay dividends.

Loss Reserve Specialist and Statements of Actuarial Opinion

Each U.S. insurance company is required to provide a Statement of Actuarial Opinion concerning the adequacy of its loss and loss expense reserves. Similarly, CastlePoint Re is required to submit an opinion of its approved loss reserve specialist with its statutory financial return in respect of its loss and LAE provisions.

Statements of Actuarial Opinion are prepared and signed by the designated actuary for each U.S. company, and by the loss reserve specialist in the case of a Bermuda company such as CastlePoint Re. The designated actuary and loss reserve specialist normally is a qualified casualty actuary, and in the case of CastlePoint Re, must be approved by the Bermuda Monetary Authority.

An independent external actuarial firm provides Statements of Actuarial Opinions for all of our insurance subsidiaries. This firm utilizes qualified Members of the Casualty Actuarial Society and Members of the American Academy of Actuaries to provide the service necessary for the Statements of Actuarial Opinion.

Guaranty Associations

In most of the jurisdictions where the insurance subsidiaries are currently licensed to transact business there is a requirement that property and casualty insurers doing business within the jurisdiction participate in guaranty associations, which are organized to pay contractual benefits owed pursuant to insurance policies issued by impaired, insolvent or failed insurers. These associations levy assessments, up to prescribed limits, on all member insurers in a particular state on the basis of the proportionate share of the premium written by member insurers in the lines of business in which the impaired, insolvent or failed insurer is engaged. Some states permit member insurers to recover assessments paid through full or partial premium tax offsets.

In none of the past five years has the assessment in any year levied against our insurance subsidiaries been material. Property and casualty insurance company insolvencies or failures may result in additional security fund assessments to our insurance subsidiaries at some future date. At this time we are unable to determine the impact, if any such assessments may have on the consolidated financial position or results of operations. We have established liabilities for guaranty fund assessments with respect to insurers that are currently subject to insolvency proceedings and assessments by the various workers’ compensation funds. See “Note 18 —Contingencies” in the notes to our audited consolidated financial statements included elsewhere in this report.

Residual Market Plans

Our insurance subsidiaries are required to participate in various mandatory insurance facilities or in funding mandatory pools, which are generally designed to provide insurance coverage for consumers who are unable to obtain insurance in the voluntary insurance market. These pools generally provide insurance coverage for workers’ compensation, personal and commercial automobile and property-related risks.

Management Companies

The activities of our managing general agencies and management companies are subject to licensing requirements and regulation under the laws of New York, Delaware, Florida and other states where they do business. The businesses of these companies depend on the validity of, and continued good standing under, the licenses and approvals pursuant to which they operate, as well as compliance with pertinent regulations.

Reinsurance

We purchase reinsurance to reduce our net liability on individual risks, to protect against possible catastrophes, to achieve a target ratio of net premiums written to policyholders’ surplus or to expand our underwriting capacity. Reinsurance coverage can be purchased on a facultative basis when individual risks are reinsured or on a treaty basis when a class or type of business is reinsured. We may purchase facultative reinsurance to provide limits in excess of the limits provided by our treaty reinsurance. Treaty reinsurance falls into three categories: quota share (also called pro rata), excess of loss and catastrophe treaty reinsurance. Under our quota share reinsurance contracts, we cede a predetermined percentage of each risk for a class of business to the reinsurer and recover the same percentage of losses and LAE on the business ceded. We pay the reinsurer the same percentage of the original premium, less a ceding commission. The ceding commission rate is based upon the ceded loss ratio on the ceded quota share premiums earned and in certain contracts is adjusted for loss experience under those contracts. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Estimates – Ceding commissions earned.” Under our excess of loss treaty reinsurance, we cede all or a portion of the liability in excess of a predetermined deductible or retention. We also purchase catastrophe reinsurance on an excess of loss basis to protect ourselves from an accumulation of certain net loss exposures from a catastrophic event or series of events such as windstorms, hailstorms, tornadoes, hurricanes, earthquakes, blizzards, freezing temperatures, riots and terrorist acts (for personal lines business). A portion of the protection we purchase is on an Original Insured Market Loss Warranty basis, whereby we can recover up to the limit of the contract for our ultimate net loss arising from the Windstorm Peril in the Northeast in an event where the Insured Market Loss exceeds a specified threshold. We generally do not receive any commission for ceding business under excess of loss or catastrophe reinsurance agreements.

The type, cost and limits of reinsurance we purchase can vary from year to year based upon our desired retention levels and the availability of quality reinsurance at acceptable prices, terms and conditions. Our excess of loss reinsurance and quota share programs were effective in 2012 and renewed on January 1, 2013. Our catastrophe reinsurance program was renewed July 1, 2012.

In an effort to maintain capacity for our business with favorable commission levels, we have in the past accepted loss ratio caps in certain of our reinsurance treaties and currently accept per occurrence loss limitations on catastrophe-exposed property quota share treaties. Loss ratio caps curtail a reinsurer’s liability for losses above a specified loss ratio. Occurrence loss limitations impose a limit upon a reinsurer’s liability for aggregate losses incurred under multiple policies in a single occurrence. These provisions have been structured to provide reinsurers with some limit on the amount of potential loss being assumed, while maintaining the transfer of significant insurance risk with the possibility of a significant loss to the reinsurers. We believe our reinsurance arrangements qualify for reinsurance accounting in accordance with GAAP and SAP guidance.

Regardless of type, reinsurance does not legally discharge the ceding insurer from primary liability for the full amount due under the reinsured policies. However, the assuming reinsurer is obligated to indemnify the ceding company to the extent of the coverage ceded. To protect our company from the possibility of a reinsurer becoming unable to fulfill its obligations under the reinsurance contracts, we attempt to select financially strong reinsurers with an A.M. Best rating of A- (Excellent) or better and continue to evaluate their financial condition and monitor various credit risks to minimize our exposure to losses from reinsurer insolvencies.

To further minimize our exposure to reinsurance recoverables, certain of our reinsurance agreements were placed on a “funds withheld” basis under which ceded premiums written are deposited in segregated trust funds from which we receive payments for losses and ceding commission adjustments. Our reinsurance receivables from non-admitted reinsurers are collateralized either by Letter of Credit or New York Regulation 114 compliant trust accounts.

Terrorism Reinsurance

In 2002, in response to the tightening of supply in certain insurance and reinsurance markets resulting from, among other things, the September 11, 2001 terrorist attacks, the Terrorism Risk Insurance Act (“TRIA”) was enacted. TRIA is designed to ensure the availability of insurance coverage for foreign terrorist acts in the United States of America. This law established a federal assistance program through the end of 2005 to help the commercial property and casualty insurance industry cover claims related to future terrorism-related losses and requires such companies to offer coverage for certain acts of terrorism.

On December 17, 2005, Congress passed a two-year extension of TRIA through December 31, 2007 with the passage of the Terrorism Risk Insurance Extension Act (“TRIEA”). Under the terms of TRIEA, the minimum size of the triggering event increased and Tower’s deductible increased. Under TRIEA, federal assistance for insured terrorism losses has been reduced as compared to the assistance previously available under TRIA. As a consequence of these changes, potential losses from a terrorist attack could be substantially larger than previously expected.

On December 26, 2007, the President signed the Terrorism Risk Insurance Program Reauthorization Act of 2007 (the “2007 Act”) which extends TRIEA for seven years through December 31, 2014. The 2007 Act maintains the same triggering event size of $100 million, company deductible of 20%, industry retention of $27.5 billion, federal share of 85% and program aggregate insured loss limit of $100 billion put in place by TRIEA. The 2007 Act extends coverage to domestic terrorism and requires additional notice to policyholders regarding the $100 billion program limit. There is no certainty that this reinsurance protection will be extended beyond 2014.

Employees

As of December 31, 2012, we had 1,432 full-time employees. None of these employees are covered by a collective bargaining agreement. We have employment agreements with certain senior executive officers. The remainder of our employees are “at-will” employees.

Available Information

We file periodic reports, proxy statements and other information with the SEC. Such reports, proxy statements and other information may be viewed at the SEC’s website at www.sec.gov or viewed or obtained at the SEC Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information pertaining to the operation of the Public Reference Room can be obtained by calling 1-800-SEC-0330.

The address for our internet website is www.twrgrp.com. We make available, free of charge, through our internet site, our annual report on Form 10-K, annual report to shareholders, quarterly reports on Form 10-Q and current reports on Form 8-K and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such materials with, or furnish it to, the SEC.

Item 3. Legal Proceedings

On August 20, 2013, Robert P. Lang, a purported shareholder of Tower Group International Ltd. (“Tower”), filed a purported class action complaint (the “Lang Complaint”) against Tower and certain of its officers in the United States District Court for the Southern District of New York. The Lang Complaint alleges that Tower and certain of its officers violated federal securities laws and seeks unspecified damages. On September 3, 2013, a second purported shareholder class action complaint was filed by Dennis Feighay, another purported Tower shareholder, containing similar allegations to those set forth in the Lang Complaint (the “Feighay Complaint”). On October 4, 2013, a third complaint was filed by Sanju Sharma (the “Sharma Complaint”). The Sharma Complaint names as defendants Tower and certain of its officers, and purports to be asserted on behalf of a plaintiff class who purchased Tower stock between May 10, 2011 and September 17, 2013. On October 18, 2013, an amended complaint was filed in the Sharma case (the “Sharma Amended Complaint”). The Sharma Amended Complaint alleges additional false and misleading statements, and purports to be asserted on behalf of a plaintiff class who purchased Tower stock between March 1, 2011 and October 7, 2013. On October 21, 2013, a number of motions were filed seeking to consolidate the shareholder class actions into one matter and for appointment of a lead plaintiff. The Company believes that it is not probable that the Lang and Feighay Complaints and the Sharma Amended Complaint will result in a loss, and that the amount of any loss cannot reasonably be estimated.

On October 18, 2013, Cinium Financial Services Corporation (“Cinium”) and certain other affiliated parties (collectively, “Plaintiffs”) filed a complaint against, among others, Tower, CastlePoint Insurance Company (“CastlePoint”), an indirect wholly owned subsidiary of Tower, and certain officers of Tower (the “Cinium Complaint”) in New York State Supreme Court. CastlePoint is a party to a Securityholders’ Agreement, dated as of June 14, 2012 (the “Securityholders’ Agreement”), among certain parties including Plaintiffs, and is also the holder of a senior note issued by Cinium dated May 15, 2012 that is convertible into shares of Cinium common stock (the “Senior Note”). Plaintiffs seek, among other things, (i) a declaratory judgment that CastlePoint has no right to exercise any control over Cinium under the Securityholders’ Agreement or to convert the Senior Note without prior regulatory approval; (ii) rescission of the Senior Note and Securityholders’ Agreement based on alleged fraudulent misrepresentations by Tower at the time these agreements were entered into; and (iii) damages of $150 million for alleged breach of fiduciary duties to Cinium and its shareholders by certain directors. The Company believes that it is not probable that the Cinium Complaint will result in a loss, and that the amount of any loss cannot reasonably be estimated.

From time to time, the Company is involved in other various legal proceedings in the ordinary course of business. The Company does not believe that the resolution of any currently pending legal proceedings, either individually or taken as a whole, will have a material adverse effect on its business, results of operations or financial condition.

Item 6. Selected Consolidated Financial Information

The selected consolidated income statement data for the years ended December 31, 2012, 2011 and 2010, and the balance sheet data as of December 31, 2012 and 2011 are derived from our audited financial statements included elsewhere in this document, which have been prepared in accordance with GAAP. You should read the following selected consolidated financial information along with the information contained in this document, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes included elsewhere in this Form 10-K/A. The financial information in these tables has been updated to reflect the restatements and revisions made to our previously issued financial statements. See Note 2 to the consolidated financial statements for more detail.


		Year ended December 31,
($ in millions, except per share amounts)		2012 (restated)			2011 (restated)			2010 (revised)		2009 (revised)		2008

Income Statement Data
Gross premiums written	$		1,971.1	$		1,810.9	$		1,496.4	$	1,070.7	$	634.8
Ceded premiums written			231.7			172.3			182.3		184.5		290.8

Net premiums written			1,739.4			1,638.6			1,314.1		886.2		344.0

Net premiums earned			1,721.9			1,593.9			1,292.7		854.7		314.6
Ceding commission revenue			32.3			34.0			39.3		42.7		79.1
Insurance services revenue			3.4			1.6			2.2		5.1		68.2
Policy billing fees			12.6			10.5			6.3		3.0		2.3
Net investment income			127.2			126.5			107.3		74.9		34.6
Net realized gains (losses) on investments			25.5			9.4			14.7		0.3		(14.4)

Total revenues			1,922.9			1,775.8			1,462.3		980.7		484.4
Losses and loss adjustment expenses			1,263.8			1,077.0			789.7		475.5		162.7
Operating expenses:
Direct and ceding commission expenses			359.3			309.8			267.9		204.7		132.5
Other operating expenses ⁽¹⁾			317.5			284.9			229.8		157.4		94.5
Acquisition-related transaction costs			9.2			0.4			2.4		14.0		-
Interest expense			32.6			34.3			24.2		17.6		8.4

Total expenses			1,982.4			1,706.3			1,314.0		869.3		398.1
Other income
Earnings in unconsolidated affiliate			(1.5)			-			-		(0.8)		0.3
Gain on investment in acquired unconsolidated affiliate			-			-			-		7.4		-
Gain on bargain purchase			-			-			-		12.7		-

Income (loss) before income taxes			(61.0)			69.5			148.4		130.7		86.6
Income tax expense (benefit)			(29.1)			14.1			49.6		42.5		32.8

Net income (loss)	$		(31.9)	$		55.4	$		98.8	$	88.2	$	53.8
Less: Net income (loss) attributable to Noncontrolling Interests			2.3			11.0			(6.1)		-		-

Net income (loss) attributable to Tower Group, Inc.	$		(34.2)	$		44.4	$		104.8	$	88.2	$	53.8

Per Share Data ⁽⁶⁾
Basic earnings (loss) per share attributable to Tower stockholders ⁽⁵⁾	$		(0.81)	$		0.96	$		2.13	$	2.05	$	2.04
Diluted earnings (loss) per share attributable to Tower stockholders	$		(0.81)	$		0.96	$		2.12	$	2.04	$	2.02
Weighted average outstanding (in thousands):
Basic			42,902			45,226			48,561		44,598		26,388
Diluted			42,902			45,337			48,772		44,844		26,608
Selected Insurance Ratios

Net loss ratio ⁽²⁾			73.4%			67.6%			61.1%		55.6%		51.7%
Net underwriting expense ratio ⁽³⁾			36.4%			34.4%			35.6%		35.0%		31.7%

Net combined ratio ⁽⁴⁾			109.8%			102.0%			96.7%		90.6%		83.4%


	As of December 31,
($ in millions, except per share amounts)	2012 (restated)		2011 (restated)		2010 (revised)		2009		2008

Summary Balance Sheet Data
Cash and cash equivalents	$	102.3	$	114.1	$	140.2	$	175.2	$	146.6
Investments		2,553.5		2,587.4		2,474.5		1,896.8		541.0
Premiums receivable		412.0		416.4		402.0		291.1		212.7
Reinsurance recoverable		477.1		315.7		294.8		214.1		272.6
Deferred acquisition costs, net		181.2		168.9		164.1		126.3		28.4
Intangible assets		106.8		114.9		123.8		53.4		20.5
Goodwill		241.5		241.5		241.5		241.5		19.0
Total assets		4,711.8		4,417.5		4,179.2		3,243.4		1,555.2
Loss and loss adjustment expenses		1,895.7		1,632.1		1,610.4		1,132.0		535.0
Unearned premium		921.3		893.2		872.0		658.9		328.8
Debt		449.7		426.9		374.3		235.1		101.0
Tower Group Inc. stockholders’ equity		950.1		1,009.8		1,035.0		1,012.2		317.6

Per Share Data:⁽⁶⁾
Book value per share⁽⁵⁾	$	21.83	$	24.34	$	22.02	$	19.86	$	12.01
Dividends declared per share-common stock	$	0.66	$	0.61	$	0.34	$	0.23	$	0.18

(1)

Includes insurance contract acquisition expenses and other underwriting expenses (which are general administrative expenses related to underwriting operations in our insurance subsidiaries), other insurance services expenses (which are general administrative expenses related to insurance services operations) and other corporate related expenses.

(2)

The net loss ratio is calculated by dividing net losses and loss adjustment expenses by net premiums earned.

(3)

The net underwriting expense ratio is calculated by dividing net underwriting expenses (consisting of direct commission expenses and other underwriting expenses net of policy billing fees and ceding commission revenue) by net premiums earned.

(4)

The net combined ratio is the sum of the net loss ratio and the net underwriting expense ratio.

(5)

Book value per share is based on Tower Group, Inc. stockholders’ equity divided by common shares outstanding at year end.

(6)

Per Share Data has been retroactively restated to reflect the Company’s reverse acquisition with Canopius Holdings Bermuda Limited, which was completed on March 13, 2013. This reverse acquisition resulted in shareholders converting their shares at a 1.1330 conversion ratio.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated audited financial statements and accompanying notes which appear elsewhere in this Form 10-K/A. It contains forward-looking statements that involve risks and uncertainties. See “Business—Note on Forward-Looking Statements” for more information. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Form 10-K/A, particularly under the headings “Business—Risk Factors” and “Business—Note on Forward-Looking Statements” and the Original Form 10-K under the heading “Risk Factors.”

Certain items within Management’s Discussion and Analysis have been restated for the matters discussed in the Explanatory Note.

Overview

Tower, through its subsidiaries, offers a broad range of general commercial, specialty commercial and personal property and casualty insurance products and services to businesses in various industries and to individuals throughout the United States. We provide these products on both an admitted and an excess and surplus (“E&S”) lines basis. Insurance companies writing on an admitted basis are licensed by the states in which they sell policies and are required to offer policies using premium rates and forms that are filed with state insurance regulators. Non-admitted carriers writing in the E&S market are not bound by most of the rate and form regulations imposed on standard market companies, allowing them the flexibility to change the coverage offered and the rate charged without the time constraints and financial costs associated with the filing process.

Our consolidated results of operations in 2012 reflect continued growth from our Assumed Reinsurance products as well as growth from acquisitions completed in prior years. Our consolidated revenues and expenses reflect the results of these acquired companies from their respective acquisition dates and this affects the comparability of our results between years.

Subsequent to the acquisition of the One Beacon Personal Lines Division (“OBPL”) on July 1, 2010, the Company changed the presentation of its business results, by allocating the personal insurance business previously reported in the Brokerage Insurance

segment along with the newly acquired OBPL business to a new Personal Insurance segment and merged the commercial business previously reported in either the Brokerage Insurance or Specialty Business segments in a new Commercial Insurance segment. The Company retained its Insurance Services segment which includes fees earned by the management companies. This change in presentation reflects the way management organizes the Company for making operating decisions and assessing profitability. In developing cost allocations between the Commercial and Personal Insurance segments, management has made significant assumptions regarding costs of reinsurance and internal services provided on behalf of such segments. As management receives additional facts which enhance its ability to apportion such costs, it may modify such allocation. If modifications are made, such adjustments will be made to all reporting periods disclosed.

Because we do not manage our invested assets by segments, our investment income is not allocated among our segments. Operating expenses incurred by each segment are recorded in such segment directly. Our home office related expenses not directly allocable to an individual segment (for example, accounting, finance and general legal costs) are allocated based upon the methodology deemed to be most appropriate which may include employee head count, policy count and premiums earned in each segment.

We offer our products and services through our insurance subsidiaries, managing general agencies and management companies. Results for our insurance subsidiaries are reported in our Commercial and Personal Insurance segments. Results for our managing general agencies and management companies are reported in our Insurance Services segment.

Our commercial lines products include commercial multiple-peril (provides both property and liability insurance), mono line general liability (insures bodily injury or property damage liability), commercial umbrella, mono line property (insures buildings, contents or business income), workers’ compensation, fire and allied lines, inland marine, commercial automobile policies and assumed reinsurance. Our personal lines products consist of homeowners, personal automobile and umbrella policies.

In our Insurance Services segment, we generate management fees primarily from the services provided by management companies to the Reciprocal Exchanges and other fees generated by the managing general agencies.

Acquisitions

See “Note 5 – Acquisitions” in the consolidated financial statements for more detail on each of the acquisitions discussed below.

NAV PAC Division of Navigators Group, Inc. (“NAV PAC”)

Renewal Rights of AequiCap Program Administrators, Inc. (“AequiCap”)

On November 2, 2010, Tower acquired the renewal rights to the commercial automobile liability and physical damage business of AequiCap (“AequiCap II”), an underwriting agency based in Fort Lauderdale, Florida. The business subject to the agreement covers both trucking and taxi risks that are consistent with Tower’s current underwriting guidelines.

One Beacon Personal Lines Division (“OBPL”)

On July 1, 2010, Tower completed the OBPL acquisition pursuant to a definitive agreement (the “Agreement”) dated February 2, 2010 by and among the Company and OneBeacon Insurance Group, LLC (“OneBeacon”). This acquisition expanded Tower’s suite of personal lines insurance products to include private passenger automobile, homeowners, umbrella, and the signature package product, OneChoice CustomPac, which provides customers with one policy for all of their homeowners, automobile and umbrella needs.

Principal Revenue and Expense Items

We generate revenue from four primary sources:

—

Net premiums earned;

—

Ceding commission revenue;

—

Insurance Service revenue; and

—

Net investment income and realized gains and losses on investments.

We incur expenses from four primary sources:

—

Losses and loss adjustment expenses;

—

Operating expenses;

—

Interest expense; and

—

Income taxes.

Each of these is discussed below.

Net premiums earned. Premiums written include all policies produced in an accounting period. Premiums are earned over the term of the related policy. The portion of the premium that relates to the policy term that has not yet expired is included on the balance sheet as unearned premium to be earned in subsequent accounting periods. Premiums can be assumed from or ceded to reinsurers. Direct premiums combined with assumed premiums are referred to as gross premiums and subtracting premiums ceded to reinsurers results in net premiums.

Ceding commission revenue. We earn ceding commission revenue (generally a percentage of the premiums ceded) on the gross premiums written that we cede to reinsurers under quota share reinsurance agreements. We typically do not earn ceding commission revenue on property catastrophe or excess of loss reinsurance that we purchase.

Insurance Service revenue. We earn fee income primarily from services provided to the Reciprocal Exchanges for underwriting, claims, investment management and other services. Additional commission and fee income is generated on premiums produced by the managing general agencies on behalf of third-party reinsurance companies.

Net investment income and realized gains and losses on investments. We invest our available funds in cash, cash equivalents, securities and investment partnerships. Our investment income includes interest and dividends earned on our invested assets. Realized gains and losses on invested assets are reported separately from net investment income. We earn realized gains when invested assets are sold for an amount greater than their amortized cost, in the case of fixed maturity securities, and cost, in the case of equity securities, and we recognize realized losses when invested assets are written down or sold for an amount less than their amortized cost or actual cost, as applicable.

Losses and loss adjustment expenses. We establish loss and loss adjustment expense (“LAE”) reserves in an amount equal to our estimate of the ultimate liability for claims under our insurance policies and the cost of adjusting and settling those claims less the amounts already paid on these claims. Loss and LAE expense recorded in a period includes estimates for losses incurred during the period and changes in estimates for prior periods.

Operating expenses. In our Commercial Insurance and Personal Insurance segments, we refer to the operating expenses that we incur to underwrite risks as underwriting expenses. These include direct and ceding commission expenses (payments to our producers for the premiums that they generate for us) and other underwriting expenses. In our Insurance Services segment, operating expenses consist of costs incurred to manage the Reciprocal Exchanges and other insurance service expenses.

Interest expense. We pay interest on our subordinated debentures, convertible senior notes, credit facility and on segregated assets placed in trust accounts on a “funds withheld” basis in order to collateralize reinsurance recoverables. In addition, interest expense includes amortization of debt origination costs and original issue discounts over the remaining term of our debt instruments.

Income taxes. We pay Federal, state and local income taxes and non income-related other taxes.

Measurement of Results

We use various measures to analyze the growth and profitability of our business segments. In our Commercial Insurance and Personal Insurance segments, we measure growth in terms of gross, ceded and net premiums written, and we measure underwriting profitability by examining our loss, expense and combined ratios. We also measure our gross and net written premiums to surplus ratios to measure the adequacy of capital in relation to premiums written. In the Insurance Services segment, we measure growth in terms of fee income generated from the Reciprocal Exchanges and, to a lesser extent, fee and commission revenue received. We measure profitability in terms of net income attributable to Tower Group, Inc. and return on average equity related to Tower Group, Inc.

Premiums written. We use gross premiums written to measure our sales of insurance products and, in turn, our ability to generate ceding commission revenues from premiums that we cede to reinsurers. Gross premiums written also correlates to our ability to generate net premiums earned.

Loss ratio. The loss ratio is the ratio of losses and LAE incurred to premiums earned and measures the underwriting profitability of a company’s insurance business. We measure our loss ratio on a gross (before reinsurance) and net (after reinsurance) basis. We also measure the loss ratio on the ceded portion (the difference between gross and net premiums) for our Commercial Insurance and Personal Insurance segments. We use the gross loss ratio as a measure of the overall underwriting profitability of the insurance business we write and to assess the adequacy of our pricing. We use the loss ratio on the ceded portion of our insurance business to measure the experience on the premiums that we cede to reinsurers, including the premiums ceded under our quota share treaties. In some cases, the loss ratio on such ceded business is considered in determining the ceding commission rate that we earn on ceded premiums. Our net loss ratio is meaningful in evaluating our financial results, which are net of ceded reinsurance, as reflected in our consolidated financial statements. In addition, we use accident year and calendar year loss ratios to measure our underwriting profitability. An accident year loss ratio measures losses and LAE for insured events occurring in a particular year, regardless of when they are reported, as a percentage of premiums earned during that particular accident year. A calendar year loss ratio measures losses and LAE for insured events occurring during a particular year and the changes in estimates in loss and LAE reserves from prior accident years as a percentage of premiums earned during that particular calendar year.

Underwriting expense ratio. The gross underwriting expense ratio is the ratio of direct commission expenses and other underwriting expenses less policy billing fees to gross premiums earned. The gross underwriting expense ratio measures a company’s operational efficiency in producing, underwriting and administering its insurance business. We also calculate our net underwriting expense ratio after the effect of ceded reinsurance. Ceding commission revenue is applied to reduce our underwriting expenses in our insurance company operation.

Combined ratio. We use the net combined ratio to measure our underwriting performance. The combined ratio is the sum of the loss ratio and the underwriting expense ratio. We analyze the combined ratio on a gross (before the effect of reinsurance) and net (after the effect of reinsurance) basis. If the combined ratio is at or above 100%, an insurance company is not underwriting profitably and may not be profitable unless investment income is sufficient to offset underwriting losses.

Management fee income earned by the management companies. Our management companies provide various underwriting, claims, investment management and other services to the Reciprocal Exchanges. We receive a percentage of the gross written premiums issued by the Reciprocal Exchanges.

Net income and return on average equity. We use net income to measure our profits and return on average equity to measure our effectiveness in utilizing our stockholders’ equity to generate net income on a consolidated basis. In determining return on average equity for a given year, net income is divided by the average of stockholders’ equity for that year.

Book value per share. Book value per share is calculated as Tower Group, Inc, stockholders’ equity divided by the number of shares outstanding. We use this as a measure of value per share of the Company independent from the market price per share.

Tangible book value per share. Tangible book value per share is calculated as Tower Group, Inc, stockholders’ equity, less intangible assets and goodwill, divided by the number of shares outstanding. We use this as a measure of value per share of the Company independent from the market price per share.

Operating income. Operating income excludes realized gains and losses and acquisition-related transaction costs, net of tax. This is a common measurement for property and casualty insurance companies. We believe this presentation enhances the understanding of our results of operations by highlighting the underlying profitability of our insurance business. Additionally, these measures are a key internal management performance standard.

The following table provides a reconciliation of operating income to net income attributable to Tower Group, Inc. on a GAAP basis. The operating income is used to calculate operating earnings per share and operating return on average equity.


		Year Ended December 31,
($ in thousands)		2012 (restated)	2011 (restated)		2010 (revised)

Operating income (loss)	$	(33,934)	$	40,285	$	97,335
Net realized gains (losses) on investments attributable to Tower Group, Inc.		12,245		6,980		14,910
Acquisition-related transaction costs		(9,229)		(360)		(2,369)
Income tax		(3,316)		(2,470)		(5,046)

Net income (loss) attributable to Tower Group, Inc.	$	(34,234)	$	44,435	$	104,830

Critical Accounting Estimates

In preparing our consolidated financial statements, management is required to make estimates and assumptions that affect reported assets, liabilities, revenues and expenses and the related disclosures as of the date of the financial statements. Management considers an accounting estimate to be critical if it requires assumptions to be made that involve uncertainty at the time the estimate is made and, had different assumptions been selected, the changes in the outcome could have a significant effect on our financial statements. We review our critical accounting estimates and assumptions quarterly. Actual results may differ, perhaps substantially, from the estimates.

Our most critical accounting estimates involve the estimation of reserves for losses (including losses that have occurred but had not been reported by the financial statement date) and LAE, establishing fair value of losses and LAE for acquired businesses, net earned premiums, the reporting of ceding commissions earned, the amount and recoverability of reinsurance recoverable balances, deferred acquisition costs, investment impairments and potential impairments of goodwill and intangible assets.

Loss and loss adjustment expense reserves. The reserving process for loss and LAE reserves provides management’s best estimate at a particular point in time of the ultimate unpaid cost of all losses and LAE incurred, including settlement and administration of losses, and is based on facts and circumstances then known and including losses that have been incurred but not yet reported. The process includes using actuarial methodologies to assist in establishing these estimates, judgments relative to estimates of future claims severity and frequency, the length of time before losses will develop to their ultimate level and the possible changes in the law and other external factors that are often beyond our control. There are various actuarial methods that are appropriate for the different lines of business, and our actuaries’ use of a particular method or weighting of methods depends in part on the maturity of each accident year by line of business, the limits of liability covered under the policies, the presence or absence of large claims in the experience, and other considerations. In general, the various actuarial methods can be grouped into three categories: loss ratio projection, loss development methods, and the B-F method. For the most recent accident year, and especially for liability lines of business, the actuarial method given the most weight is usually the loss ratio method, since the percentage of ultimate claims reported to date is expected to be low and the immature reported claims experience is not a reliable indicator of ultimate losses for that accident year. For property lines of business for the most recent accident year, the B-F method is usually given the most weight, because experience typically shows that there is a small percentage of claims reported in the subsequent period due to normal lags in reporting and processing of claims in these lines of business that can be relatively reliably estimated as a percentage of premiums, which is reflected in the B-F method. For each line of business, the actuarial reserving method usually given the most weight shifts from the loss ratio projection to the B-F method to the incurred loss projection as each accident year matures. These methods are described in “Business—Loss and Loss Adjustment Expense Reserves.”

This process helps management set carried loss reserves based upon the actuaries’ best estimates, using estimates made by segment, product or line of business, territory, and accident year. The actuaries also separately estimate loss reserves from LAE reserves and within LAE reserves estimates are made for defense and cost containment expenses or Allocated Loss Adjustment Expenses (“ALAE”) and for other claims adjusting expenses or Unallocated Loss Adjustment Expenses (“ULAE”). The amount of loss and LAE reserves for reported claims is based primarily upon a case-by-case evaluation of coverage, liability, injury severity, and any other information considered pertinent to estimating the exposure presented by the claim. The amounts of loss and LAE reserves for unreported claims are determined using historical information by line of business as adjusted to current conditions. Due to the inherent uncertainty associated with the reserving process, the ultimate liability may differ, perhaps substantially, from the original estimate. Such estimates are regularly reviewed and updated, and any resulting adjustments are included in the current year’s results. Reserves are closely monitored and are recomputed periodically using the most recent information on reported claims and a variety of statistical techniques. Specifically, on at least a quarterly basis, we review, by line of business, existing reserves, new claims, changes to existing case reserves and paid losses with respect to the current and prior years. See “Business—Loss and Loss Adjustment Expense Reserves” for additional information regarding our loss and LAE reserves.

We segregate our data for estimating loss reserves. The property lines include Fire and Allied Lines, Homeowners-property, Commercial Multi-peril Property, Multi-Family Dwellings, Inland Marine and Automobile Physical Damage. The casualty lines include Homeowners-liability, Commercial Multi-peril Liability, Other Liability, Workers’ Compensation, Commercial Automobile Liability, and Personal Automobile Liability. Commercial Insurance segment reserves are estimated separately from Personal Insurance segment reserves. For the Commercial Insurance segment we analyze reserves by line of business and, where appropriate, we further segregate the data for analysis purposes between small, middle and large policies sizes and by state or region. We also analyze various producers’ business separately where the volume of business from those producers is considered significant and the characteristics of the business from those particular producers are perceived to be different. Within the Personal Insurance segment, we estimate loss and loss expenses reserves separately for the Reciprocal Exchanges, which we manage, and for our owned companies. We utilize line of business breakdowns and, where appropriate, analyze results separately by state.

Two key assumptions that materially impact the estimate of loss reserves are the loss ratio estimate for the current accident year and the loss development factor selections for all accident years. The loss ratio estimate for the current accident year is selected after reviewing historical accident year loss ratios adjusted for rate and price changes, trend, mix of business, and other factors. In addition, as the year matures and, depending upon the line of business, we utilize B-F methods or loss development methods for the current accident year.

In most cases, our data is sufficiently credible to determine loss development factors utilizing our own data. In some cases, we supplement our own loss development experience with industry data and utilize historical loss development experience for particular books of business, programs or treaties obtained from our sources. The loss development factors are reviewed at least annually, and whenever there is a significant change in the underlying business. Each quarter we test the loss development by analyzing actual emerging claims compared to expected development.

Because of the nature of the business historically written, the Company’s management believes that the Company has limited exposure to environmental claim liabilities.

We estimate ALAE reserves separately for claims that are defended by in-house attorneys, claims that are handled by other attorneys that are not employees, and miscellaneous ALAE costs such as investigators, witness fees and court costs.

For claims that are defended by in-house attorneys, we estimate the defense cost per claim, and we attribute to each of these claims a fixed fee for defense work. We allocate to each of these litigated claims 50% of the fixed fee when litigation on a particular claim begins and 50% of the fee when the litigation is closed. The fee is determined actuarially based upon the projected number of litigated claims and expected closing patterns at the beginning of each year as well as the projected budget for our in-house attorneys, and these amounts are calibrated to reimburse our in-house legal department for all of their costs.

ULAE for claims that are handled in-house by our claims adjusters utilize a similar process to that described above for ALAE. We determine fixed fees per claim by line of business, and assign these costs to line of business and accident year. For property lines, 50% of the fixed fee is attributed to claims when a claim is opened and 50% is attributed to claims when they are closed. For casualty lines, 75% of the fixed fee is attributed to the claim when a claim is opened and 25% is attributed to the claims when the claim is closed. The IBNR portion of ULAE for these claims is based upon 50% of the fixed fee per claims for in-house ULAE multiplied by the number of claims open and by 100% of the fixed fee multiplied by the estimated number of claims to be reported for prior accident dates.

For some types of claims and for some programs where we utilize third-party administrators (“TPA”) to adjust claims, we pay them fees which are included in ULAE. In some cases, we arrange for fixed percentages of premiums earned to be the fee for claims administration, and in other cases we arrange for fixed fees per claim or hourly charges for ULAE services. The reserves for ULAE for these situations is estimated based upon the particular arrangement for these types of claims by product or program.

Establishing fair value of loss and LAE reserves for acquired companies. At acquisition date, accounting standards require that loss and LAE reserves must be set to fair value. As there are no readily observable markets for these liabilities, we use a valuation model that estimates net nominal future cash flows related to the loss and LAE reserve. This valuation is adjusted for the time value of money and a risk margin to compensate the Company for holding capital supporting the risk associated with the liabilities. This adjustment is referred to as the “reserve risk premium”, which is amortized over the expected payout pattern of the claims.

Net premiums earned. Insurance policies issued or reinsured by us are short-duration contracts. Accordingly, premium revenue, including direct writings and reinsurance assumed, net of premiums ceded to reinsurers, is recognized as earned in proportion to the amount of insurance protection provided, on a pro-rata basis over the terms of the underlying policies. Unearned premiums represent premiums applicable to the unexpired portions of in-force insurance contracts at the end of each year. Prepaid reinsurance premiums represent the unexpired portion of reinsurance premiums ceded.

Ceding commissions earned. We have historically relied on quota share, excess of loss and catastrophe reinsurance to manage our regulatory capital requirements and limit our exposure to loss.

Ceding commissions under a quota share reinsurance agreement are based on the agreed-upon commission rate applied to the amount of ceded premiums written. Ceding commissions are realized as income as ceded premiums written are earned. The ultimate commission rate earned on our quota share reinsurance contracts is determined by the loss ratio on the ceded premiums earned. If the estimated loss ratio decreases from the level currently in effect, the commission rate increases and additional ceding commissions are earned in the period in which the decrease is recognized. If the estimated loss ratio increases, the commission rate decreases, which reduces ceding commissions earned. As a result, the same uncertainties associated with estimating loss and LAE reserves affect the estimates of ceding commissions earned. We monitor the ceded ultimate loss ratio on a quarterly basis to determine the effect on the commission rate of the ceded premiums earned that we accrued during prior accounting periods. The estimated ceding commission income relating to prior years recorded in 2012, 2011, and 2010 was a decrease of $0.1 million, $2.7 million and $2.2 million, respectively. These decreases are attributed to prior year reserve development that was not initially anticipated.

Reinsurance recoverables. Reinsurance recoverable balances are established for the portion of paid and unpaid loss and LAE that is assumed by reinsurers. Prepaid reinsurance premiums represent unearned premiums that are ceded to reinsurers. Reinsurance recoverables and prepaid reinsurance premiums are reported on our balance sheet separately as assets, instead of netted against the related liabilities, since reinsurance does not relieve us of our legal liability to policyholders and ceding companies. We are required to pay losses even if a reinsurer fails to meet its obligations under the applicable reinsurance agreement. Consequently, we bear credit risk with respect to our individual reinsurers and may be required to make judgments as to the ultimate recoverability of our reinsurance recoverables. Additionally, the same uncertainties associated with estimating loss and LAE reserves affect the estimates of the amount of ceded reinsurance recoverables. We continually monitor the financial condition and rating agency ratings of our reinsurers. Non-admitted reinsurers are required to collateralize their share of unearned premium and loss reserves either by placing funds in a trust account meeting the requirements of New York Regulation 114 or by providing a letter of credit. In addition, from October 2003 to December 31, 2005, we placed our quota share treaties on a “funds withheld” basis, under which we retained the ceded premiums written and placed that amount in segregated trust accounts from which we may withdraw amounts due to it from the reinsurers.

Deferred acquisition costs, net. We defer certain expenses that vary with and are directly related to the successful acquisition of new and renewal insurance business, including commission expense on gross premiums written, premium taxes and certain other costs related to the acquisition of insurance contracts. These costs are capitalized and the resulting asset, DAC, is amortized and charged to expense or income in future periods as gross and ceded premiums written are earned. The method followed in computing deferred acquisition costs, net, limits the amount of such deferred amounts to its estimated realizable value. The ultimate recoverability of deferred acquisition costs is dependent on the continued profitability of our insurance underwriting. We also consider anticipated invested income in determining the recoverability of these costs. If our insurance underwriting becomes unprofitable, we may have to write off a portion of our deferred acquisition costs, resulting in a further charge to income in the period in which the underwriting losses are recognized. The value of business acquired (“VOBA”) is an intangible asset relating to the estimated fair value of the unexpired insurance policies acquired in a business combination. VOBA is determined at the time of a business combination and is reported on the consolidated balance sheet with DAC and is amortized in proportion to the timing of the estimated underwriting profit associated with the in force policies acquired. The cash flow or interest component of VOBA is amortized in proportion to the expected pattern of future cash flows. The Company considers anticipated investment income in determining the recoverability of these costs and believes they are fully recoverable.

Impairment of invested assets. Impairment of investment securities results in a charge to operations when a market decline below cost is deemed to be other-than-temporary. We regularly review our fixed-maturity and equity securities portfolios to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of investments. In evaluating potential impairment, we consider, among other criteria:

—

the overall financial condition of the issuer;

—

the current fair value compared to amortized cost or cost, as appropriate;

—

the length of time the security’s fair value has been below amortized cost or cost;

—

specific credit issues related to the issuer such as changes in credit rating, reduction or elimination of dividends or non-payment of scheduled interest payments;

—

whether management intends to sell the security and, if not, whether it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis;

—

specific cash flow estimations for fixed-income securities; and

—

current economic conditions.

If an other-than-temporary-impairment (“OTTI”) loss is determined for a fixed-maturity security (for which we do not have the intent to sell or it is not more likely than not we would be required to sell), the credit portion is recorded in the income statement as realized investment losses and the non-credit portion is recorded in accumulated other comprehensive income. The credit portion results in a permanent reduction in the cost basis of the underlying investment. For all other fixed-maturity security and equity security impairments, the entire impairment is reflected as a realized investment loss and reduces the cost basis of the security. The determination of OTTI is a subjective process and different judgments and assumptions could affect the timing of loss realization. We recorded OTTI losses on our fixed maturity and equity securities in the amounts of $9.9 million, $3.5 million and $14.9 million in 2012, 2011, and 2010, respectively, of which $9.6 million, $3.2 million and $3.0 million were recorded in Net realized investment gains (losses) in 2012, 2011, and 2010, respectively.

Since total unrealized losses are a component of stockholders’ equity, the recognition of OTTI losses has no effect on our comprehensive income or stockholders’ equity.

See “Business-Investments” and “Note 7 – Investments” in the notes to consolidated financial statements for additional detail regarding our investment portfolio at December 31, 2012, including disclosures regarding OTTI.

Goodwill and intangible assets and potential impairment. The costs associated with a group of assets acquired in a transaction are allocated to the individual assets, including identifiable intangible assets, based on their relative fair values. Purchase consideration in excess of the fair value of tangible and intangible assets is recorded as goodwill.

Identifiable intangible assets with a finite useful life are amortized over the period in which the asset is expected to contribute directly or indirectly to our future cash flows. Identifiable intangible assets with finite useful lives are amortized over their useful lives and tested for recoverability whenever events or changes in circumstances indicate that a carrying amount may not be recoverable. Identifiable intangible assets with indefinite useful lives are not amortized. Rather, they are tested for recoverability at least annually or whenever events or changes in circumstances indicate that a carrying amount may not be recoverable. No impairment losses were recognized on intangible assets with a finite useful life in 2012, 2011 or 2010.

The Company completed its annual indefinite lived intangible asset assessment as of September 30, 2012. An impairment loss is recognized if the carrying value of an intangible asset is not recoverable and its carrying amount exceeds its fair value. Any amount of intangible assets determined to be impaired will be recorded as an expense in the period in which the impairment determination is made. No impairment losses were recognized on indefinite lived intangible assets in 2012, 2011 or 2010.

Goodwill is not amortized. Rather, it is tested for recoverability at least annually or whenever events or changes in circumstances indicate that a carrying amount may not be recoverable. The Company completed its annual goodwill assessment as of September 30, 2012 for the two individual reporting units that carry goodwill, Commercial Insurance and Personal Insurance. Our Insurance Service reporting unit does not carry goodwill.

The process of evaluating goodwill for impairment requires judgments and assumptions to be made to determine the fair value of each reporting unit, including discounted cash flow calculations, assumptions that market participants would make in valuing each reporting unit and the level of the Company’s own share price. Fair value estimates we utilize both the market approach and income approach. Management considered valuation techniques such as peer company price-to-earnings and price-to-book multiples and an in-depth analysis of projected future cash flows and relevant discount rates, which considered market participant inputs. Other significant assumptions include levels of surplus available for distribution, future business growth and earnings projections for each reporting unit. Estimates of fair value are subject to assumptions that are sensitive to change and represent the Company’s reasonable expectation regarding future developments. Management also considers the implied control premium derived from its market capitalization and the implied fair value of the enterprise.

The first step of the Company’s analysis indicated that the Personal Insurance reporting unit’s fair value exceeded its carrying value by 7%. As such, the second step of the annual impairment assessment was not required. The first step of the Company’s analysis (“Step 1”) for Commercial Insurance indicated that its carrying value exceeded its fair value by 1%. Accordingly, management was required to perform the second step of the goodwill impairment test, which assumes the implied fair value from the Step 1 test is allocated to the fair value of each of the assets and liabilities in the Commercial Insurance reporting unit .In Step 2, the implied value of the Commercial Insurance reporting unit’s goodwill was greater than its goodwill carrying value by approximately $20 million considering an acquisition control premium of 42%; therefore, goodwill was not impaired and no write-down was required; however, the Step 1 comparison indicates a greater risk of future impairment for this reporting unit’s goodwill.

Of the assets and liabilities in Commercial Insurance, the value of business in the unearned premiums, the fair value of the distribution network and customer list and the reserve risk premium associated with losses and loss adjustment expense contain significant assumptions and judgment in estimating fair value. The second step of the impairment analysis for Commercial Insurance indicated that the implied goodwill for the reporting unit exceeded the carried value of goodwill. Accordingly, no impairment losses were recognized in 2012. Also, no impairment losses were recognized in 2011 or 2010.

In November and December 2012, Tower’s market capitalization was negatively impacted by what management believes was the uncertainty about the results of Superstorm Sandy coupled with the uncertainty as to the timing of the merger with Canopius: therefore, despite a temporary decline in the Company’s share price, management determined that there were no events or material changes in circumstances that indicated that a material change in the fair value of the Company’s reporting units had occurred.

Subsequent goodwill assessments could result in impairment due to the impact of a volatile financial market on earnings, discount assumptions, liquidity and market capitalization, as well as our assessment of segment organization upon the completion of the proposed merger with the Canopius Bermuda Operations. Slight changes in the factors we consider when evaluating our goodwill for impairment losses (such as forecasted future cash flows, changes in discount rates or market multiples derived from peer companies) could result in a significant charge for impairment losses reported in our consolidated financial statements. In addition, if our market capitalization decreases, we may be required to record goodwill impairment charges in future periods. See “Note 9 – Goodwill and Intangible Assets” in the notes to consolidated financial statements.

In 2013, as discussed in Item 1. Business, under the caption “Significant Business Developments and Risks and Uncertainties Resulting from Events Occurring in 2013, ” the Company recorded a non-cash charge of $214.0 million to impair the Commercial Insurance reporting unit goodwill.

Consolidating Supplemental Information

The following tables present the consolidating financial statements as of December 31, 2012 and 2011 and for the years ended December 31, 2012, 2011 and 2010:


	December 31, 2012
($ in thousands)	Tower (restated)		Reciprocal Exchanges (restated)		Eliminations		Total (restated)

Assets
Investments
Available-for-sale investments, at fair value:
Fixed-maturity securities	$	2,064,148	$	280,563	$	-	$	2,344,711
Equity securities		140,695		5,563		-		146,258
Short-term investments		4,750		-		-		4,750
Other invested assets		134,986		-		(77,200)		57,786

Total investments		2,344,579		286,126		(77,200)		2,553,505
Cash and cash equivalents		92,487		9,782		-		102,269
Investment income receivable		39,439		2,610		(16,717)		25,332
Investment in unconsolidated affiliate		71,894		-		-		71,894
Premiums receivable		367,760		47,031		(2,746)		412,045
Reinsurance recoverable on paid losses		16,927		2,503		(1,821)		17,609
Reinsurance recoverable on unpaid losses		407,068		55,839		(3,450)		459,457
Prepaid reinsurance premiums		46,120		21,143		(3,340)		63,923
Deferred acquisition costs, net		169,834		11,364		-		181,198
Intangible assets		99,914		6,854		-		106,768
Goodwill		241,458		-		-		241,458
Funds held by reinsured companies		137,545		-		-		137,545
Other assets		357,062		1,559		(19,852)		338,769

Total assets	$	4,392,087	$	444,811	$	(125,126)	$	4,711,772

Liabilities
Loss and loss adjustment expenses	$	1,759,888	$	139,241	$	(3,450)	$	1,895,679
Unearned premium		818,055		106,556		(3,340)		921,271
Reinsurance balances payable		33,590		11,546		(4,567)		40,569
Funds held under reinsurance agreements		98,081		500		-		98,581
Other liabilities		275,614		58,115		(36,769)		296,960
Deferred income taxes		5,069		19,694		-		24,763
Debt		449,731		77,000		(77,000)		449,731

Total liabilities		3,440,028		412,652		(125,126)		3,727,554

Stockholders’ equity
Common stock		530		-		-		530
Treasury stock		(181,435)		-		-		(181,435)
Paid-in-capital		780,036		9,400		(9,400)		780,036
Accumulated other comprehensive income		82,756		15,525		(15,525)		82,756
Retained earnings		268,171		7,234		(7,234)		268,171
Noncontrolling interests		2,001		-		32,159		34,160

Total stockholders’ equity		952,059		32,159		-		984,218

Total liabilities and stockholders’ equity	$	4,392,087	$	444,811	$	(125,126)	$	4,711,772


		December 31, 2011
($ in thousands)		Tower (restated)		Reciprocal Exchanges		Eliminations		Total (restated)

Assets
Investments
Available-for-sale investments, at fair value:
Fixed-maturity securities	$		2,153,620	$	300,054	$	-	$	2,453,674
Equity securities			87,479		1,866		-		89,345
Short-term investments			-		-		-		-
Other invested assets			121,547		-		(77,200)		44,347

Total investments			2,362,646		301,920		(77,200)		2,587,366
Cash and cash equivalents			113,432		666		-		114,098
Investment income receivable			33,842		2,978		(10,038)		26,782
Premiums receivable			372,261		44,171		-		416,432
Reinsurance recoverable on paid losses			17,793		6,326		(656)		23,463
Reinsurance recoverable on unpaid losses			280,968		20,134		(8,881)		292,221
Prepaid reinsurance premiums			39,352		14,685		-		54,037
Deferred acquisition costs, net			156,992		11,866		-		168,858
Intangible assets			110,081		4,839		-		114,920
Goodwill			241,458		-		-		241,458
Funds held by reinsured companies			69,755		-		-		69,755
Other assets			322,254		1,410		(15,575)		308,089

Total assets	$		4,120,834	$	408,995	$	(112,350)	$	4,417,479

Liabilities
Loss and loss adjustment expenses	$		1,495,839	$	145,155	$	(8,881)	$	1,632,113
Unearned premium			790,185		102,991		-		893,176
Reinsurance balances payable			17,328		4,122		(656)		20,794
Funds held under reinsurance agreements			96,726		-		-		96,726
Other liabilities			279,765		35,442		(25,813)		289,394
Deferred income taxes			2,338		18,906		-		21,244
Debt			426,901		77,000		(77,000)		426,901

Total liabilities			3,109,082		383,616		(112,350)		3,380,348

Stockholders’ equity
Common stock			526		-		-		526
Treasury stock			(158,185)		-		-		(158,185)
Paid-in-capital			772,877		7,048		(7,048)		772,877
Accumulated other comprehensive income			63,053		12,840		(12,840)		63,053
Retained earnings			331,480		5,491		(5,491)		331,480
Noncontrolling interests			2,001		-		25,379		27,380

Total stockholders’ equity			1,011,752		25,379		-		1,037,131

Total liabilities and stockholders’ equity	$		4,120,834	$	408,995	$	(112,350)	$	4,417,479


		December 31, 2012
($ in thousands)		Tower (restated)			Reciprocal Exchanges (restated)		Eliminations			Total (restated)

Revenues
Net premiums earned	$		1,558,204	$		163,660	$	-		$	1,721,864
Ceding commission revenue			18,737			14,564		(966	)		32,335
Insurance services revenue			33,570			-		(30,150	)		3,420
Policy billing fees			11,901			714		-			12,615
Net investment income			121,908			12,574		(7,317	)		127,165
Total net realized investment gains (losses)			12,245			13,231		-			25,476

Total revenues			1,756,565			204,743		(38,433	)		1,922,875

Expenses
Loss and loss adjustment expenses			1,154,540			109,218		-			1,263,758
Direct and ceding commission expense			325,906			34,367		(966	)		359,307
Other operating expenses			293,458			54,189		(30,150	)		317,497
Acquisition-related transaction costs			9,229			-		-			9,229
Interest expense			33,268			6,679		(7,317	)		32,630

Total expenses			1,816,401			204,453		(38,433	)		1,982,421

Other income (expense)
Equity in income (loss) of unconsolidated affiliate			(1,470)			-		-			(1,470)

Income (loss) before income taxes			(61,306)			290		-			(61,016)
Income tax expense (benefit)			(27,072)			(2,027)		-			(29,099)

Net income (loss)	$		(34,234)	$		2,317	$	-		$	(31,917)


Ratios

Net calendar year loss and LAE			74.1%			66.7%					73.4%
Net underwriting expenses			35.5%			44.6%					36.4%
Net Combined			109.6%			111.3%					109.8%

Return on Average Equity			-3.4%


		December 31, 2011
($ in thousands)		Tower (restated)			Reciprocal Exchanges (restated)		Eliminations (restated)			Total (restated)

Revenues
Net premiums earned	$		1,406,689	$		187,161	$	-		$	1,593,850
Ceding commission revenue			27,194			6,774		-			33,968
Insurance services revenue			30,873			-		(29,303	)		1,570
Policy billing fees			9,961			573		-			10,534
Net investment income			120,083			12,846		(6,455	)		126,474
Total net realized investment gains (losses)			6,980			2,414		-			9,394

Total revenues			1,601,780			209,768		(35,758	)		1,775,790

Expenses
Loss and loss adjustment expenses			972,567			104,419		-			1,076,986
Direct and ceding commission expense			277,285			32,541		-			309,826
Other operating expenses			261,974			52,176		(29,303	)		284,847
Acquisition-related transaction costs			360			-		-			360
Interest expense			34,290			6,455		(6,455	)		34,290

Total expenses			1,546,476			195,591		(35,758	)		1,706,309

Income (loss) before income taxes			55,304			14,177		-			69,481
Income tax expense (benefit)			10,869			3,182		-			14,051

Net income (loss)	$		44,435	$		10,995	$	-		$	55,430


Ratios

Net calendar year loss and LAE			69.1%			55.8%					67.6%
Net underwriting expenses			33.5%			41.3%					34.4%
Net Combined			102.6%			97.1%					102.0%

Return on Average Equity			4.3%


		December 31, 2010
($ in thousands)		Tower (revised)			Reciprocal Exchanges		Eliminations			Total (revised)

Revenues
Net premiums earned	$		1,198,878	$		93,791	$	-		$	1,292,669
Ceding commission revenue			37,252			2,051		-			39,303
Insurance services revenue			19,921			-		(17,752	)		2,169
Policy billing fees			5,955			300		-			6,255
Net investment income			105,505			5,118		(3,358	)		107,265
Total net realized investment gains (losses)			14,910			(257)		-			14,653

Total revenues			1,382,421			101,003		(21,110	)		1,462,314

Expenses
Loss and loss adjustment expenses			727,527			62,202		-			789,729
Direct and ceding commission expense			249,519			18,353		-			267,872
Other operating expenses			222,902			24,631		(17,752	)		229,781
Acquisition-related transaction costs			2,369			-		-			2,369
Interest expense			24,223			3,358		(3,358	)		24,223

Total expenses			1,226,540			108,544		(21,110	)		1,313,974

Income (loss) before income taxes			155,881			(7,541)		-			148,340
Income tax expense (benefit)			51,051			(1,463)		-			49,588

Net income (loss)	$		104,830	$		(6,078)	$	-		$	98,752


Ratios

Net calendar year loss and LAE			60.7%			66.3%					61.1%
Net underwriting expenses			35.0%			43.5%					35.6%
Net Combined			95.7%			109.8%					96.7%

Return on Average Equity			10.2%

Consolidated Results of Operations 2012 Compared to 2011

Total revenues. Total revenues increased by 8.3% for the year ended December 31, 2012 as compared to 2011, primarily due to increased net premiums earned.

Premiums earned. Gross premiums earned for the years ended December 31, 2012 and 2011 were $1,943.3 million and $1,789.8 million, respectively. The increase of 8.6% year over year is primarily a result of increased premiums from Tower’s assumed reinsurance business in the Commercial Insurance segment.

Ceded premiums earned increased $25.9 million to $221.8 million for the year ended December 31, 2012 from $195.9 million in 2011. The Company reinsures certain of its program business through quota share treaties and purchases excess per risk and catastrophe reinsurance for all property lines. It also reinsures the homeowners and umbrella business obtained from the OBPL through a quota share treaty. The increase in ceded premium earned in 2012 is primarily attributable to the reinstatement premium on our catastrophe reinsurance program as a result of Superstorm Sandy.

Overall, the Company’s net earned premiums increased $127.7 million for the year ended December 31, 2012 compared to the prior year.

Commission and fee income. Commission and fee income, comprised of ceding commission revenue, insurance services revenue and policy billing fees, increased by $2.3 million for the year ended December 31, 2012, compared to the same period in 2011. The increase is due to additional policy billing fees and an increase in fees earned by our managing general agencies.

Net investment income and net realized gains (losses). Net investment income increased 0.5% for the year ended December 31, 2012 compared to 2011. Net investment income was comparable to the prior year period as average cash and invested assets were relatively constant for the year ended December 31, 2012 as compared to 2011. Operating cash invested in fixed income securities in 2012 and in 2011 has been affected by an extended low interest rate environment. Investments in high-yield securities, dividend paying equity securities and in alternative investments continue to be made to help maintain overall portfolio yield and to partially mitigate the impact of the lower interest rate environment.

The Company had net realized investment gains of $25.5 million for the year ended December 31, 2012 compared to gains of $9.4 million in 2011. OTTI losses recorded in earnings for the year ended December 31, 2012 were $9.6 million, an increase from $3.2 million of OTTI losses recorded for 2011. $8.3 million of the 2012 OTTI losses were in the equity portfolio and $1.3 million were in the bond portfolio. These gains and losses were a function of individual securities selected for sale when cash needs arose in the ordinary course of business or general duration management and portfolio rebalancing activity as dictated in our investment policy statement. The increase in gains in 2012 is primarily due to sales of fixed income and equity securities in the fourth quarter of 2012 to provide liquidity for claims payments associated with Superstorm Sandy.

Loss and loss adjustment expenses. The consolidated net loss ratio, which includes the Reciprocal Exchanges, was 73.4% and 67.6% for the years ended December 31, 2012 and 2011, respectively. Excluding the Reciprocal Exchanges, the net loss ratio was 74.1% and 69.1% for the years ended December 31, 2012 and 2011, respectively. Severe weather losses added 7.3 points and 5.3 points to the loss ratio excluding the Reciprocal Exchanges in 2012 and 2011, respectively.

Excluding the Reciprocal Exchanges, there was reserve strengthening of $88.1 million for the year ended December 31, 2012 comprised of reserve strengthening in Personal Insurance of $4.0 million and reserve strengthening in Commercial Insurance of $84.1 million.

The reserve strengthening in Commercial Insurance included $56.6 million for workers’ compensation, $22.5 million for commercial automobile, and $5.0 million in other lines. The reserve strengthening in Personal Insurance was comprised mainly of $5.8 million for homeowners and other liability, and $5.4 million for other lines, partially offset by $7.2 million for amortization of reserves risk premium, principally relating to reserves acquired in the OBPL transaction.

For the Reciprocal Exchanges, the favorable development was $8.9 million, comprised of favorable development of $3.1 million for homeowners, $1.6 million for private passenger auto liability, $1.7 million for other lines, and $2.5 million for amortization of reserves risk premium.

Operating expenses. Operating expenses, which include direct and ceding commission expenses and other operating expenses, were $676.8 million for year ended December 31, 2012, compared to $594.7 million for the year ended December 31, 2011 representing an increase of 13.8%. This increase is primarily due to: (i) increased business production, including more assumed premiums written which have a higher commission rate compared to direct premiums written, (ii) the Company’s ongoing efforts to build-out our information technology infrastructure to support our policy administration and claims processing needs, and (iii) a $2.9 million after-tax charge attributable to a legal settlement with Munich Reinsurance America, Inc.(“Munich Re”).

The consolidated gross underwriting expense ratio increased to 33.9% for the year ended December 31, 2012 from 32.6% in the same period in 2011. The commission portion of the gross underwriting expense ratio increased to 18.5% for the year ended December 31, 2012 compared to 17.3% in 2011. This increase is attributed to the increase in assumed reinsurance business written, as noted above, as assumed reinsurance has a significantly higher commission rate than direct written policies. The gross OUE ratio was 15.4% for the year ended December 31, 2012 compared to 15.2% in the prior year.

Acquisition-related transaction costs. Acquisition-related transaction costs for the year ended 2012 were $9.2 million and relate primarily to the acquisition of our equity interest in Canopius Group and expenses associated with the proposed merger with Canopius Bermuda. These costs were negligible for 2011.

Interest expense. Interest expense decreased by $1.7 million for the year ended December 31, 2012 compared to 2011. Interest expense declined as payments on certain of our subordinated debentures moved from higher fixed rates to floating rates per the terms of the contracts.

Equity in income (loss) of unconsolidated affiliate. Tower recognized a loss of $1.5 million in 2012 relating to its equity method investment in Canopius Group. The Company records this investment on a one quarter lag (updated for significant events in the lag period). The loss is attributable to income incurred by Canopius Group in the third quarter of 2012 offset by fourth quarter 2012 losses associated with Superstorm Sandy claims.

Income tax expense. Income tax expense was a benefit of $29.1 million in 2012 compared to an expense of $14.1 million in 2011 The change of $43.2 million in income tax expense is directly attributable to the change of pre-tax income from $69.5 million in 2011 to a pre-tax loss of $61.0 million in 2012. The effective income tax rate (including state and local taxes) was 47.7% for the year ended December 31, 2012, compared to 20.2% for the same period in 2011. The increase in the effective tax rate in 2012 is related to the permanent income tax adjustments and the movement of a valuation allowance on the Reciprocal Exchanges in 2012, offset by acquisition-related transaction costs which increased the 2012 income tax benefit.

Net income (loss) and return on average equity. Net (loss) and annualized return on average equity attributable to Tower Group, Inc. were ($34.2) million and (3.4%) for the year ended December 31, 2012 compared to $44.4 million and 4.3% for the year ended December 31, 2011. The return on average equity is calculated by dividing net income (loss) by average stockholders’ equity. Average stockholders’ equity was $1,001.7 million and $1,029.9 million at December 31, 2012 and 2011, respectively.

The net loss in 2012 is primarily due to the reserve strengthening from Superstorm Sandy discussed above. 2012 net loss included losses of $80.1 million after-tax from Superstorm Sandy, as well as after-tax reserve strengthening of $60.7 million recorded in 2012 for accident years 2011 and prior.

Consolidated Results of Operations 2011 Compared to 2010

Total revenues. Total revenues increased by 21.4% for the year ended December 31, 2011 as compared to 2010, primarily due to increased net premiums earned, net investment income and policy billing fees resulting from the acquisition of OBPL which was acquired on July 1, 2010 and was reflected in Tower’s consolidated results for twelve months in 2011 as compared to six months in 2010.

Premiums earned. Gross premiums earned for the years ended December 31, 2011 and 2010 were $1,789.8 million and $1,519.6 million, respectively, for an increase of 17.8%. This increase is primarily a result of OBPL and to a lesser extent the AequiCap II and Navigators renewal rights transactions and the customized solutions and assumed reinsurance initiatives. Ceded premiums earned declined $31.1 million to $195.9 million in 2011 from $227.0 million in 2010. Ceded premiums earned declined as Tower elected to cancel its liability quota share reinsurance treaty in 2011. This decrease was somewhat offset by the Company’s quota share reinsurance on the OBPL homeowners business, which was in effect for twelve months in 2011 as compared to six months in 2010.

Overall, the Company’s net earned premiums increased $301.2 million, or 23.3%, to $1,593.9 million in 2011 from $1,292.7 million in 2010.

Commission and fee income. Commission and fee income decreased by $1.7 million in the year ended December 31, 2011 as compared to the year ended December 31, 2010. This decrease is primarily attributed to the decline in ceding commission revenue on a liability quota share reinsurance treaty that was effective only in 2010, offset by an increase in policy billing fees and ceding commission revenues associated with the OBPL acquired business.

Net investment income and net realized gains (losses). Net investment income increased 17.9% in the year ended December 31, 2011 compared to 2010. The increase in net investment income resulted from an increase in average cash and invested assets for the year ended December 31, 2011 as compared to 2010. The increase in average cash and invested assets resulted primarily from $365.1 million of invested assets from the OBPL acquisition (reduced by cash to finance such acquisition) and from operating cash flows of $85.0 million generated in 2011. The positive cash flow from operations was the result of an increase in premiums collected from a growing book of business. The tax equivalent investment yield of our fixed maturity portfolio at amortized cost was 4.8 % and 4.7% at December 31, 2011 and 2010, respectively. Operating cash invested in fixed income securities in 2011 and in 2010 has been affected by a low yield environment. We increased investments in high-yield securities and dividend paying equity securities to reduce the impact of this low interest rate environment.

The Company had net realized investment gains of $9.4 million for the year ended December 31, 2011 compared to gains of $14.7 million in 2010. OTTI losses recorded in earnings for the year ended December 31, 2011 were $3.2 million compared to $3.0 million of OTTI losses recorded in earnings for 2010.

Loss and loss adjustment expenses. The consolidated net loss ratio, which includes the Reciprocal Exchanges, was 67.6% and 61.1% for the years ended December 31, 2011 and 2010, respectively. Excluding the Reciprocal Exchanges, the net loss ratio was 69.1% and 60.7% for the years ended December 31, 2011 and 2010, respectively. The Reciprocal Exchanges’ net loss ratio was 55.8% and 66.3% for the years ended December 31, 2011 and 2010, respectively.

Excluding the Reciprocal Exchanges, the 2011 net loss and loss adjustment expenses included $74.3 million from claims related to severe weather related events, including first quarter 2011 claims relating to heavy snow, Hurricane Irene in August 2011, and other severe winter storms and tornados that resulted in an unusual number of claims. Excluding these severe weather related events, the net loss ratio for Tower, excluding the Reciprocal Exchanges, was 63.9% for the year ended December 31, 2011. The net loss ratio for Tower would have been 59.5% for the year ended December 30, 2010, excluding the Reciprocal Exchanges and the impact of severe weather events.

Excluding the Reciprocal Exchanges, there was reserve strengthening of $38.7 million for the year ended December 31, 2011 comprised of favorable development in Personal Insurance of $29.1 million and reserve strengthening in Commercial Insurance of $67.8 million.

The reserve strengthening in Commercial Insurance included $26.3 million for other liability, $31.9 million for workers compensation, $1.3 million for other lines, and $10.2 million for commercial automobile. This was offset in part by $1.9 million for amortization of reserves risk premium that was established in 2009 as part of fair value accounting for the acquisitions made that year. The favorable development in Personal Insurance, was comprised primarily of $22.2 million for private passenger automobile liability, $13.1 million for homeowners and $1.9 million for amortization of reserves risk premium, principally relating to reserves acquired in the OBPL transaction developing more favorably than anticipated at the time of the acquisition, offset by reserve strengthening of $4.2 million in discontinued personal lines business, $3.1 million in involuntary plans and $0.8 million in other lines.

For the Reciprocal Exchanges, the favorable development was $37.8 million, comprised of favorable development of $29.0 million for private passenger automobile liability, $7.6 million for homeowners and other lines, and $1.2 million for amortization of reserves risk premium.

Operating expenses. Operating expenses, which include direct and ceding commission expenses and other operating expenses, were $594.7 million for the year ended December 31, 2011, representing an increase of 19.5% over the prior year, primarily as a result of the OBPL acquisition, which was not included in the Company’s results for the first six months of 2010. In addition, the Company amortized the value of business acquired (“VOBA”) asset recorded on July 1, 2010 in connection with the OBPL purchase. This resulted in $10.2 million of expense recorded in 2011 and exceeded the amount of acquisition costs that were capitalized in 2011as DAC. The VOBA was fully amortized as of June 30, 2011. In addition, the Company incurred $23.9 million in 2011 compared to $13.3 million in 2010, under the transition services agreements with OneBeacon. The net underwriting expense ratio improved to 34.1% in 2011 from 35.7% in 2010.

The gross underwriting expense ratio improved slightly to 32.6% in 2011 from 32.9% in 2010. The commission portion of the gross underwriting expense ratio was 17.3% and 17.6% for years ended December 31, 2011 and 2010, respectively. The improvement in the commission ratio reflects the impact of lower commission rates in the Reciprocal Exchanges. The gross other underwriting expense (“OUE”) ratio, which includes boards, bureaus and taxes (“BB&T”), improved to 15.2% in 2011 from 15.3% in 2010.

Acquisition-related transaction costs. Acquisition-related transaction costs for the year ended December 31, 2010 were $2.4 million and relate to the acquisition of OBPL. These costs were negligible in 2011.

Interest expense. Interest expense increased by $10.1 million for the year ended December 31, 2011 compared to 2010. Interest expense increased mainly due to the issuance of $150 million of convertible senior notes in September 2010 and increased borrowings under the credit facility in 2011. Interest on funds withheld was $3.6 million in 2011 as compared to $2.7 million in 2010.

Income tax expense. Income tax expense decreased in 2011 compared to 2010 due to the decrease in pre-tax income. The effective income tax rate (including state and local taxes) was 20.2% for the year ended December 31, 2011, compared to 33.4% for the same period in 2010.

The decline in the effective tax rate from 2010 to 2011 is primarily attributed to (i) the increase in tax exempt interest income and dividend received deductions of $7.2 million in 2011 as compared to $4.9 million in 2010, (ii) the decline in pre-tax income from 2010 to 2011, and (iii) the movement of the Reciprocal Exchange valuation allowance in 2011.

Net income and return on average equity. Net income and annualized return on average equity attributable to Tower Group, Inc. were $44.4 million and 4.3% for the year ended December 31, 2011 compared to $104.8 million and 10.2% for the year ended December 31, 2010. The return on average equity is calculated by dividing net income by average stockholders’ equity. Average stockholders’ equity was $1029.9 million and $1,030.2 million at December 31, 2011 and 2010, respectively.

The decrease in the net income and annualized return on equity in 2011 is primarily due to the losses from severe weather related events in 2011, as discussed above. These losses were partially offset by increased net income attributed to the acquisition of OBPL.

Commercial Insurance Segment Results of Operations


		Year Ended December 31,
($ in thousands)		2012 (restated)			Change (restated)			Percent (restated)		2011 (restated)				Change (revised)			Percent (revised)		2010 (revised)

Net premiums written	$		1,225,624		$	73,325			6.4%	$	1,152,299		$		165,039			16.7%	$	987,260

Revenues
Net premiums earned	$		1,224,566		$	136,655			12.6%	$	1,087,911		$		146,896			15.6%	$	941,015
Ceding commission revenue			7,702			(7,084	)		-47.9%		14,786				(18,461	)		-55.5%		33,247
Policy billing fees			5,467			1,122			25.8%		4,345				1,603			58.5%		2,742

Total revenue			1,237,735			130,693			11.8%		1,107,042				130,038			13.3%		977,004


Expenses
Net loss and loss adjustment expenses			912,682			154,471			20.4%		758,211				163,183			27.4%		595,028
Underwriting expenses
Direct commission expenses			248,200			39,524			18.9%		208,676				16,755			8.7%		191,921
Other underwriting expenses			184,433			28,418			18.2%		156,015				1,479			1.0%		154,536

Total underwriting expenses			432,635			67,942			18.6%		364,691				18,234			5.3%		346,457

Underwriting profit (loss)	$		(107,580	)	$	(91,720	)		NM	$	(15,860	)	$		(51,379	)		-144.7%	$	35,519


														Year Ended December 31,
Ratios														2012			2011		2010
														(restated)			(restated)		(revised)

Net calendar year loss and LAE															74.5%			69.7%		63.2%
Net underwriting expenses															34.3%			31.8%		33.0%
Net combined															108.8%			101.5%		96.2%

Commercial Insurance Segment Results of Operations 2012 Compared to 2011

Premiums. Gross premiums written for the year ended December 31, 2012 were $1,327.9 million as compared to $1,225.3 million during the same period in 2011. The increase of $102.6 million is primarily attributed to our growth in assumed reinsurance which accounted for growth of $75.6 million in 2012 compared to 2011. Gross premiums earned were $1,321.7 million as compared to $1,178.6 million during the same period in 2011.

Ceded premiums written for the year ended December 31, 2012 were $102.3 million compared to $73.0 million for the year ended December 31, 2011. Ceded premiums earned were $97.4 million compared to $90.7 million for the year ended December 31, 2012 compared to the same period in 2011. The increase in ceded premiums written in 2012 is attributable primarily (i) to increased written premiums on certain program business which is then reinsured through the quota share treaties and (ii) to the reinstatement premiums on our catastrophe reinsurance program as a result of Superstorm Sandy. In addition, the Company’s catastrophe reinsurance premiums increased in 2012 compared to 2011.

Net premiums written and earned increased $73.3 million and $136.4 million, respectively, in 2012 as compared to 2011. These changes are attributed to the gross and ceded premium changes discussed above.

The Company’s renewal retention rate excluding programs was 80.5% for the year ended December 31, 2012 compared to 77.1% during the same period in 2011. Premiums on renewed commercial business, other than programs, increased 4% in 2012. Excluding programs, policies in-force for our commercial business decreased 9% as of December 31, 2012 from 2011.

Ceding commission revenue. Ceding commission revenue decreased for the year ended December 31, 2012 by $7.1 million compared to the same period in 2011. This was primarily due to a change in loss ratio on a prior year’s quota share treaty which reduced ceding commission revenue by $4.2 million during the year ended December 31, 2012 compared to the same period in 2011 and also as a result of the non-renewal of our liability quota share contract.

Net loss and loss adjustment expenses. The net calendar year loss ratios were 74.5% and 69.7% for the years ended December 31, 2012 and 2011, respectively. The accident year loss ratios for the years ended December 31, 2012 and 2011 were 67.7% and 63.5%, respectively.

For the year ended December 31, 2012, the Company incurred net losses of $58.2 million relating to the Superstorm Sandy. Excluding the effects of Superstorm Sandy, the net loss ratio would have been 69.8% for the year ended December 31, 2012. For the year ended December 31, 2011, the Company incurred net losses of $31.5 million relating to Hurricane Irene and other severe weather events. Excluding the effects of these storms, the net loss ratio was 66.8% for the year ended December 31, 2011.

Management’s estimates of prior years’ loss and loss expenses increased $84.1 million for the year ended December 31, 2012. This increase in prior accident year loss and loss expense was the result of a comprehensive review of its loss reserves completed in the second quarter of 2012 and an updated analysis during the third quarter as well as recent loss emergence that occurred during the fourth quarter.

The reserve strengthening related primarily to adverse development in the Company’s Commercial Insurance segment arising from changes in estimated ultimate losses for accident years 2011 and prior. The increase in prior accident year ultimate loss and loss expense was largely comprised of $56.6 million in workers compensation, $22.5 million in commercial automobile liability and $5.0 million in other lines. The reserve development was attributable mostly to programs, many of which are terminated and in runoff.

Underwriting expenses and underwriting expense ratio. Underwriting expenses, which include direct commissions and other underwriting expenses, increased by $67.9 million, or 18.6%, for the year ended December 31, 2012, respectively, compared to the same period in 2011. The net underwriting expense ratio increased 2.5 percentage points for year ended December 31, 2012 compared to the same period 2011.

The gross underwriting expense ratio was 32.3% compared to 30.6% in the same periods in 2011. The commission portion of the gross underwriting expense ratio, which is expressed as a percentage of gross premiums earned, was 18.8% for the year ended December 31, 2012 compared to 17.7% for the same periods in 2011. The increase is primarily due to the assumed reinsurance business which has a higher commission ratio. The OUE ratio, including boards, bureaus and taxes (“BB&T”), was 13.6% for the year ended December 31, 2012 compared 12.8% for the same period in 2011. The increase in the OUE ratio is primarily a result of ongoing efforts by us to build-out our information technology infrastructure to support our policy administration and claims processing needs.

Underwriting profit (loss) and combined ratio. Underwriting profit decreased $91.7 million and the combined ratio increased 7.3 percentage points for the year ended December 31, 2012 compared to the year ended December 31, 2011. The increase in the combined ratio for the twelve months ended December 31, 2012 resulted primarily from the reserve strengthening the Company recorded in the first and second quarters of 2012 and losses from Superstorm Sandy in the fourth quarter of 2012. Such losses aggregated $113.9 million and increased the calendar year loss ratio by 9.3 points. In the year ended December 31, 2011, the Company recorded catastrophe and other severe storm losses but to a much lower extent. Such losses aggregated $31.5 million and increased the loss ratio by 4.8 points in 2011. In addition, as discussed above, the expense ratio increased by 2.5 percentage points from 2011 to 2012.

Commercial Insurance Segment Results of Operations 2011 Compared to 2010

Premiums. Gross premiums written for the year ended December 31, 2011 were $1,225.3 million as compared to $1,083.9 million during the same period in 2010. The increase of $141.4 million is primarily attributed to our new initiatives with customized solutions and assumed reinsurance which accounted for growth of $85.7 million and $72.8 million in 2011 compared to 2010, respectively.

Ceded premiums written for the year ended December 31, 2011 were $73.0 million compared to $96.6 million for the year ended December 31, 2010. Ceded premiums earned were $90.7 million compared to $155.7 million for the year ended December 31, 2011 compared to the same period in 2010. The decrease in ceded premiums written resulted from our decision to not renew our liability quota share reinsurance treaty which was in effect in 2010. In addition, we reduced the ceded premiums for our excess of loss reinsurance by raising our retention from $1.5 million to $5.0 million on all lines of business except workers’ compensation on which our retention was raised from $1.5 million to $2.5 million. The company also purchased catastrophe reinsurance for all property lines.

Net premiums written and earned increased $165.0 million and $131.2 million, respectively, in 2011 as compared to 2010. These changes are attributed to the gross and ceded premium changes discussed above.

Renewal retention rate excluding programs was 77.1% for the year ended December 31, 2011 compared to 77.0% during the same period in 2010. Premiums on renewed commercial business, other than programs, increased 1.5%. Excluding programs, policies in-force for our commercial business remained flat as of December 31, 2011.

Ceding commission revenue. Ceding commission revenue decreased for the year ended December 31, 2011 by $18.5 million compared to 2010. The decrease was a result of the non-renewal of our liability quota share contract.

Net loss and loss adjustment expenses. The net calendar year loss ratios were 69.7% and 63.2% for the years ended December 31, 2011 and 2010, respectively. The accident year loss ratios for the years ended December 31, 2011 and 2010 were 63.5% and 60.5%, respectively.

For the year ended December 31, 2011, the Company incurred net losses of $31.5 million relating to Hurricane Irene and other severe weather events. Excluding the effects of these storms, the net loss ratio would have been 66.8% for the year ended December 31, 2011.

Underwriting expenses and underwriting expense ratio. Underwriting expenses, which include direct commissions and other underwriting expenses, increased by $18.2 million, or 5.3%, for the year ended December 31, 2011 as compared to the 2010. The net underwriting expense ratio improved 1.2 percentage points for the year ended December 31, 2011 compared to the same period in 2010.

The gross underwriting expense ratio was 30.6% for the year ended December 31, 2011 as compared to 31.3% in 2010. The commission portion of the gross underwriting expense ratio, which is expressed as a percentage of gross premiums earned, was 17.7% for the year ended December 31, 2011 compared to 17.5% for the same periods in 2010. This increase is attributable to the assumed reinsurance which has a higher commission. The OUE ratio, including BB&T, was 12.8% for the year ended December 31, 2011 compared 13.8% for the same period in 2010. The improvement in OUE in 2011 resulted from of our continued efforts to reduce expenses through integration, with many functions consolidated into one office.

Underwriting profit and combined ratio . The net combined ratios were 101.5% for the year ended December 31, 2011 and 96.2% for 2010. The increase in the combined ratio in 2011 resulted from an increase in the net loss ratio due to catastrophe losses and more competitive market conditions, partially offset by a decrease in the net expense ratios as described above.

Personal Insurance Segment Results of Operations


		Year Ended December 31,
		2012											2011
($ in thousands)		Tower (restated)		Reciprocal Exchanges		Total (restated)		Change (restated)		Percent (restated)			Tower (restated)		Reciprocal Exchanges		Total (restated)

Net premiums written	$		356,771	$	156,986	$	513,757	$	27,466		5.6%	$		316,854	$	169,437	$	486,291

Revenues
Net premiums earned	$		333,638	$	163,660	$	497,298	$	(8,641)		-1.7%	$		318,777	$	187,162	$	505,939
Ceding commission revenue			10,069		14,564		24,633		5,451		28.4%			12,408		6,774		19,182
Policy billing fees			6,434		714		7,148		959		15.5%			5,616		573		6,189

Total revenue			350,141		178,938		529,079		(2,231)		-0.4%			336,801		194,509		531,310

Expenses
Net loss and loss adjustment expenses			241,858		109,218		351,076		32,301		10.1%			214,355		104,420		318,775
Underwriting expenses
Direct commission expenses			76,738		34,367		111,105		9,955		9.8%			68,609		32,541		101,150
Other underwriting expenses			74,021		53,897		127,918		633		0.5%			75,117		52,168		127,285

Total underwriting expenses			150,759		88,264		239,023		10,588		4.6%			143,726		84,709		228,435

Underwriting profit (loss)	$		(42,476)	$	(18,544)	$	(61,020)	$	(45,120)		283.8%	$		(21,280)	$	5,380	$	(15,900)


Ratios
Net calendar year loss and LAE			72.5%		66.7%		70.6%							67.2%		55.8%		63.0%
Net underwriting expenses			40.2%		44.6%		41.7%							39.4%		41.4%		40.1%
Net combined			112.7%		111.3%		112.3%							106.6%		97.2%		103.1%

Personal Insurance Segment Results of Operations 2012 Compared to 2011

Premiums. Gross premiums written for the year ended December 31, 2012 were $643.2 million as compared to $585.6 million in 2011 for an increase of $57.6 million. This increase is attributed to the acquisition of personal lines renewal rights resulting in $28.8 million of written premium and an increase in homeowners business offset by a decline in mono line automobile policies. Gross premiums earned increased to $621.6 million for the year ended December 31, 2012 from $611.2 million for the same period in 2011. This increase is due primarily to the renewal rights premiums and increase in homeowners business discussed above offset by a decline in mono line automobile policies.

Ceded premiums written for the year ended December 31, 2012 were $ 129.4 million, an increase of $30.1 million as compared to $99.4 million in 2011. Ceded premiums earned were $124.4 million compared to $105.2 million for the year ended December 31, 2012 compared to the same period in 2011. The Company reinsures the homeowners and umbrella business obtained from OBPL through a quota share program. The Company also purchased catastrophe reinsurance for certain property business. The increase in ceded premiums written is due to the increase in gross premiums written and to reinstatement premiums on our catastrophe reinsurance program as a result of Superstorm Sandy.

Net premiums written increased $27.5 million and net premiums earned decreased $8.7 million, respectively, in 2012 as compared to 2011. These changes are attributed to the gross and ceded premium changes discussed above.

The Company’s personal lines renewal retention was 84.9% and 86.0% for the years ended December 31, 2012 and 2011, respectively. Premiums on renewed personal business increased by 4.6% in 2012 compared to 2.5% in 2011. Policies-in-force decreased by 5.2% at December 31, 2012 as compared to December 31, 2011.

Ceding commission revenue. Ceding commission revenue increased for the year ended December 31, 2012 by $5.5 million compared to the same period in 2011. The increase is attributable to the commission revenue earned on the previously mentioned homeowners and umbrella quota share treaties on the OBPL acquired business.

Net loss and loss adjustment expenses. For Personal Insurance, the net calendar year loss ratios were 70.6% and 63.0% for the year ended December 31, 2012 and 2011, respectively. The accident year loss ratios for the year ended December 31, 2012 and 2011 were 71.6% and 76.2%, respectively. Estimates of prior accident year loss and loss expenses decreased by $4.9 million for the year ended December 31, 2012.

For Tower personal lines, excluding the Reciprocal Exchanges, the net calendar year loss ratios were 72.5% and 67.2% for the year ended December 31, 2012 and 2011, respectively. The accident year loss ratios for the year ended December 31, 2012 and 2011 were 71.3% and 76.4%, respectively. There was reserve strengthening of $4.0 million for the year ended December 31, 2012, and net favorable loss development of $29.1 million for the year ended December 31, 2011. For the year ended December 31, 2012, the Company recorded $237.8 million of incurred losses, with $42.8 million relating to Superstorm Sandy and other severe storms.

The Reciprocal Exchanges’ net calendar year loss ratios were 66.7% and 55.8% for the year ended December 31, 2012 and 2011, respectively. The accident year loss ratios for the year ended December 31, 2012 and 2011 were 72.2% and 76.0%, respectively. Estimates of prior accident year loss and loss adjustment expenses decreased by $8.9 million for the year ended December 31, 2012. For the year ended December 31, 2012, the Reciprocal Exchanges recorded $9.0 million of losses relating to Superstorm Sandy.

Underwriting expenses. Underwriting expenses, which include direct commissions and other underwriting expenses, increased by $11.7 million, or 5.2% for the year ended December 31, 2012 as compared to the prior year. The net underwriting expense ratio increased 1.8 percentage points from 2011 to 2012.

The gross underwriting expense ratio was 37.2% compared to 36.1% in the same periods in 2011. The commission portion of the gross underwriting expense ratio, which is expressed as a percentage of gross premiums earned, was 17.9% for the year ended December 31, 2012 compared to 16.6% for the same periods in 2011. The increase in the commission ratio was due to the growth in OBPL business which carries a slightly higher commission rate than the traditional Tower business.

The OUE ratio, including BB&T, was 16.3% for the year ended December 31, 2012 compared 16.6% for the same period in 2011.

Underwriting profit and combined ratio. Underwriting profit decreased $46.3 million and the combined ratio increased 9.4 percentage points for the year ended December 31, 2012 compared to the year ended December 31, 2011. The increase in the combined ratio for the twelve months ended December 31, 2012 resulted primarily from Superstorm Sandy losses in the fourth quarter of 2012. Such losses aggregated $42.8 million and increased the calendar year loss ratio by 12.8 points. These losses were partially offset by favorable prior year loss development of $4.9 million in 2012. In the year ended December 31, 2011, the Company also recorded catastrophe and other severe storm losses. In 2011 such losses aggregated $42.8 million and increased the calendar year loss ratio by 13.4 points. In addition, as discussed above, the expense ratio increased by 1.8 percentage points from 2011 to 2012.


	Year Ended December 31,
		2011											2010
($ in thousands)		Tower (restated)		Reciprocal Exchanges		Total (restated)		Change (restated)		Percent (restated)			Tower (revised)		Reciprocal Exchanges		Total (revised)

Net premiums written	$		316,854	$	169,437	$	486,291		159,487	$	48.8%	$		223,630	$	103,174	$	326,804

Revenues
Net premiums earned	$		318,777	$	187,162	$	505,939		154,285	$	43.9%	$		257,863	$	93,791	$	351,654
Ceding commission revenue			12,408		6,774		19,182		13,126		216.7%			4,005		2,051		6,056
Policy billing fees			5,616		573		6,189		2,676		76.2%			3,213		300		3,513

Total revenue			336,801		194,509		531,310		170,087		47.1%			265,081		96,142		361,223

Expenses
Net loss and loss adjustment expenses			214,355		104,420		318,775		124,074		63.7%			132,499		62,202		194,701
Underwriting expenses
Direct commission expenses			68,609		32,541		101,150		26,312		35.2%			56,485		18,353		74,838
Other underwriting expenses			75,117		52,168		127,285		43,110		51.2%			59,360		24,815		84,175


Total underwriting expenses			143,726		84,709		228,435		69,422		43.7%			115,845		43,168		159,013

Underwriting profit (loss)	$		(21,280)	$	5,380	$	(15,900)		(23,409)	$	-311.7%	$		16,737	$	(9,228)	$	7,509


Ratios
Net calendar year loss and LAE			67.2%		55.8%		63.0%							51.4%		66.3%		55.4%
Net underwriting expenses			39.4%		41.4%		40.1%							42.3%		43.5%		42.6%
Net combined			106.6%		97.2%		103.1%							93.7%		109.8%		98.0%

Personal Insurance Segment Results of Operations 2011 Compared to 2010

Premiums. Gross premiums written for the year ended December 31, 2011 were $585.6 million compared to $412.5 million in 2010, for an increase of $173.1 million. The increase is primarily attributable to OBPL which was acquired on July 1, 2010, and was reflected in Tower’s consolidated results for twelve months in 2011 as compared to six months in 2010. Excluding the effects of OBPL, Tower’s other personal lines gross premiums written increased $7.7 million from $201.0 million in 2010 to $208.7 million in 2011 due principally to organic growth in our homeowners business.

Ceded premiums written for the year ended December 31, 2011 were $99.4 million, an increase of $13.7 million as compared to $85.7 million in 2010. Ceded premiums earned were $105.2 million compared to $71.3 million for the year ended December 31, 2011 compared to the same period in 2010. The Company reinsures the homeowners and umbrella business obtained from OBPL through a quota share program. The Company also purchased catastrophe reinsurance for certain property business. The increase in ceded premiums written is due to the increase in gross premiums written associated with the OBPL acquisition

Net premiums written and earned increased $159.5 million and $154.2 million, respectively, in 2011 as compared to 2010. These changes are attributed to the gross and ceded premium changes discussed above.

The Company’s personal lines renewal retention was 86% and 83% for the years ended December 31, 2011 and 2010, respectively. The increase in 2011 is attributed to the change in business mix as a result of the OBPL acquisition. Premiums on renewed business increased by 2.5% and 5.0% in 2011 and 2010, respectively. Policies-in-force decreased by 2.5% as of December 31, 2011 from December 31, 2010.

Ceding commission revenue. The increase in ceding commission revenue increased for the year ended December 31, 2011 by $13.1 compared to the prior year is attributed to the commission revenue earned on the previously mentioned homeowners and umbrella quota share treaties on the OBPL acquired business.

Net loss and loss adjustment expenses. For Personal Insurance, the net calendar year loss ratios were 63.0% and 55.4% for the year ended December 31, 2011 and 2010, respectively. The accident year loss ratios for the year ended December 31, 2011 and 2010 were 76.2% and 64.5%, respectively. Estimates of prior accident year loss and loss expenses decreased by $66.9 million for the year ended December 31, 2011.

For Tower personal lines, excluding the Reciprocal Exchanges, the net calendar year loss ratios were 67.2% and 51.4% for the year ended December 31, 2011 and 2010, respectively. The accident year loss ratios for the year ended December 31, 2011 and 2010 were 76.4% and 60.0%, respectively. There was net favorable loss development of $29.1 million for the year ended December 31, 2011, and net favorable development of $22.3 million for the year ended December 31, 2010. For the year ended December 31, 2011, the Company recorded $243.4 million of incurred losses of which $42.8 million related to Hurricane Irene and other severe storms.

The Reciprocal Exchanges’ net calendar year loss ratios were 55.8% and 66.3% for the year ended December 31, 2011 and 2010, respectively. The accident year loss ratios for the year ended December 31, 2011 and 2010 were 76.0% and 76.8%, respectively. Estimates of prior accident year loss and loss adjustment expenses decreased by $37.8 million for the year ended December 31, 2011

Underwriting expenses. Underwriting expenses, which include direct commissions and other underwriting expenses, increased by $67.4 million for the year ended December 31, 2011 as compared to the prior year. Nearly all of the increase is related to the OBPL acquisition. The net underwriting expense ratio improved 2.8 percentage points from 2010 to 2011.

The gross underwriting expense ratio improved to 36.1% in 2011 from 36.9% in 2010. The commission portion of the gross underwriting expense ratio was 16.5% and 17.7% for years ended December 31, 2011 and 2010, respectively. The improvement in the commission ratio reflects the impact of lower commission rates in the Reciprocal Exchanges. The gross OUE ratio, which includes BB&T, was 19.6% and 19.2% for the years ended December 31, 2011 and 2010, respectively. The costs of the transition services agreements with OneBeacon have the effect of increasing the gross OUE ratios.

Underwriting profit and combined ratio. The increase in Personal Insurance segment underwriting loss and combined ratio for the year ended December 31, 2011 as compared to the underwriting profit and combined ratio in 2010 are due primarily to the catastrophe and severe storms that affected the northeastern United States in 2011, partially offset by favorable prior year loss development of $48.3 million in 2011. Of this amount, $10.5 million of the favorable loss development related to Tower, excluding the Reciprocal Exchanges. The Reciprocal Exchanges’ favorable loss development in 2011 was $37.8 million.

Insurance Services Segment Results of Operations


		Year Ended December 31,
($ in thousands)		2012		Change			Percent		2011		Change			Percent		2010

Revenue
Management fee income	$		30,150	$	847			2.9%	$	29,303	$	11,551			65.1%	$	17,752
Other revenue			3,420		1,850			117.8%		1,570		(601	)		-27.7%		2,171

Total revenue			33,570		2,697			8.7%		30,873		10,950			55.0%		19,923

Expenses
Other expenses			23,695		4,364			22.6%		19,331		13,571			235.6%		5,760

Total expenses			23,695		4,364			22.6%		19,331		13,571			235.6%		5,760

Insurance services pre-tax income	$		9,875	$	(1,667	)		-14.4%	$	11,542	$	(2,621	)		-18.5%	$	14,163

Insurance Services Segment Results of Operations 2012 Compared to 2011

Total revenue. The increase in total revenue for the year ended December 31, 2012 compared to 2011 was primarily due to fee income earned by our managing general agencies for business placed with other insurers. The management fee income is earned by Tower for underwriting, investment management and other services provided to the Reciprocal Exchanges for 2012 was consistent with the revenues earned for the year ended December 31, 2011. The effects of these management services agreements between Tower and the Reciprocal Exchanges are eliminated in consolidation to derive consolidated net income. However, the management fee income is reported in net income attributable to Tower Group, Inc. and included in basic and diluted earnings per share.

Total expenses. The increase in total expenses for the year ended December 31, 2012 compared to 2011 was primarily attributable to a settlement with Munich Reinsurance America, Inc. (“Munich Re”) to resolve a legal action commenced by Munich Re in 2009.

Insurance Services Segment Results of Operations 2011 Compared to 2010

Total revenue. The increase in total revenue for the year ended December 31, 2011 compared to 2010 was primarily due to the management fee income earned by Tower for underwriting, investment management and other services provided to the Reciprocal Exchanges pursuant to management services agreements with the Reciprocal Exchanges.

Total expenses. The increase in total expenses for the year ended December 31, 2011 compared to 2010 was primarily due to the costs incurred under the management services agreement between Tower and the Reciprocal Exchanges, which were in place for the twelve months in 2011 as compared to six months in 2010.

Investments

Portfolio Summary

The following table presents a breakdown of the amortized cost, aggregate fair value and unrealized gains and losses by investment type as of December 31, 2012 and December 31, 2011:


	Cost or		Gross		Gross Unrealized Losses						% of
($ in thousands)	Amortized Cost		Unrealized Gains		Less than 12 Months		More than 12 Months		Fair Value		Fair Value

December 31, 2012, as restated
U.S. Treasury securities	$	183,462	$	1,500	$	(13)	$	-	$	184,949		7.4%
U.S. Agency securities		98,502		4,351		(76)		-		102,777		4.1%
Municipal bonds		633,373		52,914		(235)		(9)		686,043		27.5%
Corporate and other bonds		698,012		50,807		(1,954)		(200)		746,665		29.9%
Commercial, residential and asset-backed securities		576,837		47,891		(409)		(42)		624,277		25.0%

Total fixed-maturity securities		2,190,186		157,463		(2,687)		(251)		2,344,711		93.9%
Equity securities		149,348		1,683		(4,447)		(326)		146,258		5.9%
Short-term investments		4,749		1		-		-		4,750		0.2%

Total, December 31, 2012, as restated	$	2,344,283	$	159,147	$	(7,134)	$	(577)	$	2,495,719		100.0%

Tower	$	2,075,189	$	141,614	$	(6,732)	$	(478)	$	2,209,593
Reciprocal Exchanges		269,094		17,533		(402)		(99)		286,126

Total, December 31, 2012, as restated	$	2,344,283	$	159,147	$	(7,134)	$	(577)	$	2,495,719

December 31, 2011
U.S. Treasury securities	$	154,430	$	1,725	$	(13)	$	-	$	156,142		6.1%
U.S. Agency securities		114,411		2,779		-		-		117,190		4.6%
Municipal bonds		688,192		48,777		(255)		-		736,714		29.0%
Corporate and other bonds		750,220		34,466		(6,813)		(150)		777,723		30.6%
Commercial, residential and asset-backed securities												0.0%
Commercial, residential and asset-backed securities		627,859		42,167		(3,529)		(592)		665,905		26.2%

Total fixed-maturity securities		2,335,112		129,914		(10,610)		(742)		2,453,674		96.5%
Equity securities		93,034		1,395		(4,838)		(246)		89,345		3.5%
Short-term investments		-		-		-		-		-		0.0%

Total, December 31, 2011	$	2,428,146	$	131,309	$	(15,448)	$	(988)	$	2,543,019		100.0%

Tower	$	2,138,001	$	118,173	$	(14,160)	$	(915)	$	2,241,099
Reciprocal Exchanges		290,145		13,136		(1,288)		(73)		301,920

Total, December 31, 2011	$	2,428,146	$	131,309	$	(15,448)	$	(988)	$	2,543,019

Other Invested Assets

The following table shows the composition of the other invested assets as of December 31, 2012:


($ in thousands)	2012		2011

Limited partnerships, equity method	$	23,864	$	12,459
Real estate, amortized cost		7,422		6,888
Securities reported under the fair value option		25,000		25,000
Other		1,500		-

Total	$	57,786	$	44,347

Credit Rating of Fixed-Maturity Securities

The average credit rating of our fixed-maturity securities, using ratings assigned to securities by Standard & Poor’s, was A+ at December 31, 2012 and December 31, 2011. The following table shows the ratings distribution of our fixed-maturity portfolio:


	Tower				Reciprocal Exchanges
($ in thousands)	Fair Value		Percentage of Fair Value		Fair Value		Percentage of Fair Value

December 31, 2012, as restated
Rating
U.S. Treasury securities	$	159,457		7.7%	$	25,494		9.1%
AAA		166,982		8.1%		43,114		15.4%
AA		897,692		43.5%		58,425		20.8%
A		383,957		18.6%		85,116		30.3%
BBB		214,024		10.4%		35,364		12.6%
Below BBB		242,036		11.7%		33,050		11.8%

Total, as restated	$	2,064,148		100.0%	$	280,563		100.0%

December 31, 2011
Rating
U.S. Treasury securities	$	151,621		7.0%	$	4,521		1.5%
AAA		189,431		8.8%		49,316		16.4%
AA		930,436		43.3%		98,017		32.8%
A		459,353		21.3%		105,696		35.2%
BBB		208,552		9.7%		12,728		4.2%
Below BBB		214,227		9.9%		29,776		9.9%

Total	$	2,153,620		100.0%	$	300,054		100.0%

Fixed Maturity Investments—Time to Maturity

The following table shows the composition of our fixed maturity portfolio by remaining time to maturity at December 31, 2012 and December 31, 2011. For securities that are redeemable at the option of the issuer and have a market price that is greater than redemption value, the maturity used for the table below is the earliest redemption date. For securities that are redeemable at the option of the issuer and have a market price that is less than redemption value, the maturity used for the table below is the final maturity date:


	Tower				Reciprocal Exchanges				Total
($ in thousands)	Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value

December 31, 2012, as restated
Remaining Time to Maturity
Less than one year	$	30,082	$	30,614	$	2,678	$	2,715	$	32,760	$	33,329
One to five years		489,939		510,523		45,576		47,275		535,515		557,798
Five to ten years		564,556		607,711		76,480		80,009		641,036		687,720
More than 10 years		346,410		379,045		57,628		62,542		404,038		441,587
Mortgage and asset-backed securities		495,249		536,255		81,588		88,022		576,837		624,277

Total, as restated	$	1,926,236	$	2,064,148	$	263,950	$	280,563	$	2,190,186	$	2,344,711

December 31, 2011
Remaining Time to Maturity
Less than one year	$	40,201	$	40,529	$	44,238	$	44,942	$	84,439	$	85,471
One to five years		479,721		491,904		81,566		83,743		561,287		575,647
Five to ten years		563,830		593,838		21,522		22,797		585,352		616,635
More than 10 years		427,357		458,536		48,818		51,480		476,175		510,016
Mortgage and asset-backed securities		535,823		568,813		92,036		97,092		627,859		665,905

Total	$	2,046,932	$	2,153,620	$	288,180	$	300,054	$	2,335,112	$	2,453,674

Fixed-Maturity Investments with Third Party Guarantees

At December 31, 2012, $189.5 million of our municipal bonds, at fair value, were guaranteed by third parties from a total of $2.3 billion, at fair value, of all fixed-maturity securities held by us. The amount of securities guaranteed by third parties along with the credit rating with and without the guarantee is as follows:


($ in thousands)	With Guarantee		Without Guarantee

AA	$	146,018	$	129,288
A		34,442		49,004
BBB		9,011		3,402
BB		-		3,104
No underlying rating		-		4,673

Total	$	189,471		189,471

Tower	$	187,378	$	187,378
Reciprocal Exchanges		2,093		2,093

Total	$	189,471	$	189,471

The securities guaranteed, by guarantor, are as follows:


($ in thousands)	Guaranteed Amount		Percent of Total

National Public Finance Guarantee Corp	$	73,149		38.6%
Assured Guaranty Municipal Corp		72,951		38.5%
Ambac Financial Corp		28,019		14.8%
Berkshire Hathaway Assurance Corp		6,633		3.5%
FGIC Corp		4,280		2.3%
Others		4,439		2.3%

Total	$	189,471		100.0%

Tower	$	187,378		98.9%
Reciprocal Exchanges		2,093		1.1%

Total	$	189,471		100.0%

Municipal Bonds

As of December 31, 2012, our municipal bonds consisted of state general obligations, municipal general obligations and special revenue bonds. Municipal bonds by state at December 31, 2012 are as follows:


	State General Obligations				Municipal General Obligations				Special Revenue Bonds				Total
($ in thousands)	Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value

Texas	$	20,688	$	22,369	$	7,262	$	7,933	$	73,140	$	80,713	$	101,090	$	111,015
New York		10,400		11,481		7,845		8,517		43,832		47,213		62,077		67,211
Florida		5,564		5,989		2,000		2,234		32,163		35,497		39,727		43,720
California		10,935		12,259		13,944		14,472		9,735		10,820		34,614		37,551
Washington		14,505		15,863		7,071		7,414		11,855		12,771		33,431		36,048
Illinois		9,860		10,688		6,722		7,067		10,761		12,039		27,343		29,794
Indiana		-		-		1,001		1,001		24,804		27,307		25,805		28,308
Other		70,329		74,472		51,318		54,006		187,640		203,918		309,287		332,396

Total	$	142,281	$	153,121	$	97,163	$	102,644	$	393,930	$	430,278	$	633,374	$	686,043

No one jurisdiction within “Other” in the table above exceeded 4% of the total fair value of municipal bonds. As of December 31, 2012, the special revenue bonds are supported primarily by water and sewer utilities, electric utilities, college revenues and highway tolls.

Fair Value Consideration

Under GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an “exit price”). GAAP establishes a fair value hierarchy that distinguishes between inputs based on market data from independent sources (“observable inputs”) and a reporting entity’s internal assumptions based upon the best information available when external market data are limited or unavailable (“unobservable inputs”). The fair value hierarchy in GAAP prioritizes fair value measurements into three levels based on the nature of the inputs. Quoted prices in active markets for identical assets have the highest priority (“Level 1”), followed by observable inputs other than quoted prices including prices for similar but not identical assets or liabilities (“Level 2”), and unobservable inputs, including the reporting entity’s estimates of the assumption that market participants would use, having the lowest priority (“Level 3”).

As of December 31, 2012, substantially all of the investment portfolio recorded at fair value was priced based upon quoted market prices or other observable inputs. For investments in active markets, we used the quoted market prices provided by the outside pricing services to determine fair value. In circumstances where quoted market prices were unavailable, we used fair value estimates based upon other observable inputs including matrix pricing, benchmark interest rates, market comparables and other relevant inputs. When observable inputs were adjusted to reflect management’s best estimate of fair value, such fair value measurements are considered a lower level measurement in the GAAP fair value hierarchy.

In certain instances, we deemed it necessary to utilize Level 3 pricing over prices available through pricing services used throughout 2012 and 2011. The ability to observe stable prices and inputs may be reduced for highly-customized an illiquid instruments as currently is the case for certain non-agency residential and commercial mortgage-backed securities and asset-backed securities.

At December 31, 2012, two securities included in other invested assets were priced in Level 3 with a fair value of $25.0 million, which was also our cost basis.

As more fully described in Note 7 to our consolidated financial statements, “Investments—Impairment Review,” we completed a detailed review of all our securities in a continuous loss position, including but not limited to residential and commercial mortgage-backed securities, and concluded that the unrealized losses in these asset classes are the result of a decrease in value due to technical spread widening and broader market sentiment.

“Note 8 – Fair Value Measurements” to the consolidated financial statements provides a description of the valuation methodology utilized to value Level 3 assets, how the valuation methodology is validated and an analysis of the change in fair value of Level 3 assets. As of December 31, 2012, the fair value of Tower Level 3 assets as a percentage of Tower’s total assets carried at fair value was as follows (the Reciprocal Exchanges had no Level 3 assets):


($ in thousands)	Assets Carried at Fair Value at December 31, 2012 (restated)		Fair Value of Level 3 Assets		Level 3 Assets as a Percentage of Total Assets Carried at Fair Value

Fixed-maturity investments	$	2,344,711	$	-		0%
Equity investments		146,258		-		0%
Short-term investments		4,750		-		0%

Total investments available for sale	$	2,495,719	$	-		0%

Other invested assets		25,000		25,000		100%
Cash and cash equivalents		102,269		-		0%

Total	$	2,622,988	$	25,000		0.9%

Unrealized Losses

The fair value of our fixed maturity portfolio is directly affected by changes in interest rates and credit spreads. We regularly review both our fixed-maturity and equity portfolios to evaluate the necessity of recording impairment losses for other-than temporary declines in the fair value of investments.

For those fixed-maturity investments deemed not to be in an OTTI position, we believe that the gross unrealized investment loss was primarily caused by a spread widening in the capital markets. We expect cash flows from operations to be sufficient to meet our liquidity requirements and, therefore, we do not intend to sell these fixed maturity securities and we do not believe that we will be required to sell these securities before recovering their cost basis. For equity securities not considered OTTI, we believe we have the ability to hold these investments until a recovery of fair value to our cost basis. A substantial portion of the unrealized loss relating to the mortgage-backed securities is the result of a spread widening in the market that we believe to be temporary.

The following table presents information regarding our invested assets that were in an unrealized loss position at December 31, 2012 and December 31, 2011 by amount of time in a continuous unrealized loss position:


	Less than 12 Months				12 Months or Longer				Total
($ in thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Aggregate Fair Value		Unrealized Losses

December 31, 2012, as restated
U.S. Treasury securities	$	44,347	$	(13)	$	-	$	-	$	44,347	$	(13)
U.S. Agency securities		22,345		(76)		-		-		22,345		(76)
Municipal bonds		21,532		(235)		251		(9)		21,783		(244)
Corporate and other bonds
Finance		16,853		(1,095)		-		-		16,853		(1,095)
Industrial		53,576		(667)		4,188		(201)		57,764		(868)
Utilities		20,143		(191)		7		-		20,150		(191)
Commercial mortgage-backed securities		23,223		(141)		95		-		23,318		(141)
Residential mortgage-backed securities
Agency backed		59,009		(261)		25		(1)		59,034		(262)
Non-agency backed		815		(6)		588		(28)		1,403		(34)
Asset-backed securities		1,499		(2)		4,232		(12)		5,731		(14)

Total fixed-maturity securities		263,342		(2,687)		9,386		(251)		272,728		(2,938)
Preferred stocks		9,716		(155)		5,724		(326)		15,440		(481)
Common stocks		55,560		(4,292)		-		-		55,560		(4,292)

Total, December 31, 2012, as restated	$	328,618	$	(7,134)	$	15,110	$	(577)	$	343,728	$	(7,711)

Tower	$	270,609	$	(6,732)	$	13,338	$	(478)	$	283,947	$	(7,210)
Reciprocal Exchanges		58,009		(402)		1,772		(99)		59,781		(501)

Total, December 31, 2012, as restated	$	328,618	$	(7,134)	$	15,110	$	(577)	$	343,728	$	(7,711)


December 31, 2011
U.S. Treasury securities	$	92,001	$	(13)	$	-	$	-	$	92,001	$	(13)
U.S. Agency securities		-		-		-		-		-		-
Municipal bonds		13,449		(255)		-		-		13,449		(255)
Corporate and other bonds
Finance		138,986		(4,610)		251		(5)		139,237		(4,615)
Industrial		57,357		(2,141)		3,519		(146)		60,876		(2,287)
Utilities		1,902		(61)		-		-		1,902		(61)
Commercial mortgage-backed securities		26,130		(2,564)		-		-		26,130		(2,564)
Residential mortgage-backed securities
Agency backed		19		(1)		12		-		31		(1)
Non-agency backed		13,294		(318)		4,609		(583)		17,903		(901)
Asset-backed securities		29,624		(647)		610		(8)		30,234		(655)

Total fixed-maturity securities		372,762		(10,610)		9,001		(742)		381,763		(11,352)
Preferred stocks		17,773		(644)		1,303		(246)		19,076		(890)
Common stocks		44,132		(4,194)		-		-		44,132		(4,194)

Total, December 31, 2011	$	434,667	$	(15,448)	$	10,304	$	(988)	$	444,971	$	(16,436)

Tower	$	398,989	$	(14,160)	$	8,264	$	(915)	$	407,253	$	(15,075)
Reciprocal Exchanges		35,678		(1,288)		2,040		(73)		37,718		(1,361)

Total, December 31, 2011	$	434,667	$	(15,448)	$	10,304	$	(988)	$	444,971	$	(16,436)

At December 31, 2012, the investments in an unrealized loss position for twelve months or greater were primarily in our corporate industrial bonds and preferred stocks.

The following table stratifies the gross unrealized losses in the portfolio at December 31, 2012, by duration in a loss position and magnitude of the loss as a percentage of the cost or amortized cost of the security:


			Total Gross		Decline of Investment Value
	Fair		Unrealized		>15%		>25%		>50%
($ in thousands)	Value		Losses		Amount		Amount		Amount

Unrealized loss for less than 6 months	$	316,022	$	(5,751)	$	(500)	$	-	$	-
Unrealized loss for over 6 months		12,847		(1,393)		-		-		-
Unrealized loss for over 12 months		9,090		(263)		-		-		-
Unrealized loss for over 18 months		4,690		(246)		-		-		-
Unrealized loss for over 2 years		1,079		(58)		-		-		-

Total unrealized loss, as restated	$	343,728	$	(7,711)	$	(500)	$	-	$	-

Tower	$	284,947	$	(6,210)	$	(500)	$	-	$	-
Reciprocal Exchanges		59,781		(501)		-		-		-

Total unrealized loss, as restated	$	344,728	$	(6,711)	$	(500)	$	-	$	-

The following table shows the number of securities, fair value, unrealized loss amount and percentage below amortized cost and the ratio of fair value by security rating as of December 31, 2012:


			Unrealized Loss
					Percent of	Fair Value by Security Rating
($ in thousands) Count	Fair Value		Amount		Amortized Cost	AAA		AA		A		BBB		BB or Lower

U.S. Treasury securities	$	44,347	$	(13)	0%		0%		100%		0%		0%		0%
U.S. Agency securities		22,345		(76)	0%		0%		100%		0%		0%		0%
Municipal bonds		21,783		(244)	-1%		38%		21%		21%		20%		0%
Corporate and other bonds, as restated		94,767		(2,154)	-1%		0%		5%		27%		45%		23%
Commercial mortgage-backed securities		23,318		(141)	-1%		42%		0%		50%		8%		0%
Residential mortgage-backed securities		60,437		(296)	0%		0%		97%		1%		0%		2%
Asset-backed securities		5,731		(14)	0%		26%		74%		0%		0%		0%
Equities		71,000		(4,773)	-7%		0%		0%		9%		25%		66%

See “Note 7—Investments” in our consolidated financial statements for further information about impairment testing and other-than-temporary impairments.

Corporate and other bonds

The following tables show the fair value and unrealized loss by sector and credit quality rating of our corporate and other bonds in an unrealized loss position at December 31, 2012:


Fair Value		Rating
($ in thousands)		AAA		AA		A		BBB		BB or lower		Fair value

Sector
Financial	$		-	$	2,642	$	3,047	$	32,421	$	18,653	$	56,763
Industrial			-		2,413		10,908		2,967		1,565		17,853
Utilities			-		-		12,368		6,602		1,180		20,150

Total fair value, as restated	$		-	$	5,055	$	26,323	$	41,990	$	21,398	$	94,766

% of fair value			0%		5%		28%		44%		23%		100%


Unrealized Loss		Rating
($ in thousands)		AAA		AA		A		BBB		BB or lower		Unrealized Loss

Sector
Financial	$		-	$	(17)	$	(27)	$	(410)	$	(1,414)	$	(1,868)
Industrial			-		(21)		(65)		(4)		(5)		(95)
Utilities			-		-		(17)		(162)		(12)		(191)

Total unrealized loss, as restated	$		-	$	(38)	$	(109)	$	(576)	$	(1,431)	$	(2,154)

% of book value			0%		(1%)		0%		(1%)		(2%)		(1%)

The majority of our corporate bonds that are in an unrealized loss position are rated below AA. Based on our analysis of these securities and current market conditions, we expect price recovery on these over time, and we have determined that these securities are not other than temporarily impaired as of December 31, 2012.

Total securitized assets

The following tables show the fair value and unrealized loss by credit quality rating and deal origination year of our commercial mortgage-backed, non-agency residential mortgage-backed and asset-backed securities in an unrealized loss position at December 31, 2012:


Fair Value
		Rating
($ in thousands) Deal Origination Year		AAA		AA		A		BBB		BB or Lower		Fair Value

2001 - 2004	$		682	$	-	$	380	$	-	$	209	$	1,271
2005 - 2007			4,980		4,232		5,950		-		815		15,977
2008 - 2010			-		-		-		-		-		-
2010			-		-		-		-		-		-
2011			5,630		-		2,703		-		-		8,333
2012			-		-		2,987		1,886		-		4,873

Total fair value	$		11,292	$	4,232	$	12,020	$	1,886	$	1,023	$	30,453

% of fair value			37%		14%		40%		6%		3%		100%


Unrealized losses
		Rating
($ in thousands) Deal Origination Year		AAA		AA		A		BBB		BB or Lower		Unrealized Loss

2001 - 2004	$		-	$	-	$	(14)	$	-	$	(14)	$	(28)
2005 - 2007			(12)		(13)		(27)		-		(6)		(58)
2008 - 2010			-		-		-		-		-		-
2010			-		-		-		-		-		-
2011			(11)		-		(8)		-		-		(19)
2012			-		-		(40)		(43)		-		(83)

Total unrealized loss	$		(23)	$	(13)	$	(89)	$	(43)	$	(20)	$	(188)

% of book value			(0%)		(0%)		(1%)		(2%)		(2%)		(1%)

Liquidity and Capital Resources

Tower is organized as a holding company (the “Holding Company”) with multiple intermediate holding companies, 12 insurance subsidiaries and several management companies. The Holding Company’s principal liquidity needs include interest on debt, stockholder dividends and share repurchases under its share repurchase program. The Holding Company’s principal sources of liquidity include dividends and other permitted payments from our subsidiaries, as well as financing through borrowings and sales of securities.

The Company’s Board of Directors determined it would not declare and pay a dividend to holders of Tower’s common shares in the fourth quarter of 2013.

Tower Insurance Company of New York (“TICNY”) is the Company’s largest insurance subsidiary. Under New York law, TICNY is limited to paying dividends to the Holding Company only from statutory earned surplus. In addition, the New York Insurance Department must approve any dividend declared or paid by TICNY that, together with all dividends declared or distributed by TICNY during the preceding twelve months, exceeds the lesser of (1) 10% of TICNY’s policyholders’ surplus as shown on its latest annual statutory financial statement filed with the New York State Insurance Department or (2) 100% of adjusted net investment income during the preceding twelve months. TICNY declared $2.5 million, $15.0 million and $4.7 million in dividends to the Holding Company in 2012, 2011 and 2010, respectively. As of June 30, 2013, TICNY and the other U.S. Pool companies have negative unassigned surplus, and are therefore prohibited from paying dividends to the Holding Company.

CastlePoint Re is another of Tower’s significant insurance subsidiaries. Under the Insurance Act 1978 of Bermuda, as amended (the “Insurance Act”), CastlePoint Re is required to maintain a specified solvency margin and a minimum liquidity ratio and is prohibited from declaring or paying any dividends if doing so would cause CastlePoint Re to fail to meet its solvency margin and its minimum liquidity ratio. Under the Insurance Act, CastlePoint Re is prohibited from declaring or paying dividends without the approval of the Bermuda Monetary Authority (“BMA”), if CastlePoint Re failed to meet its solvency margin and minimum liquidity ratio on the last day of the previous fiscal year. Under the Insurance Act, CastlePoint Re is prohibited, without the approval of the BMA, from reducing by 15% or more its total statutory capital as set forth on its audited statutory financial statements for the previous year.

CastlePoint Re is also subject to dividend limitations imposed by Bermuda. Under the Companies Act 1981 of Bermuda, as amended (the “Companies Act”), we may declare or pay a dividend out of distributable reserves only if we have reasonable grounds for believing that we are, or would after the payment, be able to pay our liabilities as they become due and if the realizable value of our assets would thereby not be less than the aggregate of our liabilities and issued share capital and share premium accounts. As of June 30, 2013, CastlePoint Re may not pay dividends without consent of the BMA.

The management companies are not subject to any statutory limitations on their dividends to the Holding Company. The management companies declared dividends of $6.5 million, $19.9 million and $ 7.5 million in 2012, 2011 and 2010, respectively.

Pursuant to a tax allocation agreement, we compute and pay Federal income taxes on a consolidated basis. At the end of each consolidated return year, each entity must compute and pay to the Holding Company its share of the Federal income tax liability primarily based on separate return calculations. The tax allocation agreement allows the Holding Company to make certain Code elections in the consolidated Federal tax return. In the event such Code elections are made, any benefit or liability is accrued or paid by each entity. If a unitary or combined state income tax return is filed, each entity’s share of the liability is based on the methodology required or established by state income tax law or, if none, the percentage equal to each entity’s separate income or tax divided by the total separate income or tax reported on the return.

We have the intent and ability to hold any temporarily impaired fixed maturity securities until the anticipated date that these temporary impairments are recovered.

On October 7, 2013, Fitch downgraded Tower’s Issuer Default Rating from “BBB” to “B” and Tower’s insurance subsidiaries’ Insurer Financial Strength ratings from “A-” to “BB”. The ratings will continue to remain on negative watch until, at the earliest, the completion of Tower’s exploration of strategic alternatives.

On October 7, 2013, Demotech lowered its rating on TICNY and three other U.S. based insurance subsidiaries (Kodiak Insurance Company, Massachusetts Homeland Insurance Company and York Insurance Company of Maine) from A’ (A prime) to A (A exceptional). In addition, Demotech removed its previous A’ (A prime) rating on six other U.S. based insurance subsidiaries (CastlePoint Florida Insurance Company, CastlePoint Insurance Company, CastlePoint National Insurance Company, Hermitage Insurance Company, North East Insurance Company and Preserver Insurance Company). Demotech also affirmed its A ratings on Adirondack Insurance Exchange, New Jersey Skylands Insurance Association, New Jersey Skylands Insurance Company and Mountain Valley Indemnity Company.

Management expects these rating actions, in combination with other items that have impacted the Company in the second quarter, to result in a decrease in the amount of premiums the insurance subsidiaries are able to write. The net written premiums in the Commercial Insurance segment were $343.6 million for the six months ended June 30, 2013. The net written premiums in the Specialty Insurance and Reinsurance segment were $306.6 million for the six months ended June 30, 2013. Business written through certain program underwriting agents requires an A.M. Best rating of A- or greater.

The Company is required to maintain minimum capital and surplus for each of its insurance subsidiaries. U.S. based insurance companies are required to maintain capital and surplus above Company Action Level, which is a calculated capital and surplus number using a risk-based formula adopted by the state insurance regulators. The basis for this formula is the National Association of Insurance Commissioners’ (“NAIC’s”) risk-based capital (“RBC”) system and is designed to measure the adequacy of a U.S. regulated insurer’s statutory capital and surplus compared to risks inherent in its business. If an insurance entity falls into Company Action Level, its management is required to submit a comprehensive financial plan that identifies the conditions that contributed to the financial condition. This plan must contain proposals to correct the financial problems and provide projections of the financial condition, both with and without the proposed corrections. The plan must also outline the key assumptions underlying the projections and identify the quality of, and problems associated with, the underlying business. Depending on the level of actual capital and surplus in comparison to the Company Action Level, the state insurance regulators could increase their regulatory oversight, restrict the placement of new business, or place the company under regulatory control. Bermuda based insurance entities minimum capital and surplus requirements are calculated from a solvency formula prescribed by the Bermuda Monetary Authority (the “BMA”).

As of June 30, 2013, Tower Reinsurance, Ltd. (“TRL”), one the Company’s two Bermuda-based reinsurers had capital and surplus that did not meet the minimum capital and surplus requirements of the BMA. The Company has discussed with the BMA its intention to combine a substantial portion of the business and the capital of CastlePoint Re, the Company’s other Bermuda based reinsurer, with TRL. Through this combination, management believes that the combined entity’s capital would meet the minimum capital and surplus thresholds determined by the BMA. The Company is currently developing this plan and expects to deliver this plan to its Bermuda regulators in the next several weeks. The Company cannot provide assurance that it will be successful in pursuing this alternative. Should the business combination not be approved, TRL would be operating at a capital level that is below the regulatory minimums as designated by the BMA. As such, TRL could be subject to significant additional regulatory oversight or, in the event that such oversight did not satisfy the BMA, placed into liquidation.

Tower has in place several intercompany reinsurance transactions between its U.S. based insurance subsidiaries and its Bermuda based insurance subsidiaries. The U.S. based insurance subsidiaries have historically reinsured on a quota share basis obligations to CastlePoint Re, the Company’s other Bermuda based reinsurer. The 2013 obligations that CastlePoint Re assumes from the U.S. based insurance subsidiaries are then retroceded to TRL. In addition, CastlePoint Re also entered into a loss portfolio transaction with TRL where its reserves associated with the U.S. insurance subsidiary business for underwriting years prior to 2013 were all transferred to TRL. Therefore, TRL recorded $175 million of reserve strengthening on its balance sheet as of June 30, 2013 and, consequently, the financial result of such development was a reduction in the capital of TRL to $8.3 million at June 30, 2013. In addition TRL is required to collateralize the additional $175 million of assumed reserves in a trust for the benefit of TICNY, the lead pool company of the U.S. insurance companies. TRL had unencumbered liquid assets of $96 million at June 30, 2013, and during October of 2013, TRL commuted two reinsurance treaties which provided an additional $79 million in unencumbered assets.

Tower Group, Inc. (“TGI”), is the obligor under the bank credit facility ($70 million outstanding as of June 30, 2013) and the Convertible Senior Notes (“Notes”) due September 2014 ($150 million par amount outstanding as of June 30,2013). The indebtedness of TGI is guaranteed by Tower Group International, Ltd. (“TGIL”) TGI amended its credit facility on October 11, 2013, and agreed to several restrictions under the credit facility, including:

•

To not enter into any new borrowings under the credit facility;

•

To pledge to the lending banks any proceeds of new capital raises by TGI or TGIL until such time as the credit facility is paid in full;

•

To pledge to the lending banks proceeds from any sales of assets occurring at TGI; and

•

To submit to regulatory authorities, as appropriate, a request for approval to pledge the capital stock of the U.S. based and Bermuda based insurance subsidiaries.

In addition, the following financial covenants are included in the credit facility:

•

Debt to capitalization ratio limit of 46%;

•

Bermuda enhanced minimum capital requirement of 150% for CastlePoint Re at December 31, 2013 and 110% for TRL;

•

Minimum statutory surplus for all insurance companies of the greater of $419,000,000 or 85% of Combined Surplus at June 30, 2013; and

•

Tower currently is in compliance with all covenants contained in the credit facility.

The credit facility matures on May 30, 2014, at which point any unpaid balance becomes due.

The Company is evaluating potential opportunities to raise additional capital in private sales transactions as well as through other strategic alternatives currently being considered by TGIL’s Board of Directors, and intends to liquidate certain investments at TGI to repay the credit facility. Should the Company default on the credit facility and should such default not be waived by the credit banks it would cause an acceleration of the maturity of the Notes, and such notes would become due concurrently with the unpaid balance on the credit facility. The Company’s plan to repay the Notes includes a combination of using proceeds from the sale of assets held at TGI as well as using proceeds generated by future strategic alternatives being evaluated by TGIL’s Board of Directors, and to the extent necessary, issuing debt and/or equity securities to pay down the principal of the Notes. To the extent that such asset sales and debt securities issuances are not executed or are not successful, the Company may seek to sell certain of its operating assets to satisfy this obligation. The Company cannot currently provide assurance that it will be successful in finalizing the liquidation of the assets held at TGI, issuing new debt and/or equity securities or selling certain of its operating assets.

As of December 31, 2012, there are $235 million of subordinated debentures outstanding. The subordinated debentures do not have financial covenants that would cause an acceleration of their stated maturities. The earliest stated maturity date is on a $10 million debenture, with a stated maturity in May 2033. The Company has the ability to defer interest payments on its subordinated debentures for up to twenty quarters.

See the Liquidity section in “Note 1 – Nature of Business” to the consolidated financial statements for further discussion on Liquidity and Capital Resources.

Book Value per Common Share

Book value per common share represents Tower Group Inc. stockholders’ equity divided by the number of common shares outstanding. Management uses growth in book value per common share as a key measure of the value generated for our common

shareholders each period and believes that book value per common share is a key driver of TWGP’s share price over time. Book value per common share is impacted by, among other factors, our underwriting results, investment returns and share repurchase activity, which has an accretive or dilutive impact on book value per common share depending on the purchase price. Historical shares outstanding have been adjusted by the 1.1330 share conversion ratio resulting from the Merger Transaction.


(in thousands, except per share data)	December 31, 2012		December 31, 2011
(in thousands, except per share data)	(restated)		(restated)

Calculation of book value per common share:
Tower Group, Inc. stockholders’ equity	$	950,058	$	1,009,751
Common shares outstanding		43,514		44,438

Book value per common share	$	21.83	$	22.72

Commitments

The following table summarizes information about contractual obligations and commercial commitments. The minimum payments under these agreements as of December 31, 2012 were as follows:


	Payments due by period
($ in millions)	Total		Less than 1 Year		1-3 Years		4-5 Years		After 5 Years

Subordinated Debentures	$	235.1	$	-	$	-	$	-	$	235.1
Interest on subordinated debentures and interest rate swaps		389.7		-		32.9		32.9		323.9
Convertible senior notes		150.0		-		150.0		-		-
Interest on convertible senior notes		15.0		7.5		7.5		-		-
Credit facility		70.0		70.0		-		-		-
Operating lease obligations		81.9		9.7		20.4		18.9		32.9
Capital lease obligation		39.7		9.5		26.9		3.2		0.1
Gross loss reserves		1,895.7		787.4		665.1		276.9		166.3
Limited partnership funding commitments		29.7		29.7		-		-		-

Total contractual obligations	$	2,906.8	$	913.8	$	902.8	$	331.9	$	758.3

At various times over the past nine years we have issued trust preferred securities through wholly-owned Delaware statutory business trusts. The trusts used the proceeds of the sale of the trust preferred securities to third-party investors and common trust securities to Tower to purchase junior subordinated debentures from the Company. The terms of the junior subordinated debentures match the terms of the trust preferred securities. Interest on the junior subordinated debentures and the trust preferred securities is payable quarterly. In some cases, the interest rate is fixed for an initial period of five years after issuance and then floats with changes in the London Interbank Offered Rate (“LIBOR”). In other cases the interest rate floats with LIBOR without any initial fixed-rate period. See “Note 14 – Debt” for the principal terms of the subordinated debentures.

We do not consolidate the statutory business trusts for which we hold 100% of the common trust securities because we are not the primary beneficiary of the trusts. Our $7.1 million investment in the common trust securities of the statutory business trusts are reported in Other Assets. We report as a liability the outstanding subordinated debentures issued to the statutory business trusts.

Under the terms for all of the trust preferred securities, an event of default may occur upon:

—

non-payment of interest on the trust preferred securities, unless such non-payment is due to a valid extension of an interest payment period;

—

non-payment of all or any part of the principal of the trust preferred securities;

—

our failure to comply with the covenants or other provisions of the indentures or the trust preferred securities; or

—

bankruptcy or liquidation of us or the trusts.

If an event of default occurs and is continuing, the entire principal and the interest accrued on the affected trust preferred securities and junior subordinated debentures may be declared to be due and payable immediately.

Pursuant to the terms of our subordinated debentures, we and our subsidiaries cannot declare or pay any dividends if we are in default or have elected to defer payments of interest on the subordinated debentures.

In October 2010, the Company effected interest rate swap contracts with $190 million notional on the subordinated debentures. Certain of these subordinated debentures are currently paying a variable interest rate and other subordinated debentures will convert to variable rates over the next year. The interest rate swaps will fix the variable interest payments on the subordinated debentures to rates from 5.1% to 5.9%. The interest rate swaps mature in 2015.

In September 2010, the Company issued $150 million principal amount of 5.0% convertible senior notes (the “Notes”) due September 2014. Interest is being paid semi-annually commencing March 2011. Holders may convert their Notes into cash or common shares, at the Company’s option, at any time on or after March 15, 2014 or earlier under certain circumstances determined by: (i) the market price of the Company’s stock, (ii) the trading price of the Notes, or (iii) the occurrence of specified corporate transactions. Upon conversion, the Company intends to settle its obligation either entirely or partially in cash. The Company has been adjusting the conversion rate quarterly as the Company pays its quarterly dividend. At December 31, 2012 the conversion rate is 37.1689 shares of common stock per $1,000 principal amount of the Notes (equivalent to a conversion price of $26.90 per share), subject to further adjustment upon the occurrence of certain events, including future dividend payments. In February 2013, the conversion rate was adjusted to 37.2895, equivalent to a conversion price of $26.82 per share. Additionally, in the event of a fundamental change, the holders may require the Company to repurchase the Notes for a cash price equal to 100% of the principal plus any accrued and unpaid interest.

In May 2010, the Company entered into a $125.0 million credit facility agreement. The credit facility is a revolving credit facility with a letter of credit sublimit of $25.0 million. The credit facility is being used for general corporate purposes. The Company may request that the facility be increased by an amount not to exceed $50.0 million, and the facility expires May 2013. The Company has $70.0 million and $50.0 million outstanding under the credit facility as of December 31, 2012 and 2011, respectively. On November 26, 2012, the Company further amended its credit facility whereby the lenders provided consent to the proposed merger of the Company with a subsidiary of Canopius Holdings Bermuda Limited. The second amendment also increased the Company’s maximum revolving commitment by $70 million to $220 million upon the effectiveness of the Merger and the satisfaction of certain other conditions set forth in the Second Amendment.

On February 15, 2012, the Company amended its $125.0 million credit facility by increasing borrowing capacity up to $150 million, extending the maturity out to February 2016, and resetting borrowing fees to more favorable current market terms. On October 11, 2013 the Company amended its credit facility to reduce its capacity from $220 million to $70 million and change its maturity date to May 30, 2014.

The gross loss reserve payments due by period in the table above are based upon the loss and loss expense reserves estimates as of December 31, 2012 and actuarial estimates of expected payout patterns by line of business. As a result, our calculation of loss reserve payments due by period is subject to the same uncertainties associated with determining the level of reserves and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. The projected gross loss payments presented do not include the estimated amounts recoverable from reinsurers that amounted to $459.5 million, which are estimated to be recovered as follows: less than one year, $190.9 million; one to three years, $161.2 million; four to five years, $67.1 million; and after five years, $40.3 million. The interest on the subordinated debentures is calculated using interest rates in effect at December 31, 2012 for variable rate debentures.

For a discussion of our loss and LAE reserving process, see “Critical Accounting Policies—Loss and LAE Reserves.” Actual payments of losses and loss adjustment expenses by period will vary, perhaps materially, from the above table to the extent that current estimates of loss reserves vary from actual ultimate claims amounts and as a result of variations between expected and actual payout patterns. See “Risk Factors-Risks Related to Our Business—If our actual loss and loss adjustment expense reserves exceed our loss and loss adjustment expense reserves, our financial condition and results of operations could be significantly adversely affected,” for a discussion of the uncertainties associated with estimating loss and LAE expense reserves. The estimated ceded reserves recoverable referred to above also assumes timely reimbursement from our reinsurers. If our reinsurers do not meet their contractual obligations on a timely basis, the payment assumptions presented above could vary materially.

Capital

Our capital resources consist of funds deployed or available to be deployed to support our business operations. At December 31, 2012 and December 31, 2011, our capital resources were as follows:


	December 31,
($ in thousands)	2012 (restated)		2011 (restated)

Outstanding under credit facility	$	70,000	$	50,000
Subordinated debentures		235,058		235,058
Convertible Senior Notes		144,673		141,843
Tower Group, Inc. stockholders’ equity		950,058		1,009,751

Total capitalization	$	1,399,789	$	1,436,652

Ratio of debt to total capitalization		32.1%		29.7%

We monitor our capital adequacy to support our business on a regular basis. The future capital requirements of our business will depend on many factors, including our ability to write new business successfully and to establish premium rates and reserves at levels sufficient to cover losses. Our ability to underwrite is largely dependent upon the quality of our claims paying and financial strength ratings as evaluated by independent rating agencies. In particular, we require (1) sufficient capital to maintain our financial strength ratings, at a level considered necessary by management to enable our insurance subsidiaries to compete, and (2) sufficient capital to enable our insurance subsidiaries to meet the capital adequacy tests performed by statutory agencies in the United States and Bermuda.

As part of Tower’s capital management strategy, the Board of Directors of Tower approved a $100 million share repurchase program on March 3, 2011. This authorization is in addition to the $100 million share repurchase program approved on February 26, 2010. Purchases under both programs can be made from time to time in the open market or in privately negotiated transactions in accordance with applicable laws and regulations. The new share repurchase program will expire on March 4, 2013. The timing and amount of purchases under the programs depend on a variety of factors, including the trading price of the stock, market conditions and corporate and regulatory considerations. For the year ended December 31, 2012, 1.2 million shares of common stock were purchased under this program at an aggregate consideration of $21.0 million. In the year ended December 31, 2011, 3.3 million shares were purchased under this program at an aggregate consideration of $64.6 million. As of December 31, 2012, $26.4 million remained available for future share repurchases under the new program.

We may seek to raise additional capital or may seek to return additional capital to our stockholders through share repurchases, cash dividends or other methods (or a combination of such methods). Any such determination will be at the discretion of our Board of Directors and will be dependent upon our profits, financial requirements and other factors, including legal restrictions, rating agency requirements, credit facility limitations and such other factors as our Board of Directors deems relevant.

Stock Based Compensation Expense

The actual restricted stock expense that the Company has incurred for the year ended December 31, 2012 and the future restricted stock expense that the Company expects to incur for grants made as of December 31, 2012 assuming no forfeitures is shown in the table below:


(in $ thousands)	Restricted Stock Expense Before Tax		Tax Benefit		Restricted Stock Expense After Tax

2012
First Quarter⁽¹⁾	$	2,262	$	(792)	$	1,470
Second Quarter⁽¹⁾		2,365		(828)		1,537
Third Quarter⁽¹⁾		2,378		(832)		1,546
Fourth Quarter⁽¹⁾		2,292		(802)		1,490

2012 restricted stock expense		9,297		(3,254)		6,043

2013 ⁽²⁾
First Quarter		1,981		(693)		1,288
Second Quarter		1,286		(450)		836
Third Quarter		1,293		(453)		840
Fourth Quarter		1,282		(449)		833

Subtotal - 2013		5,842		(2,045)		3,797
2014 ⁽²⁾		3,877		(1,357)		2,520
2015 ⁽²⁾		2,300		(805)		1,495
2016 ⁽²⁾		594		(208)		386
2017 ⁽²⁾		30		(11)		19

Total expected future restricted stock expense	$	12,643	$	(4,426)	$	8,217

⁽¹⁾ Actual expense incurred

⁽²⁾ Expected restricted stock expense to be incurred

Cash Flows

The primary sources of consolidated cash flows are from the insurance subsidiaries’ gross premiums collected, ceding commissions from quota share reinsurers, loss payments by reinsurers, investment income and proceeds from the sale or maturity of investments. Funds are used by the insurance subsidiaries for loss payments and loss adjustment expenses. The insurance subsidiaries also use funds for ceded premium payments to reinsurers, which are paid on a net basis after subtracting losses paid on reinsured claims and reinsurance commissions on our net business, commissions to producers, salaries and other underwriting expenses as well as to purchase investments, fixed assets and to pay dividends to the Holding Company. The management companies’ primary sources of cash are management fees for acting as the attorneys-in-fact for the Reciprocal Exchanges.

The reconciliation of net income to cash provided from operations is generally influenced by the collection of premiums in advance of paid losses, the timing of reinsurance, issuing company settlements and loss payments.

Cash flow and liquidity are categorized into three sources: (1) operating activities; (2) investing activities; and (3) financing activities, which are shown in the following table:


	Year Ended December 31,
($ in thousands)	2012 (restated)			2011 (restated)			2010 (revised)

Cash provided by (used in):
Operating activities	$	109,213		$	82,754		$	197,025
Investing activities		(89,062	)		(104,950	)		(260,115)
Financing activities		(31,980	)		(3,927	)		28,087

Net increase (decrease) in cash and cash equivalents		(11,829	)		(26,123	)		(35,003)
Cash and cash equivalents, beginning of year		114,098			140,221			175,224

Cash and cash equivalents, end of period	$	102,269		$	114,098		$	140,221

Comparison of Years Ended December 31, 2012 and 2011

For the year ended December 31, 2012, net cash provided by operating activities was $109.2 million as compared to $82.8 million for 2011. The increase in operating cash flow in 2012 primarily resulted from the increase in premium earned and an increase in claims relating to Superstorm Sandy that will be paid in 2013.

Net cash flows used in investing activities were $89.1 million for the year ended December 31, 2012 compared to $105.0 million used for the year ended December 31, 2011. The year ended December 31, 2012 and 2011 included an increase to fixed assets of

$19.5 million and $53.6 million, respectively, primarily related to the build out of new systems. The remaining cash flows in 2011 relates to the Company’s purchases and sales of fixed-maturity and equity investments. The remaining net cash outflows in 2012 relate primarily to the Company’s $71.5 million investment in Canopius Group and a $35.0 million increase in restricted cash collateral posted for assumed reinsurance business with Lloyd’s of London offset by securities sales to generate cash to pay Superstorm Sandy claims.

The net cash flows used in financing activities for the year ended December 31, 2012 are primarily the result of uses of cash for the repurchase of common stock for $21.0 million and dividends of $29.1 million partially offset by cash inflows from a $20.0 million drawdown of our line of credit. In 2011, the Company had uses of cash for the repurchase of common stock and dividend payments of $64.6 million and $27.9 million, respectively, offset by net cash inflows of $50.0 million from a drawdown on our line of credit and $39.8 million from capital lease financings.

Cash flow needs at the holding company level are primarily for dividends to our stockholders, interest and principal payments on our outstanding debt and payments under the credit facility.

Comparison of Years Ended December 31, 2011 and 2010

The Company continued to direct excess cash balances to higher yielding investments to maximize investment income. Accordingly, Tower’s cash balances declined from December 31, 2010 to 2011.

For the year ended December 31, 2011, net cash provided by operating activities was $82.8 million as compared to $197.0 million for 2010. The decrease in cash flow for the year ended December 31, 2011 primarily resulted from a $66.2 million cash transfer to provide collateral support for business written on our behalf, claims payments on third quarter 2011 catastrophes and severe storms, tornado losses in the second quarter of 2011 and winter storms in late December 2010. These were partially offset by the receipt of a $22.0 million Federal income tax refund in 2011.

Net cash flows used in investing activities were $105.0 million for the year ended December 31, 2011 compared to $260.1 million used for the year ended December 31, 2010. The year ended December 31, 2011 and 2010 included an increase to fixed assets of $53.6 million and $36.9 million, respectively, primarily related to the build out of new systems. The additional cash outflows in 2010 related to the purchase of OBPL on July 1, 2010. The remaining cash flows in both years relate to purchases and sales of fixed maturity and equity securities. The net cash flows used in financing activities for the year ended December 31, 2011 are primarily the result of uses of cash for the repurchase of common stock for $64.6 million and dividends of $27.9 million offset by cash inflows from a $50.0 million drawdown of our line of credit and $39.8 million from capital lease financings related to the aforementioned systems costs, and other fixtures and equipment. In 2010, the Company had uses of cash for the repurchase of common stock and dividend payments of $88.0 million and $16.6 million, respectively, offset by net cash inflows of $134.1 million for the issuance of the senior convertible notes, senior convertible noted hedge, and warrants.

Cash flow needs at the holding company level are primarily for dividends to our stockholders, interest and principal payments on our outstanding debt and payments under the credit facility.

Inflation

Property and casualty loss and loss adjustment expense reserves are established before we know the amount of losses and loss adjustment expenses or the extent to which inflation may affect such amounts. We attempt to anticipate the potential impact of inflation in establishing our loss and LAE reserves. Inflation in excess of the levels we have assumed could cause loss and LAE expenses to be higher than we anticipated.

Substantial future increases in inflation could also result in future increases in interest rates, which in turn are likely to result in a decline in the market value of the investment portfolio and cause unrealized losses or reductions in stockholders’ equity.

Adoption of New Accounting Pronouncements

For a discussion of accounting standards, see “Note 3 – Accounting Policies and Basis of Presentation” of Notes to Consolidated Financial Statements.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Market risk is the risk that we will incur losses in our investments due to adverse changes in market rates and prices. Market risk is directly influenced by the volatility and liquidity in the market in which the related underlying assets are invested. We believe that we are principally exposed to three types of market risk: changes in interest rates, changes in credit quality of issuers of investment securities, and changes in equity prices.

Interest Rate Risk

Interest rate risk is the risk that we may incur economic losses due to adverse changes in interest rates. The primary market risk to the investment portfolio is interest rate risk associated with investments in fixed-maturity securities, although conditions affecting particular asset classes (such as conditions in the commercial and housing markets that affect commercial and residential mortgage-backed securities) can also be significant sources of market risk. Fluctuations in interest rates have a direct impact on the market valuation of these securities. The fair value of our fixed-maturity securities as of December 31, 2012 was $2.3 billion.

For fixed-maturity securities, short-term liquidity needs and potential liquidity needs for our business are key factors in managing our portfolio. We use modified duration analysis to measure the sensitivity of the fixed income portfolio to changes in interest rates as discussed more fully below under sensitivity analysis.

As of December 31, 2012, we had a total of $235.1 million of outstanding floating rate subordinated debentures underlying our trust preferred securities issued by the statutory business trusts and carrying an interest rate that is determined by reference to market interest rates. In order to reduce the interest rate risk on the subordinated debentures, the Company entered into interest rate swap contracts with Keybank National Association that are designed to convert $190 million of these outstanding borrowings from their respective floating rates to fixed rates ranging from 5.1% to 5.9%. These swaps mature in 2015.

Sensitivity Analysis

Sensitivity analysis is a measurement of potential loss in future earnings, fair values or cash flows of market sensitive instruments resulting from one or more selected hypothetical changes in interest rates and other market rates or prices over a selected time. In our sensitivity analysis model, we select a hypothetical change in market rates that reflects what we believe are reasonably possible near-term changes in those rates. The term “near-term” means a period of time going forward up to one year from the date of the consolidated financial statements. Actual results may differ from the hypothetical change in market rates assumed in this disclosure, especially since this sensitivity analysis does not reflect the results of any action that we may take to mitigate such hypothetical losses in fair value.

In this sensitivity analysis model, we use fair values to measure our potential loss. The sensitivity analysis model includes fixed-maturities, preferred stocks and short-term investments.

For invested assets, we use modified duration modeling to calculate changes in fair values. Durations on invested assets are adjusted for call, put and interest rate reset features. Durations on tax-exempt securities are adjusted for the fact that the yield on

such securities is generally less sensitive to changes in interest rates compared to Treasury securities. Invested asset portfolio durations are calculated on a market value weighted basis, including accrued investment income, using holdings as of December 31, 2012.

The following table summarizes the estimated change in fair value on our fixed-maturity portfolio including preferred stocks and short-term investments based on specific changes in interest rates as of December 31, 2012:


Change in interest rate	Estimated Increase (Decrease) in Fair Value (in thousands)		Estimated Percentage Increase (Decrease) in Fair Value

300 basis point rise	$	(326,394)	-13.7%
200 basis point rise		(220,369)	-9.3%
100 basis point rise		(110,066)	-4.6%
As of 12/31/12		-	0.0%
100 basis point decline		106,738	4.5%

The sensitivity analysis model used by us produces a predicted pre-tax loss in fair value of market-sensitive instruments of $110.1 million or (4.6%) based on a 100 basis point increase in interest rates as of December 31, 2012. This loss amount only reflects the impact of an interest rate increase on the fair value of our fixed-maturity investments.

Interest expense would also be affected by a hypothetical change in interest rates. As of December 31, 2012, the Company had $235.1 million of floating rate debt obligations, of which $190.0 million are hedged through our interest rate swaps. A 100 basis point increase in interest rates would increase annual interest expense by $0.5 million, a 200 basis point increase would increase interest expense by $0.9 million, and a 300 basis point increase would increase interest expense by $1.4 million on the $45.1 million of non-hedged floating rate debt obligations.

With respect to investment income, the most significant assessment of the effects of hypothetical changes in interest rates on investment income would be an adjustment to amortization for mortgage-backed securities. The rates at which the mortgages underlying mortgage-backed securities are prepaid, and therefore the average life of mortgage-backed securities, can vary depending on changes in interest rates (for example, mortgages are prepaid faster and the average life of mortgage-backed securities falls when interest rates decline). The adjustments for changes in amortization, which are based on revised average life assumptions, would have an impact on investment income if a significant portion of our mortgage-backed securities holdings had been purchased at significant discounts or premiums to par value. As of December 31, 2012, the par value of our residential mortgage-backed securities holdings was $329.6 million and the amortized cost of our residential mortgage-backed securities holdings was $322.3 million. This equates to an average price of 97.8% of par, thus an adjustment in accordance with this GAAP guidance would not have a significant effect on investment income.

Credit Risk

Our credit risk is the potential loss in principal resulting from an adverse change in the counter-party’s ability to repay its obligations. We seek to manage credit risk through regular review and analysis of the creditworthiness of all investments and potential investments. However, no assurance can be given that we will achieve our investment goals.

We bear credit risk on our reinsurance recoverables and premiums ceded to reinsurers. To mitigate the credit risk associated with reinsurance recoverables, we secure certain of our reinsurance recoverables by withholding ceded premium and requiring funds to be placed in trust as well as monitoring our reinsurers’ financial condition and rating agency ratings and outlook.

The following table presents the top ten reinsurer groups by reinsurance recoverable and prepaid reinsurance balances at December 31, 2012 and 2011:


			Recoverable on
($ in millions)	A.M. Best Rating		Unpaid Losses (restated)		Paid Losses (restated)		Prepaid Reinsurance		Total (restated)

December 31, 2012
Swiss Reinsurance America Corp.	A+	$		79,021	$	5,324	$	103	$	84,448
Lloyd’s Syndicates	A			47,335		1,100		8,785		57,220
Allianz Risk Transfer (Bermuda) Ltd.	A			38,837		1,037		1		39,875
OneBeacon Insurance Co.	A			37,803		-		-		37,803
Hannover Ruckversicherungs, AG	A+			21,920		473		3,662		26,055
Endurance Reinsurance Corp of America	A			15,269		1,235		9,121		25,625
Alterra Bermuda Ltd.	A			24,788		15		152		24,955
NationsBuilders Insurance Co.	NR			8,028		1,713		9,241		18,982
Tokio Millennium Re (UK) Ltd.	NR			9,407		1,379		8,156		18,942
Munich Reinsurance America Inc.	A+			15,002		594		-		15,596
Others				162,047		4,739		24,702		191,488

Total		$		459,457	$	17,609	$	63,923	$	540,989

December 31, 2011
Swiss Reinsurance America Corp.	A+			91,915		5,154		4		97,073
OneBeacon Insurance Co.	A			49,357		2		17		49,376
Hannover Ruckversicherungs, AG	A			23,881		317		3,806		28,004
Lloyd’s Syndicates	-			15,336		1,969		6,119		23,424
Allianz Risk Transfer (Bermuda) Ltd.	A			21,788		1,204		1		22,993
Munich Reinsurance America, Inc.	A+			17,993		151		-		18,144
Endurance Reinsurance Corp. of America	A			10,749		547		5,851		17,147
Platinum Underwriters Reinsurance Inc.	A			12,225		1,106		1,211		14,542
Alterra Bermuda Ltd.	-			10,487		154		162		10,803
Westport Insurance Corp.	A+			8,620		252		-		8,872
Others				29,870		12,607		36,866		79,343

Total		$		292,221	$	23,463	$	54,037	$	369,721

The following collateral is available to the Company for amounts recoverable from reinsurers as of December 31, 2012 and 2011:


($ in thousands)	A.M. Best Rating	Regulation 114 Trust		Letters of Credit		Funds Held		Total

December 31, 2012
Swiss Reinsurance America Corp.	A+	$	-	$	-	$	49,466	$	49,466
Allianz Risk Transfer (Bermuda) Ltd.	A		-		3,257		26,489		29,746
Tokio Millennium Re (UK) Ltd.	-		-		18,690		-		18,690
Alterra Insurance Ltd.	A		12,853		3,608		-		16,461
NationsBuilders Insurance Co.	-		-		-		15,296		15,296
Amlin AG	A		-		10,462		-		10,462
Lion Insurance Company	A -		7,644		-		-		7,644
Others			13,617		20,916		7,330		41,863

Total		$	34,114	$	56,933	$	98,581	$	189,628

December 31, 2011
Swiss Reinsurance America Corp.	A+		-		-		62,447		62,447
Allianz Risk Transfer AG	A		-		3,257		20,816		24,073
Tokio Millennium Re (UK) Ltd.	-		-		20,505		-		20,505
Alterra Insurance Ltd.	-		14,046		327		-		14,373
Tokio Millennium Re Ltd.	A++		7,869		-		3,033		10,902
NationsBuilders Insurance Co.	NR		-		-		8,369		8,369
Maiden Insurance Company	A-		7,437		-		-		7,437
Others			6,545		5,145		2,061		13,751

Total		$	35,897	$	29,234	$	96,726	$	161,857

We had no single reinsurer from whom our unsecured recoverables was in excess of 5% of our stockholders’ equity as of December 31, 2011. Moreover, no one syndicate in our Lloyd’s recoverable is greater than 5% of our stockholders’ equity as of December 31, 2012.

We also bear credit risk on the premium deposits paid by our policyholders to our producers. Producers collect such premiums and remit them to us within prescribed periods. After receiving a deposit, the insurance subsidiaries’ premiums are directly billed to insureds. In New York State and other jurisdictions, premiums paid to producers by an insured may be considered to have been paid under applicable insurance laws and regulations, and the insured will no longer be liable to us for those amounts, whether or not we have actually received the premium payment from the producer. Consequently, we assume a degree of credit risk associated with producers. Due to the unsettled and fact specific nature of the law, we are unable to quantify our exposure to this risk.

Our interest rate swap contracts contain credit support annex provisions which require Keybank National Association to post collateral if the swap fair values exceed $5 million (asset position). As of December 31, 2012 and 2011, the swaps had a fair value of $9.0 million (liability position) and $7.4 million (liability position), respectively. As of December 31, 2012, $9.1 million collateral had been posted. No collateral was required in 2011.

Equity Risk

Equity risk is the risk that we may incur economic losses due to adverse changes in equity prices. Our equity investment securities are classified as available for sale in accordance with GAAP and carried on the balance sheet at fair value. Our outside investment managers are constantly reviewing the financial health of these issuers. In addition, we perform periodic reviews of these issuers.

Item 8. Financial Statements and Supplementary Data

Index to Consolidated Financial Statements


		Page

Reports of Independent Registered Public Accounting Firm		F-2
Consolidated Balance Sheets as of December 31, 2012 and 2011		F-3
Consolidated Statements of Operations for the years ended December 31, 2012, 2011, and 2010		F-4
Consolidated Statements of Comprehensive Income for the years ended December 31, 2012, 2011 and 2010		F-5
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2012, 2011, and 2010		F-6
Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011, and 2010		F-7
Notes to Consolidated Financial Statements		F-8

F-1

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of Tower Group, Inc.

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, comprehensive income (loss), changes in stockholders’ equity and cash flows present fairly, in all material respects, the financial position of Tower Group, Inc. and its subsidiaries (the “Company”) at December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing on page S-1 present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Management and we previously concluded that the Company maintained effective internal control over financial reporting as of December 31, 2012. However, management has subsequently determined that material weaknesses in internal control over financial reporting related to (i) the loss reserving process and (ii) the premium receivables reconciliation process existed as of that date. Accordingly, management’s report has been restated and our present opinion on internal control over financial reporting, as presented herein, is different from that expressed in our previous report. In our opinion, the Company did not maintain, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) because material weaknesses in internal control over financial reporting related to (i) the loss reserving process and (ii) the premium receivables reconciliation process existed as of that date. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. The material weaknesses referred to above are described in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. We considered these material weaknesses in determining the nature, timing, and extent of audit tests applied in our audit of the 2012 consolidated financial statements and our opinion regarding the effectiveness of the Company’s internal control over financial reporting does not affect our opinion on those consolidated financial statements. The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in management’s report referred to above. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As described in Note 1 to the consolidated financial statements, the Company has experienced significant losses in 2013 that have reduced certain of its insurance subsidiaries’ statutory capital, resulting in the need for corrective actions which may require regulatory approval and may negatively impact the Company’s ability to meet its obligations under the bank credit facility and convertible notes. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.

As discussed in Note 2 to the accompanying consolidated financial statements and Note 3 to the financial statement schedules, the Company has restated its 2012 and 2011 consolidated financial statements and the financial statement schedules to correct errors.

A company’s internal control over financial reporting is a process designed 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. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

/s/ PricewaterhouseCoopers LLP

New York, New York

March 4, 2013, except with respect to our opinion on the consolidated financial statements insofar as it relates to the matters that raise substantial doubt about the Company’s ability to continue as a going concern described in Note 1, and except for the effects of the restatement discussed in Note 2 to the consolidated financial statements, and Note 3 to the financial statement schedules as well as the matters described in the fifth and sixth paragraphs of Management’s Report on Internal Control over Financial Reporting, as to which the date is November 25, 2013

F-2

Part I -- FINANCIAL INFORMATION

Item 1. Financial Statements

Tower Group, Inc.

Consolidated Balance Sheets


	December 31,
	2012		2011
($ in thousands, except par value and share amounts)	(restated)		(restated)

Assets
Investments - Tower
Available-for-sale investments, at fair value:
Fixed-maturity securities (amortized cost of $1,926,236 and $2,046,932)	$	2,064,148	$	2,153,620
Equity securities (cost of $144,204 and $91,069)		140,695		87,479
Short-term investments (cost of $4,749 and $0)		4,750		-
Other invested assets		57,786		44,347
Investments - Reciprocal Exchanges
Available-for-sale investments, at fair value:
Fixed-maturity securities (amortized cost of $263,950 and $288,180)		280,563		300,054
Equity securities (cost of $5,144 and $1,965)		5,563		1,866

Total investments		2,553,505		2,587,366
Cash and cash equivalents (includes $9,782 and $666 relating to Reciprocal Exchanges)		102,269		114,098
Investment income receivable (includes $2,610 and $2,978 relating to Reciprocal Exchanges)		25,332		26,782
Investment in unconsolidated affiliate		71,894		-
Premiums receivable (includes $44,285 and $44,171 relating to Reciprocal Exchanges)		412,045		416,432
Reinsurance recoverable on paid losses (includes $682 and $5,670 relating to Reciprocal Exchanges)		17,609		23,463
Reinsurance recoverable on unpaid losses (includes $52,389 and $11,253 relating to Reciprocal Exchanges)		459,457		292,221
Prepaid reinsurance premiums (includes $17,803 and $14,685 relating to Reciprocal Exchanges)		63,923		54,037
Deferred acquisition costs, net (includes $11,364 and $11,866 relating to Reciprocal Exchanges)		181,198		168,858
Intangible assets (includes $6,854 and $4,839 relating to Reciprocal Exchanges)		106,768		114,920
Goodwill		241,458		241,458
Funds held by reinsured companies		137,545		69,755
Other assets (includes $1,559 and $2,685 relating to Reciprocal Exchanges)		338,769		308,089

Total assets	$	4,711,772	$	4,417,479

Liabilities
Loss and loss adjustment expenses (includes $135,791 and $136,274 relating to Reciprocal Exchanges)	$	1,895,679	$	1,632,113
Unearned premium (includes $103,216 and $102,991 relating to Reciprocal Exchanges)		921,271		893,176
Reinsurance balances payable (includes $6,979 and $3,466 relating to Reciprocal Exchanges)		40,569		20,794
Funds held under reinsurance agreements (includes $500 and $0 relating to Reciprocal Exchanges)		98,581		96,726
Other liabilities (includes $21,346 and $10,035 relating to Reciprocal Exchanges)		296,960		289,394
Deferred income taxes (includes $19,719 and $18,906 relating to Reciprocal Exchanges)		24,763		21,244
Debt		449,731		426,901

Total liabilities		3,727,554		3,380,348
Contingencies (Note 18)		-		-
Stockholders’ equity
Common stock ($0.01 par value; 100,000,000 shares authorized, 53,048,011 and 52,625,970 shares issued, and 43,513,678 and 44,437,509 shares outstanding)		530		526
Treasury stock (9,534,333 and 8,188,461 shares)		(181,435)		(158,185)
Paid-in-capital		780,036		772,877
Accumulated other comprehensive income		82,756		63,053
Retained earnings		268,171		331,480

Tower Group, Inc. stockholders’ equity		950,058		1,009,751

Noncontrolling interests		34,160		27,380

Total stockholders’ equity		984,218		1,037,131

Total liabilities and stockholders’ equity	$	4,711,772	$	4,417,479

See accompanying notes to the consolidated financial statements.

F-3

Tower Group, Inc.

Consolidated Statements of Operations


		Year Ended December 31,
		2012		2011		2010
(in thousands, except per share amounts)		(restated)		(restated)		(revised)

Revenues
Net premiums earned	$		1,721,864	$	1,593,850	$	1,292,669
Ceding commission revenue			32,335		33,968		39,303
Insurance services revenue			3,420		1,570		2,169
Policy billing fees			12,615		10,534		6,255
Net investment income			127,165		126,474		107,265
Net realized investment gains (losses):
Other-than-temporary impairments			(9,919)		(3,509)		(14,930)
Portion of loss recognized in other comprehensive income			286		264		11,909
Other net realized investment gains			35,109		12,639		17,674

Total net realized investment gains (losses)			25,476		9,394		14,653

Total revenues			1,922,875		1,775,790		1,462,314
Expenses
Loss and loss adjustment expenses			1,263,758		1,076,986		789,729
Direct and ceding commission expense			359,307		309,826		267,872
Other operating expenses			317,497		284,847		229,781
Acquisition-related transaction costs			9,229		360		2,369
Interest expense			32,630		34,290		24,223

Total expenses			1,982,421		1,706,309		1,313,974
Other income (expense)
Equity in income (loss) of unconsolidated affiliate			(1,470)		-		-

Income (loss) before income taxes			(61,016)		69,481		148,340
Income tax expense (benefit)			(29,099)		14,051		49,588

Net income (loss)	$		(31,917)	$	55,430	$	98,752
Less: Net income (loss) attributable to Noncontrolling interests			2,317		10,995		(6,078)

Net income (loss) attributable to Tower Group, Inc.	$		(34,234)	$	44,435	$	104,830

Earnings (loss) per share attributable to Tower Group, Inc. stockholders:
Basic	$		(0.81)	$	0.96	$	2.13
Diluted	$		(0.81)	$	0.96	$	2.12

Weighted average common shares outstanding:
Basic			42,902		45,226		48,561
Diluted			42,902		45,337		48,772

Dividends declared and paid per common share	$		0.66	$	0.61	$	0.34

See accompanying notes to the consolidated financial statements.

F-4

Tower Group, Inc.

Consolidated Statements of Comprehensive Income


		Year Ended December 31,
		2012		2011		2010
(in thousands)		(restated)		(restated)		(revised)

Net income (loss)	$		(31,917)	$	55,430	$	98,752
Other comprehensive income (loss) before tax
Gross unrealized investment holding gains arising during the period			62,326		50,851		45,912
Less: Reclassification adjustment for investment (gains) losses included in net income			(25,476)		(9,394)		(14,653)
Portion of other-than-temporary impairment losses recognized in other comprehensive income			(286)		(264)		(11,909)
Cumulative translation adjustment			1,852		-		-
Deferred gain (loss) on cash flow hedge			(2,422)		(10,541)		3,223

Other comprehensive income (loss) before tax			35,994		30,652		22,573
Income tax benefit (expense) related to items of other comprehensive income (loss):
Unrealized investment holding gains (losses) arising during periods			(22,546)		(9,430)		(14,081)
Reclassification adjustment for (gains) losses included in net income			8,917		1,742		4,494
Portion of other-than-temporary impairment losses recognized in other comprehensive income			100		49		3,652
Cumulative translation adjustment			(648)		-		-
Deferred gain (loss) on cash flow hedge			571		1,955		(988)

Other comprehensive income, net of income tax			22,388		24,968		15,650

Comprehensive income (loss)	$		(9,529)	$	80,398	$	114,402

Less: Comprehensive income (loss) attributable to Noncontrolling interests			5,001		21,189		(3,432)

Comprehensive income (loss) attributable to Tower Group, Inc.	$		(14,530)	$	59,209	$	117,834

See accompanying notes to the consolidated financial statements.

F-5

Tower Group, Inc.

Consolidated Statements of Changes in Stockholders’ Equity


									Accumulated
									Other						Total
	Common Stock				Treasury		Paid-in		Comprehensive		Retained		Noncontrolling		Stockholders’
(in thousands)	Shares		Amount		Stock		Capital		Income (loss)		Earnings		Interests		Equity

Balance at December 31, 2009		51,090		511		(1,995)		751,818		35,275		226,660		-		1,012,269
Dividends declared		-		-		-		-		-		(16,551)		-		(16,551)
Stock based compensation		736		7		(1,750)		10,275		-		-		-		8,532
Repurchase of common stock		-		-		(88,034)		-		-		-		-		(88,034)
Reciprocal Exchanges’ equity on July 1, 2010, date of consolidation		-		-		-		-		-		-		7,622		7,622
Equity component of convertible senior notes issuance, net of income tax and issue costs		-		-		-		7,055		-		-		-		7,055
Convertible senior notes hedge transactions, net of tax		-		-		-		(9,945)		-		-		-		(9,945)
Warrants issued related to convertible senior notes issuance		-		-		-		3,800		-		-		-		3,800
Net income, as revised		-		-		-		-		-		104,830		(6,078)		98,752
Other comprehensive income		-		-		-		-		13,004		-		2,646		15,650

Balance at December 31, 2010, as revised		51,826	$	518	$	(91,779)	$	763,003	$	48,279	$	314,939	$	4,190	$	1,039,150

Dividends declared		-		-		-		-		-		(27,894)		-		(27,894)
Stock based compensation		800		8		(1,834)		10,657		-		-		-		8,831
Deferred taxes on stock option activity		-		-		-		(783)		-		-		-		(783)
Repurchase of common stock		-		-		(64,572)		-		-		-		-		(64,572)
Net income, as restated		-		-		-		-		-		44,435		10,995		55,430
Other comprehensive income		-		-		-		-		14,774		-		10,194		24,968
Noncontrolling interest in acquired consolidated partnership		-		-		-		-		-		-		2,001		2,001

Balance at December 31, 2011, as restated		52,626	$	526	$	(158,185)	$	772,877	$	63,053	$	331,480	$	27,380	$	1,037,131

Dividends declared		-		-		-		-		-		(29,075)		-		(29,075)
Stock based compensation		422		4		(2,263)		8,937		-		-		-		6,678
Repurchase of common stock		-		-		(20,987)		-		-		-		-		(20,987)
Net income, as restated				-		-		-		-		(34,234)		2,317		(31,917)
Transfer of assets to Reciprocal Exchanges				-		-		(1,778)		-		-		1,778		-
Other comprehensive income, as restated				-		-		-		19,703		-		2,685		22,388

Balance at December 31, 2012, as restated		53,048	$	530	$	(181,435)	$	780,036	$	82,756	$	268,171	$	34,160	$	984,218

See accompanying notes to the consolidated financial statements.

F-6

Tower Group, Inc.

Consolidated Statements of Cash Flows


		Year Ended December 31,
($ in thousands)		2012 (restated)		2011 (restated)		2010 (revised)

Cash flows provided by (used in) operating activities:
Net income (loss)	$		(31,917)	$	55,430	$	98,752
Adjustments to reconcile net income to net cash provided by (used in) operations:
Gain on investment in acquired unconsolidated affiliate			(1,064)		-		-
Net realized investment (gains) losses			(25,476)		(9,394)		(14,653)
Depreciation and amortization			33,609		30,940		21,634
Amortization of bond premium or discount			11,447		9,239		2,237
Amortization of restricted stock			8,247		10,292		8,694
Deferred income taxes			(14,935)		5,847		60,619
Changes in operating assets and liabilities:
Investment income receivable			1,450		(2,912)		(3,598)
Premiums receivable			4,387		(15,832)		11,974
Reinsurance recoverable			(161,382)		(20,934)		(24,915)
Prepaid reinsurance premiums			(9,886)		23,590		45,024
Deferred acquisition costs, net			(12,340)		(4,735)		3,359
Funds held by reinsured companies			(67,790)		(66,176)		(3,579)
Other assets			(37,494)		13,659		(62,289)
Increase (decrease) in liabilities:
Loss and loss adjustment expenses			263,566		21,692		76,166
Unearned premium			28,095		21,150		(23,269)
Reinsurance balances payable			19,775		(14,243)		(61,249)
Funds held under reinsurance agreements			1,855		3,573		79,416
Other liabilities			99,066		21,568		(17,298)

Net cash flows provided by operations			109,213		82,754		197,025

Cash flows provided by (used in) investing activities:
Net cash (used in) acquired from acquisitions			-		2,274		(171,907)
Purchase of fixed assets			(44,951)		(53,568)		(36,905)
Investment in unconsolidated affiliate			(71,512)		-		-
Purchase - fixed-maturity securities			(1,855,590)		(2,019,603)		(2,024,965)
Purchase - equity securities			(1,525,206)		(819,180)		(96,439)
Short-term investments, net			(4,750)		1,560		561,827
Purchase of other invested assets			(13,440)		(42,346)		-
Sale of fixed-maturity securities			1,813,628		-		1,427,528
Maturity of fixed-maturity securities			205,534		2,032,027		-
Sale - equity securities			1,442,225		793,886		80,746
Change in restricted cash			(35,000)		-		-

Net cash flows provided by (used in) investing activities			(89,062)		(104,950)		(260,115)

Cash flows provided by (used in) financing activities:
Proceeds from credit facility borrowings			20,000		67,000		56,000
Repayment of credit facility borrowings			-		(17,000)		(56,000)
Proceeds from capital lease financing			-		39,839		-
Proceeds from convertible senior notes			-		-		145,634
Payments for convertible senior notes hedge			-		-		(15,300)
Proceeds from issuance of warrants			-		-		3,800
Proceeds from share-based payment arrangements			345		534		288
Treasury stock acquired-net employee share-based compensation			(2,263)		(1,834)		(1,750)
Repurchase of Common Stock			(20,987)		(64,572)		(88,034)
Dividends paid			(29,075)		(27,894)		(16,551)

Net cash flows provided by (used in) financing activities			(31,980)		(3,927)		28,087

Increase (decrease) in cash and cash equivalents			(11,829)		(26,123)		(35,003)
Cash and cash equivalents, beginning of period			114,098		140,221		175,224

Cash and cash equivalents, end of period	$		102,269	$	114,098	$	140,221


Supplemental disclosures of cash flow information:
Cash paid for income taxes	$		-	$	3,000	$	29,000
Cash paid for interest			20,917		25,880		19,834
Schedule of non-cash investing and financing activities:

See accompanying notes to the consolidated financial statements.

F-7

Tower Group, Inc.

Notes to Consolidated Financial Statements

Note 1—Nature of Business

Tower Group, Inc. (the “Company” or “Tower”) offers a broad range of commercial, specialty and personal specialty property and casualty insurance products and services through its subsidiaries to businesses in various industries and to individuals. The Company’s common stock is publicly traded on the NASDAQ Global Select Market under the symbol “TWGP”.

The Company operates three business segments as follows:

•

Commercial Insurance (“Commercial”) Segment offers a broad range of standard and specialty commercial lines property and casualty insurance products to businesses distributed through a network of retail and wholesale agents and program underwriting agents on both an admitted and non-admitted basis. This segment also includes assumed reinsurance;

•

Personal Insurance (“Personal”) Segment offers a broad range of personal lines property and casualty insurance products to individuals distributed through a network of retail and wholesale agents; and

•

Insurance Services (“Services”) Segment provides underwriting, claims and reinsurance brokerage services to insurance companies.

Significant Business Developments and Risks and Uncertainties Resulting from Events Occurring in 2013

In the preparation of Tower’s June 30, 2013 consolidated financial statements, subsequent to December 31, 2012, the Company recorded an increase in its loss and loss adjustment expense reserves of approximately $365 million relating to reserve strengthening associated with losses from prior accident years. This adverse loss development arose primarily from accident years 2008-2011 within the workers’ compensation, commercial multi-peril liability (“CMP”), other liability and commercial auto liability lines of business. In the second quarter of 2013, the Company performed a comprehensive update to its internal reserve study in response to continued observance in the second quarter of 2013 of higher than expected reported loss development. In conjunction with its comprehensive internal review, the Company also retained its consulting actuary to perform an independent reserve study covering lines of business comprising over 90% of the Company’s loss reserves. Since 2010, the Company has changed the mix of business by reducing the amount of program and middle market workers’ compensation and liability business that it underwrites.

The reserve strengthening was viewed by the Company as events or circumstances that required the Company to perform, in the second quarter of 2013, a detailed quantitative analysis of whether the recorded goodwill was impaired. After performing the quantitative analysis as of June 30, 2013, it was determined that $214.0 million of goodwill, which represents all of the goodwill allocated to the Commercial Insurance reporting unit at that date, was impaired. Accordingly, the consolidated statement of operations as of June 30, 2013 includes a non-cash charge of $214.0 million.

Reinsurance Agreements

The first agreement was between Tower Insurance Company of New York (“TICNY”), on its behalf and on behalf of each of its pool participants, and Arch. Under this multi-line quota share agreement, TICNY will cede 17.5% on a quota share of certain commercial automobile liability, commercial multi-peril property, commercial multi-peril liability and brokerage other liability (mono line liability) businesses. The agreement covers losses occurring on or after July 1, 2013 for policies in-force as at June 30, 2013 and policies written or renewed from July 1, 2013 to December 31, 2013. The agreement has a special termination clause whereby either party may terminate the agreement upon the occurrence of certain circumstances, including an A.M. Best financial strength rating downgrade to below A-. As noted below, A.M. Best downgraded Tower’s financial strength rating to B++. Neither party has provided notice to terminate the agreement.

F-8

Tower Group, Inc.

Notes to Consolidated Financial Statements

A.M. Best, Fitch and Demotech Downgrade the Company’s Financial Strength and Issuer Credit Ratings

Management expects these rating actions, in combination with other items that have impacted the Company in the second quarter of 2013, to result in a decrease in the amount of premiums the insurance subsidiaries are able to write. Business written through certain program underwriting agents requires an A.M. Best rating of A- or greater.

Statutory Capital

The Company is required to maintain minimum capital and surplus for each of its insurance subsidiaries.

F-9

Tower Group, Inc.

Notes to Consolidated Financial Statements

Liquidity

TGI is the obligor under the bank credit facility agreement dated as of February 15, 2012, as amended, with Bank of America N.A. and the other lenders named therein ($70 million outstanding as of June 30,2013) and the Convertible Senior Notes (“Notes”) due September 2014 ($150 million par amount outstanding as of June 30, 2013). The indebtedness of TGI is guaranteed by Tower Group International, Ltd. (“TGIL”), as well as several of TGI’s non-insurance subsidiaries.

TGI amended its credit facility on October 11, 2013, and agreed to several restrictions under the credit facility, including:

•

To not enter into any new borrowings under the credit facility;

•

To pledge to the lending banks any proceeds of new capital raises by TGI or TGIL until such time as the credit facility is paid in full;

•

To pledge to the lending banks proceeds from any sales of assets occurring at TGI; and

•

To submit to regulatory authorities, as appropriate, a request for approval to pledge the capital stock of the U.S. based and Bermuda based insurance subsidiaries.

F-10

Tower Group, Inc.

Notes to Consolidated Financial Statements

In addition, the following financial covenants are included in the credit facility:

•

Debt to capitalization ratio limit of 46%;

•

Bermuda enhanced minimum capital requirement of 150% for CastlePoint Re at December 31, 2013 and 110% for TRL;

•

Minimum statutory surplus for all insurance companies of the greater of $419,000,000 or 85% of Combined Surplus at June 30, 2013; and

•

Tower currently is in compliance with all covenants contained in the credit facility.

The credit facility matures on May 30, 2014, at which point any unpaid balance becomes due.

The Company’s plan to repay the Notes includes a combination of using proceeds from the sale of assets held at TGI as well as using proceeds generated by future strategic alternatives being evaluated by TGIL’s Board of Directors, and to the extent necessary, issuing debt and/or equity securities to pay down the principal of the Notes. To the extent that such asset sales and debt securities issuances are not executed or are not successful, the Company may seek to sell certain of its operating assets to satisfy this obligation. The Company provides no assurance that it will be successful in finalizing the liquidation of the assets held at TGI, issuing new debt and/or equity securities or selling certain of its operating assets.

The Company and certain of its senior officers have been named as defendants in several class action lawsuits instituted against them by certain shareholders.

Note 2 – Restatement of Previously Issued Financial Statements

Management is restating and revising the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 (as amended by Amendment No. 1 to Form 10-K filed with the SEC on March 13, 2013), for the loss reserve and premium receivables errors discussed below and is also correcting other immaterial adjustments that were initially recorded in the period they were identified. These immaterial adjustments are being recast into the periods in which they originated.

On November 14, 2013, Tower issued a Current Report on Form 8-K stating that it had reached a determination to restate Tower’s audited annual consolidated financial statements as of and for the years ended December 31, 2011 and 2012 contained in the Amendment No. 1 to Tower’s Annual Report on Form 10-K for the year ended December 31, 2012, which was filed with the SEC on March 13, 2013 (the “2012 Form 10-K/A”), and that such financial statements should no longer be relied upon. In addition, Tower will revise its (i) audited annual consolidated financial statements for the year ended December 31, 2010 contained in the 2012 Form 10-K/A and (ii) unaudited interim consolidated financial statements as of and for the three months ended March 31, 2013 and 2012 contained in its Quarterly Report on Form 10-Q for the quarter ended March 31, 2013, which was filed with the SEC on May 10, 2013 (the “First Quarter 2013 Form 10-Q”). Following management review of the matter with the Audit Committee of Tower’s Board of Directors (the “Audit Committee”), and upon management’s recommendation, the Audit Committee reached a conclusion on November 7, 2013 that previously issued financial statements of the Company covering one or more periods for which the Company is required to provide financial statements need to be revised or restated and may no longer be relied upon because of the inadvertent mistakes described below. At such meeting, the Audit Committee authorized the Company’s Chief Financial Officer and Chief Accounting Officer to determine, in consultation with the Company’s independent registered public accounting firm, the specific financial statements that should be revised or restated and should no longer be relied upon. Acting upon such authority, on November 12, 2013, these officers reached a conclusion, and advised Tower’s Board of Directors, as to the specific financial statements that need to be so revised or restated and should no longer be relied upon, as described above. The Company had previously determined and announced on October 7, 2013 that its June 30, 2013 loss reserves were strengthened by approximately $365 million. The Company then undertook to review its reserve analyses for prior years. During this evaluation, the Company considered its historical loss reserve analyses and the analyses of its independent actuaries and reviewed and discussed its conclusions with its independent registered public accounting firm. Upon completion of this evaluation, the Company determined that inadvertent mistakes in classification of insurance premiums by line of business used in the loss reserving process resulted in (1) an increase in the loss and loss adjustment expenses of $9.6 million, $21.7 million and $5.7 million, for the years ended December 31, 2012, 2011 and 2010, respectively, and (2) a decrease in the reinsurance recoverables on unpaid losses asset balance by $37.0 million, $27.4 million and $5.7 million as of December 31, 2012, 2011 and 2010, respectively.

F-11

Tower Group, Inc.

Notes to Consolidated Financial Statements

In addition, subsequent to the announcement on October 7, 2013, the Company identified errors in its historical premiums receivable balances due to inadvertent mistakes in its premiums receivable reconciliation process. This resulted in (1) a decrease of premiums receivable asset balance of $11.0 million, $10.0 million, $5.6 million and $7.2 million as of the years ended December 31, 2012, 2011, 2010 and 2009, respectively, and (2) an increase (decrease) of other operating expenses of $1.0 million, $4.4 million, ($1.6) million and $7.2 million for the years ended December 31, 2012, 2011, 2010 and 2009, respectively. The Company has also corrected other immaterial adjustments that were initially recorded in the period they were identified.

The effects of the restatement on the consolidated balance sheets are presented in the table below:


		As of December 31, 2012										As of December 31, 2011
($ in thousands, except par value and share amounts)		As Previously Filed			Restated			Effect of Adjustments				As Previously Filed			Restated			Effect of Adjustments

Assets
Total investments			2,554,505			2,553,505			(1,000	)			2,587,366			2,587,366			-
Cash and cash equivalents			100,293			102,269			1,976				114,098			114,098			-
Investment income receivable			25,332			25,332			-				26,782			26,782			-
Investment in unconsolidated affiliate			70,830			71,894			1,064				-			-			-
Premiums receivable			422,112			412,045			(10,067	)			426,432			416,432			(10,000)
Reinsurance recoverable on paid losses			17,609			17,609			-				23,903			23,463			(440)
Reinsurance recoverable on unpaid losses			496,192			459,457			(36,735	)			319,664			292,221			(27,443)
Prepaid reinsurance premiums			63,923			63,923			-				54,037			54,037			-
Deferred acquisition costs, net			180,941			181,198			257				168,858			168,858			-
Intangible assets			106,768			106,768			-				114,920			114,920			-
Goodwill			241,458			241,458			-				241,458			241,458			-
Funds held by reinsured companies			137,545			137,545							69,755			69,755
Other assets			331,506			338,769			7,263				306,295			308,089			1,794

Total assets	$		4,749,014		$	4,711,772		$	(37,242	)	$		4,453,568		$	4,417,479		$	(36,089)

Liabilities
Loss and loss adjustment expenses	$		1,895,073		$	1,895,679		$	606		$		1,632,113		$	1,632,113		$	-
Unearned premium			920,859			921,271			412				893,176			893,176			-
Reinsurance balances payable			40,569			40,569			-				20,794			20,794			-
Funds held under reinsurance agreements			98,581			98,581			-				96,726			96,726			-
Other liabilities			292,239			296,960			4,721				289,394			289,394			-
Deferred income taxes			36,464			24,763			(11,701	)			33,285			21,244			(12,041)
Debt			449,731			449,731			-				426,901			426,901			-

Total liabilities			3,733,516			3,727,554			(5,962	)			3,392,389			3,380,348			(12,041)
Stockholders’ equity
Common stock (1)			530			530			-				525			425			-
Treasury stock			(181,435	)		(181,435	)		-				(158,185	)		(158,185	)		-
Paid-in-capital (1)			780,036			780,036			-				772,878			772,878			-
Accumulated other comprehensive income			83,406			82,756			(650	)			63,053			63,053			-
Retained earnings			298,299			268,171			(30,128	)			355,528			331,480			(24,048)

Tower Group, Inc. stockholders’ equity			980,836			950,058			(30,778	)			1,033,799			1,009,751			(24,048)

Noncontrolling interests			34,662			34,160			(502	)			27,380			27,380			-

Total stockholders’ equity			1,015,498			984,218			(31,280	)			1,061,179			1,037,131			(24,048)

Total liabilities and stockholders’ equity	$		4,749,014		$	4,711,772		$	(37,242	)	$		4,453,568		$	4,417,479		$	(36,089)

(1)	Common stock and paid-in-capital have been revised for “previously filed” and “restated” for the effects of the share conversion discussed in “Note 3 – Accounting Policies and Procedures.”

F-12

Tower Group, Inc.

Notes to Consolidated Financial Statements

The effects of the restatement on the consolidated statements of operations and consolidated statements of comprehensive income are shown in the table below:


		Year Ended December 31, 2012										Year Ended December 31, 2011										Year Ended December 31, 2010
		As						Effect				As						Effect				As						Effect
		Previously						of				Previously						of				Previously						of
($ in thousands)		Filed			Restated			Adjustments				Filed			Restated			Adjustments				Filed			Revised			Adjustments

Revenues
Net premiums earned	$		1,721,542		$	1,721,864		$	322		$		1,593,850		$	1,593,850		$	-		$		1,292,669		$	1,292,669		$ -
Ceding commission revenue			32,335			32,335			-				33,968			33,968			-				39,303			39,303		-
Insurance services revenue			3,420			3,420			-				1,570			1,570			-				2,169			2,169		-
Policy billing fees			12,615			12,615			-				10,534			10,534			-				6,255			6,255		-
Net investment income			127,165			127,165			-				126,474			126,474			-				107,265			107,265		-
Net realized investment gains (losses):									-										-									-
Other-than-temporary impairments			(9,919	)		(9,919	)		-				(3,509	)		(3,509	)		-				(14,930	)		(14,930	)	-
Portion of loss recognized in other comprehensive income			286			286			-				264			264			-				11,909			11,909		-
Other net realized investment gains			35,109			35,109			-				12,639			12,639			-				17,674			17,674		-

Total net realized investment gains (losses)			25,476			25,476			-				9,394			9,394			-				14,653			14,653		-

Total revenues			1,922,553			1,922,875			322				1,775,790			1,775,790			-				1,462,314			1,462,314		-
Expenses
Loss and loss adjustment expenses			1,253,860			1,263,758			9,898				1,055,249			1,076,986			21,737				784,023			789,729		5,706
Direct and ceding commission expense			359,710			359,307			(403	)			309,826			309,826			-				267,872			267,872		-
Other operating expenses			316,645			317,497			852				280,447			284,847			4,400				231,381			229,781		(1,600)
Acquisition-related transaction costs			9,229			9,229			-				360			360			-				2,369			2,369		-
Interest expense			32,630			32,630			-				34,290			34,290			-				24,223			24,223		-

Total expenses			1,972,074			1,982,421			10,347				1,680,172			1,706,309			26,137				1,309,868			1,313,974		4,106
Other income (expense)
Equity in income (loss) of unconsolidated affiliate			(2,534	)		(1,470	)		1,064				-			-			-				-			-		-

Income (loss) before income taxes			(52,055	)		(61,016	)		(8,961	)			95,618			69,481			(26,137	)			152,446			148,340		(4,106)
Income tax expense (benefit)			(26,720	)		(29,099	)		(2,379	)			24,142			14,051			(10,091	)			52,168			49,588		(2,580)

Net income (loss)	$		(25,335	)	$	(31,917	)	$	(6,582	)	$		71,476		$	55,430		$	(16,046	)	$		100,278		$	98,752		$ (1,526)
Less: Net income (loss) attributable to Noncontrolling interests			2,819			2,317			(502	)			10,995			10,995			-				(6,078	)		(6,078	)	-

Net income (loss) attributable to Tower Group, Inc.	$		(28,154	)	$	(34,234	)	$	(6,080	)	$		60,481		$	44,435		$	(16,046	)	$		106,356		$	104,830		$ (1,526)

Comprehensive income (loss)			(2,297	)		(9,529	)		(7,232	)			96,444			80,398			(16,046	)			115,928			114,402		(1,526)
Less: Comprehensive income (loss) attributable to Noncontrolling interests			5,503			5,001			(502	)			21,189			21,189			-				(3,432	)		(3,432	)	-

Comprehensive income (loss) attributable to Tower Group, Inc.			(7,800	)		(14,530	)		(6,730	)			75,255			59,209			(16,046	)			119,360			117,834		(1,526)

Earnings (loss) per share attributable to Tower Group, Inc. stockholders:
Basic (1)	$		(0.66	)	$	(0.81	)	$	(0.15	)	$		1.31			0.96			(0.35	)			2.16			2.13		(0.03)
Diluted (1)	$		(0.66	)	$	(0.81	)	$	(0.15	)	$		1.31			0.96			(0.35	)			2.15			2.12		(0.03)

(1)	Basic and diluted earnings (loss) per share have been revised for “previously filed” and “restated” for the effects of the share conversion discussed in “Note 3 – Accounting Policies and Procedures.”

The effect of the restatement on the consolidated statement of cash flows is shown in the table below:


		Year Ended December 31, 2012									Year Ended December 31, 2011									Year Ended December 31, 2010
		As						Effect			As						Effect			As						Effect
		Previously						of			Previously						of			Previously						of
($ in thousands)		Filed			Restated			Adjustments			Filed			Restated			Adjustments			Filed			Revised			Adjustments

Cash provided by (used in):
Operating activities	$		107,237		$	109,213		$	1,976	$		82,754		$	82,754		$	-	$		197,025		$	197,025		$	-
Investing activities			(89,062	)		(89,062	)		-			(104,950	)		(104,950	)		-			(260,115	)		(260,115	)		-
Financing activities			(31,980	)		(31,980	)		-			(3,927	)		(3,927	)		-			28,087			28,087			-

Net increase (decrease) in cash and cash equivalents			(13,805	)		(11,829	)		1,976			(26,123	)		(26,123	)		-			(35,003	)		(35,003	)		-
Cash and cash equivalents, beginning of year			114,098			114,098			-			140,221			140,221			-			175,224			175,224			-

Cash and cash equivalents, end of period	$		100,293		$	102,269		$	1,976	$		114,098		$	114,098		$	-	$		140,221		$	140,221		$	-

Note 3—Accounting Policies and Basis of Presentation

Basis of Presentation

The accompanying consolidated financial statements include the accounts of Tower and its insurance subsidiaries, managing general agencies and management companies. The consolidated financial statements also include the accounts of Adirondack Insurance Exchange (“Adirondack”), a New York reciprocal insurer, and New Jersey Skylands Insurance Association (“New Jersey Skylands”), a New Jersey reciprocal insurer (together, the “Reciprocal Exchanges”). The Company does not own the Reciprocal Exchanges but manages them through its management companies.

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). All inter-company accounts and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Intercompany transactions

In the first quarter 2012, Tower transferred a licensed insurance subsidiary shell to the Reciprocal Exchanges and received cash for its statutory book value. At the date of the transfer, Tower’s GAAP carrying basis in this subsidiary exceeded the statutory book value and the transfer resulted in a loss to Tower of $1.8 million. Since this was a non-recurring transaction between entities under common control, assets are transferred at historical book value. Any difference in the consideration paid and the book value of the assets transferred is treated as an adjustment to equity. This transaction had no effect on consolidated stockholders’ equity.

F-13

Tower Group, Inc.

Notes to Consolidated Financial Statements

Reclassifications and Adjustments

Certain reclassifications have been made to prior years’ financial information to conform to the current year presentation.

The Company completed the Merger Transaction with Canopius Bermuda. Since the Company accounted for the Merger Transaction as a reverse acquisition and recapitalization, it has retroactively restated Common Stock, Treasury Stock and Paid-in-Capital accounts and earnings per share for periods prior to the Merger Transaction to reflect the historical capitalization of TGI, adjusted for the 1.1330 conversion ratio.

The table below reflects the previously reported and revised shareholders’ equity accounts resulting from the Merger Transaction:


($ in thousands, except per share amounts)		As previously Reported			Revised Amount

As of December 31, 2012
Common stock	$		469		$	530
Treasury stock			(181,435	)		(181,435)
Paid-in-capital			780,097			780,036
As of December 31, 2011
Common stock			465			526
Treasury stock			(158,185	)		(158,185)
Paid-in-capital			772,938			772,877
As of December 31, 2010
Common stock			457			518
Treasury stock			(91,779	)		(91,779)
Paid-in-capital			763,064			763,003
As of December 31, 2009
Common stock			451			511
Treasury stock			(1,995	)		(1,995)
Paid-in-capital			751,878			751,818
For the year ended December 31, 2012
Earnings (Loss) per Share:
Basic	$		(0.73	)	$	(0.81)
Diluted			(0.73	)		(0.81)
Weighted average common shares outstanding
Basic			38,795			42,902
Diluted			38,975			42,902
For the year ended December 31, 2011
Earnings (Loss) per Share:
Basic	$		1.48		$	0.96
Diluted			1.48			0.96
Weighted average common shares outstanding
Basic			40,833			45,226
Diluted			40,931			45,337
For the year ended December 31, 2010
Earnings (Loss) per Share:
Basic	$		2.45		$	2.13
Diluted			2.44			2.12
Weighted average common shares outstanding
Basic			43,462			48,561
Diluted			43,648			48,772

Accounting Policies

Net Premiums Earned

The insurance policies issued or reinsured by the Company are short-duration contracts. Accordingly, premium revenue, including direct business and reinsurance assumed, net of business ceded to reinsurers, is recognized on a pro-rata basis over the terms of the underlying policies. Unearned premiums represent premium applicable to the unexpired risk of in-force insurance contracts at each balance sheet date. Prepaid reinsurance premiums represent the unexpired portion of reinsurance premiums on risks ceded and are earned consistent with premiums. Mandatory reinstatement premiums are recognized and earned at the time a loss event occurs.

Ceding Commission Revenue

Commissions on reinsurance premiums ceded are earned in a manner consistent with the recognition of the costs to acquire the underlying policies, generally on a pro-rata basis over the terms of the policies reinsured. Certain reinsurance agreements contain provisions whereby the ceding commission rates vary based on the loss experience of the policies covered by the agreements. The Company records ceding commission revenue based on its current estimate of losses on the reinsured policies subject to variable commission rates. The Company records adjustments to the ceding commission revenue in the period that changes in the estimated losses are determined.

Insurance Services Revenue

Direct commission revenue from the Company’s managing general underwriting services is recognized and earned as insurance policies are placed with the issuing companies of its managing general agencies. Fees relating to the provision of reinsurance intermediary services are earned when the Company’s insurance subsidiaries or the issuing companies of its managing general agencies cede premiums to reinsurers. Management fees earned by the management companies for services provided to the Reciprocal Exchanges are reported as management fee income within the segment but are eliminated in consolidation.

Policy Billing Fees

Policy billing fees are earned on a pro-rata basis over the terms of the underlying policies. These fees include installment and other fees related to billing and collections.

Loss and Loss Adjustment Expenses (“LAE”)

The liability for loss and LAE represents management’s best estimate of the ultimate cost and expense of all reported and unreported losses that are unpaid as of the balance sheet date. The liability for loss and LAE is recorded net of a tabular reserve discount for workers’ compensation and excess workers’ compensation claims in the amount of $8.4 million and $3.7 million at December 31, 2012 and 2011, respectively. The 2012 discount relates to $393.9 million of total net reserves for workers’ compensation. The projection of future claims payments and reporting is based on an analysis of the Company’s historical experience, supplemented by analyses of industry loss data. Management believes that the liability for loss and LAE is adequate to cover the ultimate cost of losses and claims to date; however, because of the uncertainty from various sources, including changes in reporting patterns, claims settlement patterns, judicial decisions, legislation, and economic conditions, actual loss experience may not conform to the assumptions used in determining the estimated amounts for such liability at the balance sheet date. As adjustments to these estimates become necessary, such adjustments are reflected in expense for the period in which the estimates are changed.

Tower estimates reserves separately for losses, allocated loss adjustment expenses, and unallocated loss adjustment expenses. Allocated loss adjustment expenses (“ALAE”) refers to costs of attorneys as well as miscellaneous costs such as investigators, witness fees and court costs attributable to specific claims that generally are in various stages of litigation. Unallocated loss adjustment expenses (“ULAE”) refers to costs for administering claims that are not related to attorney fees and miscellaneous costs associated with litigated claims. Tower estimates the ALAE liability separately for claims that are defended by in-house attorneys, claims that are handled by other attorneys that are not employees, and miscellaneous ALAE costs such as witness fees and court costs. Similarly, Tower estimates the ULAE liability separately for claims which are handled internally by our employees and for claims which are handled by third party administrators.

F-14

Tower Group, Inc.

Notes to Consolidated Financial Statements

The Company determines a fixed fee per in-house litigated claim for ALAE stemming from defense by in-house attorneys and allocates to each of these litigated claims 50% of this fixed fee when litigation on a particular claim begins and 50% of the fee when the litigation is closed. The fee is determined actuarially based upon the projected number of litigated claims and expected closing patterns at the beginning of each year as well as the projected budget for the Company’s in-house attorneys, and these amounts are subject to adjustment each quarter based upon actual experience.

The Company determines a standard cost per claim for ULAE for each line of business that represents the ultimate average cost to administer that claim. For property lines, 50% of this standard cost is recorded as paid ULAE when a claim is opened, and 50% of this standard cost is recorded as paid ULAE when a claim is closed. For casualty lines, 75% of this standard cost is recorded as paid ULAE when a claim is opened, and 25% is recorded as paid ULAE when a claim is closed. The standard costs are determined actuarially and subject to adjustment each quarter. Calendar period costs for the claims function is recorded as paid ULAE each quarter.

Reinsurance

The Company uses reinsurance to limit its exposure to certain risks. Management has evaluated its reinsurance arrangements and determined that significant insurance risk is transferred to the reinsurers. Reinsurance agreements have been determined to be short-duration prospective contracts and, accordingly, the costs of reinsurance are recognized over the life of the contracts in a manner consistent with the earning of premiums on the underlying policies subject to the reinsurance contract.

Reinsurance recoverable represents management’s best estimate of paid and unpaid loss and LAE recoverable from reinsurers. Ceded losses recoverable are estimated using techniques and assumptions consistent with those used in estimating the liability for loss and LAE. These techniques and assumptions are continually reviewed and updated with any resulting adjustments recorded in current earnings. Loss and LAE incurred as presented in the consolidated statement of income and comprehensive net income are net of reinsurance recoveries.

Management estimates uncollectible amounts receivable from reinsurers based on an assessment of a number of factors. The Company recorded no allowance for uncollectible reinsurance at December 31, 2012 or 2011. The Company did not write-off balances from reinsurers during the three year period ended December 31, 2012.

Cash and Cash Equivalents

Cash consists of cash in banks, generally in operating accounts. The Company maintains its cash balances at several financial institutions. Management monitors balances and believes they do not represent a significant credit risk to the Company.

The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Cash and cash equivalents are presented at cost, which approximates fair value. Cash restricted as to use is included in Other Assets.

Investments

The Company’s fixed-maturity and equity securities are classified as available-for-sale and carried at fair value. The Company may sell its available-for-sale securities in response to changes in interest rates, risk/reward characteristics, liquidity needs or other factors.

Fair value for fixed-maturity securities and equity securities is primarily based on quoted market prices or a matrix pricing using observable inputs, with limited exceptions as discussed in “Note 8 – Fair Value Measurements”. Changes in unrealized gains and losses, net of tax effects, are reported as a separate component of other comprehensive income while cumulative unrealized gains and losses are reported net of tax effects within accumulated other comprehensive income in stockholders’ equity. Realized gains and losses are determined on the specific identification method. Investment income is recorded when earned and includes the amortization of premium and discount on investments.

The Company, along with its outside portfolio managers, regularly reviews its fixed-maturity and equity security portfolios to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of investments. In evaluating potential impairment, management considers, among other criteria: (i) the overall financial condition of the issuer, (ii) the current fair value compared to amortized cost or cost, as appropriate; (iii) the length of time the security’s fair value has been below amortized cost or cost; (iv) specific credit issues related to the issuer such as changes in credit rating, reduction or elimination of dividends or non-payment of scheduled interest payments; (v) whether management intends to sell the security and, if not, whether it is not more likely than not that the Company will be required to sell the security before recovery of its cost or amortized cost basis; (vi) specific cash flow estimations for fixed-maturity securities and (vii) current economic conditions. If

F-15

Tower Group, Inc.

Notes to Consolidated Financial Statements

an other-than-temporary-impairment (“OTTI”) loss is determined for a fixed-maturity security (and management does not intend to sell the security or it is not more likely than not that the Company will be required to sell the security), the credit portion is recorded in the statement of income as net realized losses on investments and the non-credit portion is recorded in accumulated other comprehensive income. The credit portion results in a permanent reduction of the cost basis of the underlying investment. OTTI losses on fixed-maturity securities management has the intent to sell or it is more likely than not that the Company will be required to sell and on equity securities are reported in realized losses for the entire impairment.

The Company’s other invested assets consist of investments in limited partnerships accounted for using the equity method of accounting, real estate and certain securities for which the Company has elected the fair value option. In accounting for the partnerships, management uses the financial information provided by the general partners, which is on a three-month lag. As of December 31, 2012, the Company had future funding commitments of $29.7 million to these limited partnerships. For securities in which the Company has elected the fair value option, interest and dividends are reported in net investment income with the remaining change in overall fair value reported in other net realized investment gains (losses).

Fair Value

GAAP establishes a three-level hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) followed by similar but not identical assets or liabilities (Level 2) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the assets or liabilities fall within different levels of the hierarchy, the classification is based on the lowest level input that is significant to the fair value measurement of the asset or liability. Classification of assets and liabilities within the hierarchy considers the markets in which the assets and liabilities are traded, including during periods of market disruption, and the reliability and transparency of the assumptions used to determine fair value. The hierarchy requires the use of observable market data when available.

The Company primarily uses outside pricing services to assist in determining fair values. For investments in active markets, the Company uses the quoted market prices provided by the outside pricing services to determine fair value. In circumstances where quoted market prices are unavailable, the pricing services utilize fair value estimates based upon other observable inputs including matrix pricing, benchmark interest rates, market comparables and other relevant inputs.

As management is responsible for the recorded fair values, the Company has processes in place to validate the market prices obtained from the outside pricing sources including, but not limited to, periodic evaluation of model pricing methodologies and analytical reviews of certain prices. The Company also periodically performs back-testing of selected sales activity to determine whether there are any significant differences between the market price used to value the security prior to sale and the actual sale price.

Premiums Receivable

Premiums receivable represent amounts due from insureds and reinsureds for insurance coverage and are presented net of an allowance for doubtful accounts of $16.5 million and $14.4 million at December 31, 2012 and 2011, respectively. The allowance for uncollectible amounts is based on an analysis of amounts receivable giving consideration to historical loss experience and current economic conditions and reflects an amount that, in management’s judgment, is adequate. Uncollectible premiums receivable of $4.8 million, $3.0 million and $4.5 million were written off in 2012, 2011 and 2010, respectively.

Deferred Acquisition Costs

Acquisition costs represent the costs of writing business that vary with, and are primarily related to, the successful production of insurance business (principally commissions, premium taxes and certain underwriting costs). Policy acquisition costs are deferred and recognized as expense as related premiums are earned. Deferred acquisition costs (“DAC”) presented in the balance sheet are net of deferred ceding commission revenue.

The value of business acquired (“VOBA”) is an intangible asset relating to the estimated fair value of the unexpired insurance policies acquired in a business combination. VOBA is determined at the time of a business combination and is reported on the consolidated balance sheet with DAC and is amortized in proportion to the timing of the estimated underwriting profit associated with the in force policies acquired. The Company considers anticipated investment income in determining the recoverability of these costs and believes they are fully recoverable. See “Note 10 – Deferred Acquisition Costs” for additional information regarding deferred acquisition costs.

F-16

Tower Group, Inc.

Notes to Consolidated Financial Statements

Goodwill and Intangible Assets

In business combinations, including the acquisition of a group of assets, the Company allocates the purchase price to the net tangible and intangible assets acquired based on their relative fair values. Any portion of the purchase price in excess of this amount results in goodwill. Identifiable intangible assets with a finite useful life are amortized over the period that the asset is expected to contribute directly or indirectly to the future cash flows of the Company. Intangible assets with an indefinite life and goodwill are not amortized and are subject to annual impairment testing at the reporting unit level. For purposes of goodwill impairment testing, the Company defined its two segments, Commercial Insurance and Personal Insurance as reporting units. The Insurance Services segment does not carry goodwill.

To estimate the fair value of its reporting units, the Company may utilize a combination of widely accepted valuation techniques including a stock price and market capitalization analysis, discounted cash flow calculations and peer company price to earnings multiples analysis. The stock price and market capitalization analysis takes into consideration the quoted market price of the Company’s outstanding common stock and includes a control premium, derived from historical insurance industry acquisition activity, in determining the estimated fair value of the consolidated entity before allocating that fair value to individual reporting units. The discounted cash flow analysis utilizes long term assumptions for revenue growth, capital growth, earnings projections including those used in the Company’s strategic plan, and an appropriate discount rate. The peer company price to earnings multiples analysis takes into consideration the price earnings multiples of peer companies for each reporting unit and estimated income from the Company’s strategic plan.

The Company conducted the required annual goodwill and intangible asset impairment testing as of September 30 for 2012. Additionally, identifiable intangible assets and goodwill are tested for recoverability whenever events or changes in circumstances indicate that a carrying amount may not be recoverable. No impairment losses were recognized in 2012, 2011 or 2010.

Other Assets

Tower’s other assets balances are comprised primarily of fixed assets, capitalized software development costs, restricted cash, receivables for securities sold, receivables for the participation in involuntary pools and current tax receivables.

Fixed Assets

Furniture, leasehold improvements, computer equipment, and software, including internally developed software, are reported at cost less accumulated depreciation and amortization. Gross fixed assets were $194.0 million and $176.4 million as of December 31, 2012 and 2011, respectively. Capitalized leases of $44.0 million and $41.0 million were included in this amount as at December 31, 2012 and 2011, respectively. Accumulated depreciation and amortization of $54.7 million and $56.5 million were recorded as of December 31, 2012 and 2011, respectively. In 2012, the Company wrote off $21.5 million of fully depreciated fixed assets with no impact to net income Depreciation and amortization is provided using the straight-line method over the estimated useful lives of the assets. The Company estimates the useful life for computer equipment to be three years, computer software, three to seven years, furniture and other equipment seven years and leasehold improvements is the term of the lease. Depreciation and amortization expense of $20.2 million, $22.0 million and $15.4 million were recorded for the years ended December 31, 2012, 2011 and 2010, respectively. Fixed assets are recorded in Other Assets on the balance sheet.

Other liabilities

Tower’s other liabilities balances are comprised primarily of accrued operating expenses, payables for securities purchased, accrued boards, bureaus and tax expenses, and capital lease obligations.

Variable Interest Entities

The Company consolidates the Reciprocal Exchanges as it has determined that these are variable interest entities and that the Company is the primary beneficiary. See “Note 6 – Variable Interest Entities” for more details.

Investment in unconsolidated affiliate

Although the Company owned less than 20% of the outstanding common stock of Canopius Group, Limited (“CGL”) at December 31, 2012, it recorded its investment in CGL under the equity method of accounting as it was able to significantly influence the operating and financial policies and decisions of CGL.

F-17

Tower Group, Inc.

Notes to Consolidated Financial Statements

Income Taxes

Pursuant to a written tax agreement (the “Tax Sharing Agreement”), each of the Tower’s subsidiaries is required to make payments to Tower for federal income tax imposed on its taxable income in a manner consistent with filing a separate federal income tax return (but subject to certain limitations that are applied to the Tower consolidated group as a whole). The Reciprocal Exchanges are not subject to the Tax Sharing Agreement but file separate tax returns annually.

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and for operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that all or some portion of the deferred tax asset will not be realized.

Treasury Stock

The Company accounts for the treasury stock at the repurchase price as a reduction to stockholders’ equity as it does not currently intend to retire the treasury stock held at December 31, 2012.

Stock-based Compensation

The Company accounts for restricted stock shares and options awarded at fair value at the date awarded and compensation expense is recorded over the requisite service period that has not been rendered. The Company amortizes awards with graded vesting on a straight-line basis over the requisite service period.

Assessments

Insurance related assessments are accrued in the period in which they have been incurred. The Company is subject to a variety of assessments. Among such assessments are state guaranty funds and workers’ compensation second injury funds. State guaranty fund assessments are used by state insurance oversight boards to cover losses of policyholders of insolvent insurance companies and for the operating expenses of such agencies. The Company uses estimates derived from state regulators and/or NAIC Tax and Assessments Guidelines.

Earnings per Share

The Company measures earnings per share at two levels: basic earnings per share and diluted earnings per share. Basic earnings per share is calculated by dividing net income attributable to Tower common stockholders by the weighted average number of common shares outstanding during the year. This weighted average number of shares includes unvested share-based awards that contain nonforfeitable rights to dividends or dividend equivalents whether paid or unpaid (“participating securities”). Diluted earnings per share is calculated by dividing net income attributable to Tower common stockholders by the weighted average number of common shares outstanding during the year, as adjusted for the potentially dilutive effects of stock options, warrants, unvested restricted stock and/or preferred stock that are not participating securities, unless such items are not dilutive.

Foreign currency

The Company’s reporting currency is the U.S. dollar. The Company holds an equity method investment in Canopius Group, Limited, which is denominated in British pounds sterling (“GBP”). The Company translates this investment to U.S. dollars at the exchange rate in effect at the balance sheet date. Tower’s portion of changes in translation adjustment, based on its percentage ownership in this investment, is included as a component of accumulated other comprehensive income.

Statutory Accounting Principles

The Company’s insurance subsidiaries are required to prepare statutory basis financial statements in accordance with practices prescribed or permitted by the state or country in which they are domiciled. See “Note 19 – Statutory Financial Information and Accounting Policies” for more details.

F-18

Tower Group, Inc.

Notes to Consolidated Financial Statements

Concentration and Credit Risk

Financial instruments that potentially subject the Company to concentration and credit risk are primarily cash and cash equivalents, investments, interest rate swaps, premiums receivable and reinsurance recoverables. Investments are diversified through many industries and geographic regions through the use of money managers who employ different investment strategies. The Company limits the amount of credit exposure with any one financial institution and believes that no significant concentration of credit risk exists with respect to cash and investments. The interest rate swap contracts contain credit support annex agreements with collateral posting provisions which reduces counterparty non-performance risk. The premiums receivable balances are generally diversified due to the number of entities comprising the Company’s distribution network and its customer base, which is largely concentrated in the Northeast, Florida, Texas and California. To reduce credit risk, the Company performs ongoing evaluations of its distribution network’s and customers’ financial condition. The Company also has receivables from its reinsurers. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company periodically evaluates the financial condition of its reinsurers and, in certain cases, requires collateral from its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. As at December 31, 2012, the largest uncollateralized reinsurance recoverable balance from any one reinsurer was $47.8 million representing 8.3% of the Company’s total reinsurance recoverable balance. Management’s policy is to review all outstanding receivables at period end as well as the bad debt write-offs experienced in the past and establish an allowance for doubtful accounts, if deemed necessary.

Our largest agent accounted for 7.5%, 10% and 12%, respectively, of the insurance subsidiaries’ premiums receivable balances at December 31, 2012, 2011 and 2010. Our largest agent accounted for 7%, 7% and 4% of the insurance subsidiaries’ direct premiums written in 2012, 2011 and 2010, respectively.

Accounting Pronouncements

Accounting guidance adopted in 2012

In May 2011, the Financial Accounting Standards Board (“FASB”) issued new guidance concerning fair value measurement and disclosure. This new guidance requires additional disclosure about fair value measurements categorized as Level 3. This guidance had no effect on the Company’s financial position, results of operations or cash flows. The Company’s fair value disclosures have been revised effective January 1, 2012 to comply with this guidance.

In June 2011 (and as amended in December 2011), the FASB issued new guidance concerning the presentation of comprehensive income. The Company adopted this new guidance retrospectively on January 1, 2012 and now reports its comprehensive income in a separate consolidated financial statement immediately following the statement of operations.

In September 2011, the FASB issued amended guidance on testing goodwill for impairment. This guidance was intended to reduce the cost and complexity of the annual goodwill impairment test by allowing an entity to utilize more qualitative factors. The Company considered this guidance in the performance of its goodwill impairment test in the fourth quarter as of September 30, 2012. However, the Company did perform the Step 1 impairment test with no impairment noted. This guidance will not affect the Company’s financial position, result of operations or cash flows.

Accounting guidance not yet effective

In July 2012, the FASB issued amended guidance on testing indefinite lived intangible assets for impairment. This guidance is intended to reduce the cost and complexity of the annual impairment test by allowing an entity to utilize more qualitative factors. This guidance is effective for fiscal years beginning after September 15, 2012. This guidance will not affect the Company’s financial position, result of operations or cash flows.

Note 4 – Investment in Canopius Group Limited and Exercise of Merger Option

On August 20, 2012, Tower closed on its $74.9 million acquisition of a 10.7% stake in Canopius Group Limited (“Canopius Group”), a privately owned Lloyd’s insurance holding company domiciled in Guernsey, Channel Islands. In connection with this acquisition, which was agreed to on April 25, 2012, Tower also entered into an agreement dated April 25, 2012 (the “Master Transaction Agreement”) under which Canopius Group committed to assist Tower with the establishment of a presence at Lloyd’s of London through a special purpose syndicate (“SPS Transaction Right and Acquisition Right”), subject to required approvals and granted Tower an option (the “Merger Option”) to combine with Canopius Holdings Bermuda Limited (“Canopius Bermuda”). On July 30, 2012, Tower announced that it had exercised the Merger Option and executed an Agreement and Plan of Merger (the “Original Merger Agreement”) with Canopius Bermuda pursuant to which a wholly-owned subsidiary of Canopius Bermuda will acquire all of Tower’s common stock. Under applicable accounting principles Tower will be regarded as the

F-19

Tower Group, Inc.

Notes to Consolidated Financial Statements

acquiring entity. Tower paid Canopius Group a fee of $1,000,000 to exercise the Merger Option. On November 8, 2012, the Original Merger Agreement was amended by Amendment No. 1 to the Agreement and Plan of Merger to reflect changes to the merger consideration to be received by Tower stockholders (the Original Merger Agreement as so amended, the “Merger Agreement”).

The consideration paid by Tower was allocated as follows based upon each of the acquired assets’ estimated fair values:


($ in thousands)

Investment in Unconsolidated Affiliate	$	71,512
Merger Option		484
SPS Transaction Right and Acquisition Right		2,903

Total	$	74,899

Tower accounts for its 10.7% investment in Canopius Group using the equity method of accounting on a one quarter lag. Management has concluded it exerts significant influence over Canopius Group due to the following: Tower has a board seat on Canopius Group’s Board of Directors, Tower assumes approximately 6% of premiums written by Canopius Group, and Tower has certain rights in accordance with the Merger Option and SPS Transaction Right and Acquisition Right to cause Canopius Group to assist Tower as defined in the Master Transaction Agreement. For the year ended December 31, 2012, Tower recorded a reduction in its investment in Canopius Group by $0.7 million, of which $2.5 million is related to losses recorded in the statement of operations offset by a $1.8 million foreign currency translation adjustment which is recorded in other comprehensive income.

F-20

Tower Group, Inc.

Notes to Consolidated Financial Statements

The Merger Option and SPS Transaction Right and Acquisition Right are reported in “Other assets” in the accompanying balance sheet at December 31, 2012.

Tower also participates in Canopius Group’s reinsurance program. For the year ended December 31, 2012, Tower had assumed earned premiums, losses and loss adjustment expenses and commission expense of $49.8 million, $32.3 million and $14.2 million, respectively, relating to business assumed from Canopius Group.

Note 5—Acquisitions

NAV PAC Division of Navigators Group, Inc. (“NAV PAC”)

Acquisition of the Renewal Rights of AequiCap Program Administrators Inc. (“AequiCap”)

On November 2, 2010, Tower acquired the renewal rights to the commercial automobile liability and physical damage business of AequiCap for $12 million (“AequiCap II”). The business subject to the agreement covers both trucking and taxi risks that are consistent with Tower’s current underwriting guidelines. The acquisition was accounted for as a business combination under GAAP. The distribution network was the only identifiable asset acquired and had a fair value of $11.3 million. No liabilities were assumed. $0.7 million of goodwill was recorded as a result of this transaction.

Acquisition of the OneBeacon Personal Lines Division

On July 1, 2010, Tower completed the OBPL acquisition pursuant to a definitive agreement (the “Agreement”) dated February 2, 2010 by and among the Company and OneBeacon Insurance Group (“OneBeacon”). This acquisition expanded Tower’s suite of personal lines insurance products to include private passenger automobile, homeowners, umbrella, and the signature package product, OneChoice CustomPac, which provides customers with one policy for all of their homeowners, auto and umbrella needs.

Under the terms of the Agreement, the Company acquired Massachusetts Homeland Insurance Company (“MHIC”), York Insurance Company of Maine (“York”) and two management companies (collectively the “Stock Companies”). The management companies are the attorneys-in-fact for the Reciprocal Exchanges. Tower purchased $102 million principal of surplus notes issued by the Reciprocal Exchanges (the “surplus notes”). In addition, Tower also reinsured the personal lines business written by other subsidiaries of OneBeacon not acquired by Tower. The total consideration paid for OBPL was $164.3 million.

Effective July 1, 2010, Tower entered into transition service agreements with OneBeacon whereby OneBeacon will provide certain information technology and operational support to Tower until such time that these processes are migrated to Tower. Expenses incurred under such transition service agreements were $20.3 million and $23.9 million for the years ended December 31, 2012 and 2011, respectively.

Tower consolidated OBPL as of July 1, 2010 and the purchase consideration has been allocated to the assets acquired and liabilities assumed, including separately identified intangible assets, based on their fair values as of the close of the acquisition, with the amounts exceeding the fair value recorded as goodwill. The goodwill consisted largely of the synergies and economies of scale expected from combining the operations of the Company and OBPL.

Direct costs of the acquisition are accounted for separately from the business combination and are expensed as incurred.

All goodwill associated with the OBPL acquisition has been allocated to the Personal Insurance segment.

Note 6–Variable Interest Entities (“VIEs”)

Through its management companies, Tower is the attorney-in-fact for the Reciprocal Exchanges and has the ability to direct their activities. The Reciprocal Exchanges are policyholder-owned insurance carriers organized as unincorporated associations. Each policyholder insured by the Reciprocal Exchanges shares risk with the other policyholders.

F-21

Tower Group, Inc.

Notes to Consolidated Financial Statements

In the event of dissolution, policyholders would share any residual unassigned surplus in the same proportion as the amount of insurance purchased but are not subject to assessment for any deficit in unassigned surplus of the Reciprocal Exchanges. Tower receives management fee income for the services provided to the Reciprocal Exchanges. The assets of the Reciprocal Exchanges can be used only to settle the obligations of the Reciprocal Exchanges and general creditors to their liabilities have no recourse to Tower as the primary beneficiary.

In addition, Tower holds the surplus notes issued by the Reciprocal Exchanges when they were originally capitalized. The obligation to repay principal and interest on the surplus notes is subordinated to the Reciprocal Exchanges’ other liabilities including obligations to policyholders and claimants for benefits under insurance policies. Principal and interest on the surplus notes are payable only with regulatory approval. The Company has no ownership interest in the Reciprocal Exchanges.

The Company determined that each of the Reciprocal Exchanges qualifies as a VIE and that the Company is the primary beneficiary as it has both the power to direct the activities of the Reciprocal Exchanges that most significantly impact their economic performance and the risk of economic loss through its ownership of the surplus notes. Accordingly, the Company consolidates these Reciprocal Exchanges and eliminates all intercompany balances and transactions with Tower.

For the year ended December 31, 2012, the Reciprocal Exchanges recognized total revenues, total expenses and net income of $204.7 million, $202.4 million and $2.3 million, respectively. For the year ended December 31, 2011, the Reciprocal Exchanges recognized total revenues, total expenses and net income of $209.8 million, $198.8 million and $11.0 million, respectively.

Note 7—Investments

The cost or amortized cost and fair value of the Company’s investments in fixed maturity and equity securities, gross unrealized gains and losses, and other-than-temporary impairment losses as of December 31, 2012 and December 31, 2011 are summarized as follows:


($ in thousands)	Cost or Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value		Unrealized OTTI Losses (1)

December 31, 2012, as restated
U.S. Treasury securities	$	183,462	$	1,500	$	(13	)	$	184,949	$	-
U.S. Agency securities		98,502		4,351		(76	)		102,777		-
Municipal bonds		633,373		52,914		(244	)		686,043		-
Corporate and other bonds
Finance		233,849		21,293		(1,095	)		254,047		-
Industrial		412,465		26,556		(868	)		438,153		-
Utilities		51,698		2,958		(191	)		54,465		-
Commercial mortgage-backed securities		211,819		30,375		(141	)		242,053		-
Residential mortgage-backed securities
Agency backed securities		283,652		12,326		(262	)		295,716		-
Non-agency backed securities		38,615		3,575		(34	)		42,156		(6)
Asset-backed securities		42,751		1,615		(14	)		44,352		-

Total fixed-maturity securities		2,190,186		157,463		(2,938	)		2,344,711		(6)
Preferred stocks, principally financial sector		31,272		730		(481	)		31,521		-
Common stocks, principally financial and industrial sectors		118,076		953		(4,292	)		114,737		-
Short-term investments		4,749		1		-			4,750		-

Total, December 31, 2012, as restated	$	2,344,283	$	159,147	$	(7,711	)	$	2,495,719	$	(6)

Tower	$	2,075,189	$	141,614	$	(7,210	)	$	2,209,593	$	(6)
Reciprocal Exchanges		269,094		17,533		(501	)		286,126		-

Total, December 31, 2012, as restated	$	2,344,283	$	159,147	$	(7,711	)	$	2,495,719	$	(6)

F-22

Tower Group, Inc.

Notes to Consolidated Financial Statements



December 31, 2011
U.S. Treasury securities	$	154,430	$	1,725	$	(13	)	$	156,142	$	-
U.S. Agency securities		114,411		2,779		-			117,190		-
Municipal bonds		688,192		48,777		(255	)		736,714		-
Corporate and other bonds
Finance		331,917		9,201		(4,615	)		336,503		-
Industrial		388,139		22,198		(2,287	)		408,050		-
Utilities		30,164		3,067		(61	)		33,170		-
Commercial mortgage-backed securities		232,877		22,854		(2,564	)		253,167		(483	)
Residential mortgage-backed securities
Agency backed securities		304,876		15,401		(1	)		320,276		-
Non-agency backed securities		29,907		2,603		(901	)		31,609		(695	)
Asset-backed securities		60,199		1,309		(655	)		60,853		-

Total fixed-maturity securities		2,335,112		129,914		(11,352	)		2,453,674		(1,178	)
Preferred stocks, principally financial sector		24,083		317		(890	)		23,510		-
Common stocks, principally industrial and financial sectors		68,951		1,078		(4,194	)		65,835		-
Short-term investments		-		-		-			-		-

Total, December 31, 2011	$	2,428,146	$	131,309	$	(16,436	)	$	2,543,019	$	(1,178	)

Tower	$	2,138,001	$	118,173	$	(15,075	)	$	2,241,099	$	(1,178	)
Reciprocal Exchanges		290,145		13,136		(1,361	)		301,920		-

Total, December 31, 2011	$	2,428,146	$	131,309	$	(16,436	)	$	2,543,019	$	(1,178	)

(1) Represents the gross unrealized loss on other-than-temporarily impaired securities recognized in accumulated other comprehensive income (loss).

As at December 31, 2012 and 2011, U.S. Treasury Notes and other securities with carrying values of $351.1 million and $226.8 million, respectively, were on deposit with various states to comply with the insurance laws in which the Company is licensed.

In addition, the Company had $481.5 million and $340.8 million of investments as of December 31, 2012 and 2011, respectively, held by counterparties as collateral or in trusts to support letter of credit issued on Tower’s behalf, reinsurance liabilities on certain assumed reinsurance treaties, and collateral posted for certain leases.

Major categories of net investment income are summarized as follows:


	Year Ended December 31,

($ in thousands)	2012			2011			2010

Income
Fixed-maturity securities	$	96,056		$	105,533		$	103,921
Equity securities		28,989			24,576			7,225
Cash and cash equivalents		1,112			695			732
Other invested assets		6,680			274			-
Other		387			643			539

Total		133,224			131,721			112,417
Expenses
Investment expenses		(6,059	)		(5,247	)		(5,152)

Net investment income	$	127,165		$	126,474		$	107,265

Tower		121,907			120,083			105,506
Reciprocal Exchanges		12,575			12,846			5,118
Elimination of interest on Reciprocal Exchange surplus notes		(7,317	)		(6,455	)		(3,359)

Net investment income	$	127,165		$	126,474		$	107,265

Proceeds from the sale of fixed-maturity securities were $1.8 billion, $2.0 billion and $1.4 billion for the year ended December 31, 2012, 2011 and 2010, respectively. Proceeds from the sale of equity securities were $1.4 billion, $793.9 million and $80.7 million for the year ended December 31, 2012, 2011 and 2010, respectively.

F-23

Tower Group, Inc.

Notes to Consolidated Financial Statements

Gross realized gains, losses and impairment write-downs on investments are summarized as follows:


	Year Ended December 31,

($ in thousands)	2012			2011			2010

Fixed-maturity securities
Gross realized gains	$	59,319		$	44,550		$	31,587
Gross realized losses		(2,780	)		(11,101	)		(11,388)

		56,539			33,449			20,199
Equity securities
Gross realized gains		13,090			8,328			482
Gross realized losses		(31,404	)		(29,138	)		(3,007)

		(18,314	)		(20,810	)		(2,525)
Other ⁽¹⁾
Gross realized gains		3,432			-			-
Gross realized losses		(6,548	)		-			-

		(3,116	)		-			-

Net realized gains on investments		35,109			12,639			17,674

Other-than-temporary impairment losses:
Fixed-maturity securities		(1,320	)		(580	)		(3,021)
Equity securities		(8,313	)		(2,665	)		-

Total other-than-temporary impairment losses recognized in earnings		(9,633	)		(3,245	)		(3,021)

Total net realized investment gains (losses)	$	25,476		$	9,394		$	14,653

Tower	$	12,245		$	6,980		$	14,910
Reciprocal Exchanges		13,231			2,414			(257)

Total net realized investment gains (losses)	$	25,476		$	9,394		$	14,653

⁽¹⁾	Other gross realized gains and losses consists primarily of “debt and equity securities sold, not yet purchased,” which are reported with Other liabilities.

Management may dispose of a particular security due to changes in facts and circumstances related to the invested asset that have arisen since the last analysis supporting management’s determination whether or not it intended to sell the security, and if not, whether it is more likely than not that the Company would be required to sell the security before recovery of its amortized cost basis.

Impairment Review

Management regularly reviews the Company’s fixed-maturity and equity security portfolios in accordance with its impairment policy to evaluate the necessity of recording impairment losses for OTTI. The determination of OTTI is a subjective process and different judgments and assumptions could affect the timing of loss realization.

Management, in conjunction with its outside portfolio managers, analyzes its non-agency residential mortgage-backed securities (“RMBS”) using default loss models based on the performance of the underlying loans. Performance metrics include delinquencies, defaults, foreclosures, anticipated cash flow prepayments and cumulative losses incurred. The expected losses for a mortgage pool are compared to the break-even loss, which represents the point at which the Company’s tranche begins to experience losses.

The commercial mortgage-backed securities (“CMBS”) holdings are evaluated using analytical techniques and various metrics including the level of subordination, debt-service-coverage ratios, loan-to-value ratios, delinquencies, defaults and foreclosures.

For the non-structured fixed-maturity securities (U.S. Treasury and Agency securities, municipal bonds, and certain corporate debt), unrealized losses are reviewed to determine whether full recovery of principal and interest will be received. The estimate of expected cash flows is determined by projecting a recovery value and a recovery time frame and assessing whether further principal and interest will be received. The determination of recovery value incorporates an issuer valuation assumption utilizing one or a combination of valuation methods as deemed appropriate by management. The present value of the cash flows is determined by applying the effective yield of the security at the date of acquisition (or the most recent implied rate used to accrete the security if the implied rate has changed as a result of a previous impairment) and an estimated recovery time frame. For securities for which the issuer is financially troubled but not in bankruptcy, that time frame is generally longer. Included in the present value calculation are expected principal and interest payments; however, for securities for which the issuer is classified as bankrupt or in default, the present value calculation assumes no interest payments and a single recovery amount. In situations for which a present value of cash flows cannot be estimated, a write-down to fair value is recorded.

F-24

Tower Group, Inc.

Notes to Consolidated Financial Statements

In estimating the recovery value, significant judgment is involved in the development of assumptions relating to a number of factors related to the issuer including, but not limited to, revenue, margin and earnings projections, the likely market or liquidation values of assets, potential additional debt to be incurred pre- or post- bankruptcy/restructuring, the ability to shift existing or new debt to different priority layers, the amount of restructuring/bankruptcy expenses, the size and priority of unfunded pension obligations, litigation or other contingent claims, the treatment of intercompany claims and the likely outcome with respect to inter-creditor conflicts.

The evaluation of equity securities includes management’s intent and ability to hold the security to recovery. Management will record OTTI in those situations where it does not intend to hold the security to recovery or if the security is not expected to recover in value in the near term.

The following table shows the amount of fixed-maturity and equity securities that were OTTI for the years ended December 31, 2012, 2011 and 2010. This resulted in recording impairment write-downs included in net realized investment gains (losses), and reduced the unrealized loss in other comprehensive net income:



($ in thousands)	2012			2011			2010

Municipal bonds	$	(113	)	$	-		$	-
Corporate and other bonds		(1,029	)		-			-
Commercial mortgage-backed securities		(430	)		(219	)		(6,987)
Residential mortgage-backed securities		(34	)		(235	)		(6,164)
Asset-backed securities		-			(391	)		(1,779)
Equities		(8,313	)		(2,664	)		-

Other-than-temporary-impairments		(9,919	)		(3,509	)		(14,930)
Portion of loss recognized in accumulated other comprehensive income (loss)		286			264			11,909

Impairment losses recognized in earnings	$	(9,633	)	$	(3,245	)	$	(3,021)

Tower	$	(9,919	)	$	(3,245	)	$	(3,021)
Reciprocal Exchanges		286			-			-

Impairment losses recognized in earnings	$	(9,633	)	$	(3,245	)	$	(3,021)

The following table provides a rollforward of the cumulative amount of credit related OTTI for securities still held showing the amounts that have been included in earnings on a pretax basis for the years ended 2012 and 2011 (none of such OTTI was included within the Reciprocal Exchanges):


	Year Ended December 31,
($ in thousands)	2012			2011			2010

Balance, January 1,	$	12,666		$	18,075		$	41,904
Additional credit losses recognized during the period, related to securities for which:
No OTTI has been previously recognized		1,259			44			707
OTTI has been previously recognized		61			537			2,314
Reductions due to:
Securities sold during the period (realized)		(9,494	)		(5,990	)		(26,850)

Balance, December 31,	$	4,492		$	12,666		$	18,075

Unrealized Losses

There are 213 securities at December 31, 2012, including fixed maturities and equity securities, which account for the gross unrealized loss, none of which is deemed by management to be OTTI. Temporary losses on corporate and other bonds result from purchases made in a lower interest rate environment or lower yield spread environment. In addition, there have been some ratings downgrades on certain of these securities. After analyzing the credit quality, balance sheet strength and company outlook, management believes these securities will recover in value. The structured securities that had significant unrealized losses resulted primarily from declines in both residential and commercial real estate prices. To the extent projected cash flows on

F-25

Tower Group, Inc.

Notes to Consolidated Financial Statements

structured securities change adversely, they would be considered OTTI, and an impairment loss would be recognized in the current period. Management considered all relevant factors, including expected recoverability of cash flows, in assessing whether a loss was other-than-temporary. The Company does not intend to sell these fixed maturity securities, and it is not more likely than not that these securities will be sold before recovering their cost basis.

For all fixed-maturity securities in an unrealized loss position at December 31, 2012, the Company has received all contractual interest payments (and principal if applicable). Based on the continuing receipt of cash flow and the foregoing analyses, management expects continued timely payments of principal and interest and considers the losses to be temporary.

The unrealized loss position associated with the fixed-maturity portfolio was $2.9 million as of December 31, 2012, consisting primarily of corporate bonds and mortgage-backed securities of $2.6 million. The total fixed-maturity portfolio of gross unrealized losses included 183 securities which were, in aggregate, approximately 1.1% below amortized cost. Of the 183 fixed maturity investments identified, 31 have been in an unrealized loss position for more than 12 months. The total unrealized loss on these investments at December 31, 2012 was $0.3 million. Management does not consider these investments to be other-than-temporarily impaired.

For common stocks, there were 23 securities in a loss position at December 31, 2012 totaling $4.3 million. Management evaluated the financial condition of the common stock issuers, the severity and duration of the impairment, and our ability and intent to hold to recovery and determined these securities are not OTTI. The evaluation consisted of a detailed review, including but not limited to some or all of the following factors for each security: the current S&P rating, analysts’ reports, past earnings trends and analysts’ earnings expectations for the next 12 months, liquidity, near-term financing risk, and whether the company was currently paying dividends on its equity securities. Management does not consider these investments to be other-than-temporarily impaired.

F-26

Tower Group, Inc.

Notes to Consolidated Financial Statements

The following table presents information regarding invested assets that were in an unrealized loss position at December 31, 2012 and December 31, 2011 by amount of time in a continuous unrealized loss position:


	Less than 12 Months					12 Months or Longer					Total

	Fair		Unrealized			Fair		Unrealized			Aggregate		Unrealized
($ in thousands)	Value		Losses			Value		Losses			Fair Value		Losses

December 31, 2012, as restated
U.S. Treasury securities	$	44,347	$	(13	)	$	-	$	-		$	44,347	$	(13)
U.S. Agency securities		22,345		(76	)		-		-			22,345		(76)
Municipal bonds		21,532		(235	)		251		(9	)		21,783		(244)
Corporate and other bonds
Finance		16,853		(1,095	)		-		-			16,853		(1,095)
Industrial		53,576		(667	)		4,188		(202	)		57,764		(869)
Utilities		20,143		(191	)		7		-			20,150		(191)
Commercial mortgage-backed securities		23,223		(141	)		95		-			23,318		(141)
Residential mortgage-backed securities
Agency backed		59,009		(261	)		25		(1	)		59,034		(262)
Non-agency backed		815		(6	)		588		(28	)		1,403		(34)
Asset-backed securities		1,499		(2	)		4,232		(11	)		5,731		(13)

Total fixed-maturity securities, as restated		263,342		(2,687	)		9,386		(251	)		272,728		(2,938)
Preferred stocks		9,716		(155	)		5,724		(326	)		15,440		(481)
Common stocks		55,560		(4,292	)		-		-			55,560		(4,292)

Total, December 31, 2012, as restated	$	328,618	$	(7,134	)	$	15,110	$	(577	)	$	343,728	$	(7,711)

Tower	$	270,609	$	(6,732	)	$	13,338	$	(478	)	$	283,947	$	(7,210)
Reciprocal Exchanges		58,009		(402	)		1,772		(99	)		59,781		(501)

Total, December 31, 2012, as restated	$	328,618	$	(7,134	)	$	15,110	$	(577	)	$	343,728	$	(7,711)


December 31, 2011
U.S. Treasury securities	$	92,001	$	(13	)	$	-	$	-		$	92,001	$	(13)
U.S. Agency securities		-		-			-		-			-		-
Municipal bonds		13,449		(255	)		-		-			13,449		(255)
Corporate and other bonds
Finance		138,986		(4,610	)		251		(5	)		139,237		(4,615)
Industrial		57,357		(2,141	)		3,519		(146	)		60,876		(2,287)
Utilities		1,902		(61	)		-		-			1,902		(61)
Commercial mortgage-backed securities		26,130		(2,564	)		-		-			26,130		(2,564)
Residential mortgage-backed securities
Agency backed		19		(1	)		12		-			31		(1)
Non-agency backed		13,294		(318	)		4,609		(583	)		17,903		(901)
Asset-backed securities		29,624		(647	)		610		(8	)		30,234		(655)

Total fixed-maturity securities		372,762		(10,610	)		9,001		(742	)		381,763		(11,352)
Preferred stocks		17,773		(644	)		1,303		(246	)		19,076		(890)
Common stocks		44,132		(4,194	)		-		-			44,132		(4,194)

Total, December 31, 2011	$	434,667	$	(15,448	)	$	10,304	$	(988	)	$	444,971	$	(16,436)

Tower	$	398,989	$	(14,160	)	$	8,264	$	(915	)	$	407,253	$	(15,075)
Reciprocal Exchanges		35,678		(1,288	)		2,040		(73	)		37,718		(1,361)

Total, December 31, 2011	$	434,667	$	(15,448	)	$	10,304	$	(988	)	$	444,971	$	(16,436)

Management evaluated the severity of the impairment in relation to the carrying values for the securities referred to above and considered all relevant factors in assessing whether the loss was other-than-temporary. Management does not intend to sell its fixed-maturity securities, and it is not more likely than not that fixed maturity and equity securities will be sold until there is a recovery of fair value to the original cost basis, which may be at maturity.

F-27

Tower Group, Inc.

Notes to Consolidated Financial Statements

Fixed-Maturity Investment—Time to Maturity

The following table shows the composition of the fixed-maturity portfolio by remaining time to maturity at December 31, 2012 and 2011. For securities that are redeemable at the option of the issuer and have a market price that is greater than par value, the maturity used for the table below is the earliest redemption date. For securities that are redeemable at the option of the issuer and have a market price that is less than par value, the maturity used for the table below is the final maturity date.


	Tower				Reciprocal Exchanges				Total

	Amortized		Fair		Amortized		Fair		Amortized		Fair
($ in thousands)	Cost		Value		Cost		Value		Cost		Value

December 31, 2012, as restated
Remaining Time to Maturity
Less than one year	$	30,082	$	30,614	$	2,678	$	2,715	$	32,760	$	33,329
One to five years		489,939		510,523		45,576		47,275		535,515		557,798
Five to ten years		564,556		607,711		76,480		80,009		641,036		687,720
More than 10 years		346,410		379,045		57,628		62,542		404,038		441,587
Mortgage and asset-backed securities		495,249		536,255		81,588		88,022		576,837		624,277

Total, as restated	$	1,926,236	$	2,064,148	$	263,950	$	280,563	$	2,190,186	$	2,344,711

December 31, 2011
Remaining Time to Maturity
Less than one year	$	40,201	$	40,529	$	44,238	$	44,942	$	84,439	$	85,471
One to five years		479,721		491,904		81,566		83,743		561,287		575,647
Five to ten years		563,830		593,838		21,522		22,797		585,352		616,635
More than 10 years		427,357		458,536		48,818		51,480		476,175		510,016
Mortgage and asset-backed securities		535,823		568,813		92,036		97,092		627,859		665,905

Total	$	2,046,932	$	2,153,620	$	288,180	$	300,054	$	2,335,112	$	2,453,674

Other Invested Assets

The following table shows the composition of the other invested assets as of December 31, 2012 and 2011:


($ in thousands)	2012		2011

Limited partnerships, equity method	$	23,864	$	12,459
Real estate, amortized cost		7,422		6,888
Securities reported under the fair value option		25,000		25,000
Other		1,500		-

Total	$	57,786	$	44,347

In December 2011, the Company purchased two securities for which it elected the fair value option. This election was made to simplify the accounting for these instruments which contain embedded derivatives and other features.

Note 8—Fair Value Measurements

GAAP establishes a three-level hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the assets or liabilities fall within different levels of the hierarchy, the classification is based on the lowest level input that is significant to the fair value measurement of the asset or liability. Classification of assets and liabilities within the hierarchy considers the markets in which the assets and liabilities are traded, including during periods of market disruption, and the reliability and transparency of the assumptions used to determine fair value. The hierarchy requires the use of observable market data when available. The levels of the hierarchy are as follows:

Level 1 — Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities traded in active markets. Included are those equity securities that are traded on active exchanges, such as the NASDAQ Global Select Market.

F-28

Tower Group, Inc.

Notes to Consolidated Financial Statements

Level 2 — Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability and market-corroborated inputs. Included are investments in U.S. Treasury and Agency securities and, together with municipal bonds, corporate debt securities, commercial mortgages, residential mortgage-backed securities and asset-backed securities. Additionally, interest-rate swap contracts utilize Level 2 inputs in deriving fair values.

Level 3 — Inputs to the valuation methodology are unobservable in the market for the asset or liability and are significant to the fair value measurement. Material assumptions and factors considered in pricing investment securities may include projected cash flows, collateral performance including delinquencies, defaults and recoveries, and any market clearing activity or liquidity circumstances in the security or similar securities that may have occurred since the prior pricing period. Generally included in this valuation methodology are investments in certain mortgage-backed and asset-backed securities and securities the Company is reporting under the fair value option.

The availability of observable inputs varies and is affected by a wide variety of factors. When the valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires significantly more judgment. The degree of judgment exercised by management in determining fair value is greatest for investments categorized as Level 3. For investments in this category, management considers prices and inputs that are current as of the measurement date. In periods of market dislocation, as characterized by current market conditions, the ability to observe stable prices and inputs may be reduced for many instruments. This condition could cause a security to be reclassified between levels.

F-29

Tower Group, Inc.

Notes to Consolidated Financial Statements

As at December 31, 2012 and 2011, the Company’s financial instruments carried at fair value are allocated among levels as follows:


($ in thousands)	Level 1		Level 2			Level 3		Total

December 31, 2012, as restated
Fixed-maturity securities
U.S. Treasury securities	$	-	$	184,949		$	-	$	184,949
U.S. Agency securities		-		102,777			-		102,777
Municipal bonds		-		686,043			-		686,043
Corporate and other bonds		-		746,665			-		746,665
Commercial mortgage-backed securities		-		242,053			-		242,053
Residential mortgage-backed securities		-		-			-		-
Agency		-		295,716			-		295,716
Non-agency		-		42,156			-		42,156
Asset-backed securities		-		44,352			-		44,352

Total fixed-maturities, as restated		-		2,344,711			-		2,344,711
Equity securities		146,258		-			-		146,258
Short-term investments		-		4,750			-		4,750

Total investments at fair value, as restated		146,258		2,349,461			-		2,495,719
Other invested assets (1)		-		-			25,000		25,000
Other liabilities		-		-			-		-
Interest rate swap contracts		-		(9,016	)		-		(9,016)
Debt and equity securities sold, not yet purchased		-		(17,101	)		-		(17,101)

Total, December 31, 2012, as restated	$	146,258	$	2,323,344		$	25,000	$	2,494,602

Tower	$	140,695	$	2,042,780		$	25,000	$	2,208,475
Reciprocal Exchanges		5,563		280,564			-		286,127

Total, December 31, 2012, as restated	$	146,258	$	2,323,344		$	25,000	$	2,494,602


December 31, 2011
Fixed-maturity securities
U.S. Treasury securities	$	-	$	156,142		$	-	$	156,142
U.S. Agency securities		-		117,190			-		117,190
Municipal bonds		-		736,714			-		736,714
Corporate and other bonds		-		777,723			-		777,723
Commercial mortgage-backed securities		-		253,167			-		253,167
Residential mortgage-backed securities		-		-			-		-
Agency		-		320,276			-		320,276
Non-agency		-		31,609			-		31,609
Asset-backed securities		-		60,853			-		60,853

Total fixed-maturities		-		2,453,674			-		2,453,674
Equity securities		89,345		-			-		89,345
Short-term investments		-		-			-		-

Total investments		89,345		2,453,674			-		2,543,019
Other invested assets (2)		-		-			25,000		25,000
Other liabilities		-		-			-		-
Interest rate swap contracts		-		(7,384	)		-		(7,384)

Total, December 31, 2011	$	89,345	$	2,446,290		$	25,000	$	2,560,635

Tower	$	87,479	$	2,146,236		$	25,000	$	2,258,715
Reciprocal Exchanges		1,866		300,054			-		301,920

Total, December 31, 2011	$	89,345	$	2,446,290		$	25,000	$	2,560,635

(1) $25.0 million of the $57.8 million Other invested assets reported on the consolidated balance sheet at December 31, 2012 is reported at fair value. The remaining $32.8 million of Other invested assets is reported under the equity method of accounting or at amortized cost.

(2) $25.0 million of the $44.3 million Other invested assets reported on the consolidated balance sheet at December 31, 2011 is reported at fair value. The remaining $19.3 million of Other invested assets is reported under the equity method of accounting or at amortized cost.

F-30

Tower Group, Inc.

Notes to Consolidated Financial Statements

value estimates based upon other observable inputs including matrix pricing, benchmark interest rates, market comparables and other relevant inputs. When observable inputs were adjusted to reflect management’s best estimate of fair value, such fair value measurements are considered a lower level measurement in the GAAP fair value hierarchy.

Our process to validate the market prices obtained from the outside pricing sources includes, but is not limited to, periodic evaluation of model pricing methodologies and analytical reviews of certain prices. We also periodically perform testing of the market to determine trading activity, or lack of trading activity, as well as market prices. Several securities sold during the quarter were “back-tested” (i.e., the sales price is compared to the previous month end reported market price to determine reasonableness of the reported market price). If management believes that the price provided from the pricing source is distressed, management will use a valuation method that reflects an orderly transaction between market participants, generally a discounted cash flow method that incorporates relevant interest rate, risk and liquidity factors.

The ability to observe stable prices and inputs may be reduced for highly-customized and illiquid instruments which had been the case for certain non-agency residential and commercial mortgage-backed securities and asset-backed securities in previous periods.

Substantially all of the portfolio valuations at December 31, 2012 classified as Level 1 or Level 2 in the above table is priced by utilizing the services of several independent pricing services that provide the Company with a price quote for each security. There were no adjustments made to the prices obtained from the independent pricing sources and dealers on securities classified as Level 1 or Level 2.

In 2012, there were no transfers of investments between Level 1 and Level 2 or between Level 2 and Level 3.

The fair values of the interest rate swaps were derived by using an industry standard swap valuation model with market based inputs for swaps having similar characteristics.

The fair values of the debt and equity securities sold, not yet purchased were derived by using quoted prices for similar securities in active markets. These instruments resulted in net realized gains (losses) of $(2.1) million for the year ended December 31, 2012.

In December 2011, the Company purchased two securities that are reported in other invested assets and have been classified as Level 3 of the fair value hierarchy. Management utilizes a discounted cash flow analysis to derive the fair values. For one security, which matures in 2015 and whose cash flows are supported by underlying short-term loans, the significant unobservable inputs include the underlying short-term loans’ probability of default and loss severity, and a discount for the security’s lack of marketability. Increases in the probability of default and loss severity assumptions (which generally move directionally with each other) would have the effect of decreasing the fair value of this security. The Company obtains credit ratings on the underlying short-term loans quarterly and considers these ratings when updating its assumptions. The second security is an equity instrument which entitles the Company to residual interests of a finite life special purpose vehicle. The significant unobservable inputs include the estimated losses to be incurred by the vehicle and the equity instrument’s lack of marketability. The Company obtains quarterly financial data from the vehicle and evaluates the estimated incurred loss figure. An increase in the vehicle’s estimated incurred losses would have the effect of decreasing the instrument’s fair value.

Management is responsible for the determination of the value of the investments carried at fair value and the supporting methodologies and assumptions. Management has reviewed the pricing techniques and methodologies of the independent pricing sources and believes that their policies adequately consider market activity, either based on specific transactions for the issue valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. Management monitors security-specific valuation trends and discusses material changes or the absence of expected changes with the portfolio managers to understand the underlying factors and inputs and to validate the reasonableness of pricing. Management also back-tests the prices on numerous sales of securities during the year to validate the previous pricing provided as well as utilizes other pricing sources to validate the pricing provided by our primary provider of the majority of the non-U.S. Treasury securities and non-agency securities included in Level 2.

There were no changes in Level 3 assets measured at fair value for the years ended December 31, 2012 and 2011.

F-31

Tower Group, Inc.

Notes to Consolidated Financial Statements

The following table summarizes changes in Level 3 assets measured at fair value for the year ended December 31, 2012 and 2011 for Tower (the Reciprocal Exchanges have no Level 3 assets):


	Year Ended December 31,

($ in thousands)	2012		2011			2010

Beginning balance, January 1	$	25,000	$	2,058		$	13,595
Total gains (losses)-realized / unrealized
Included in net income		-		(1,067	)		(32)
Included in other comprehensive income (loss)		-		-			(6,229)
Purchases, issuances and settlements		-		25,000			-
Net transfers into (out of) Level 3		-		(991	)		(5,276)

Ending balance, December 31,	$	25,000	$	25,000		$	2,058

Note 9—Goodwill and Intangible Assets

Goodwill

Goodwill is calculated as the excess of purchase price over the net fair value of assets acquired. See Note 5 – “Acquisitions” for information regarding the calculation of goodwill related to the recent acquisitions. The following is a summary of goodwill by reporting units:


($ in thousands)	Commercial Insurance			Personal Insurance			Total

Balance, January 1, 2011 as reported	$	189,121		$	56,427		$	245,548
Adjustments (a)		(3,203	)		(887	)		(4,090)

Balance, January 1, as adjusted		185,918			55,540			241,458
Adjustments		-			-			-

Balance, January 1, 2012		185,918			55,540			241,458
Adjustments		-			-			-

Total, December 31, 2012	$	185,918		$	55,540		$	241,458

(a) In 2012, the Company identified deferred tax assets that should have been recorded in purchase accounting for certain acquisitions. The Company increased deferred tax assets by $4,090 and reduced goodwill to properly report 2010 and prior items as of the earliest period presented.

Goodwill impairment testing

The Company performs an impairment test for each of our reporting units with goodwill annually or whenever events or circumstances indicate that the value of goodwill may be impaired. In performing Step 1 of the impairment test, management compared the fair value of the reporting units to their carrying value including goodwill. If the carrying value including goodwill were to exceed the fair value of a reporting unit, Step 2 of the test would be performed. Step 2 of the impairment test requires the carrying value of goodwill to be reduced to its fair value, if lower, as of the test date. For Step 1 of the test, the Company estimated the reporting unit’s fair value using an average of five standard valuation techniques, which include a market multiples based on (i) book value; (ii) tangible book value; (ii) estimates of projected results for 2013 and 2014; and, (iv) a valuation technique using discounted cash flows (“DCF”) to be generated by the reporting unit, which include a terminal value.

The market multiples techniques are based on book value; tangible book value; and estimates of projected future results were derived from selected guideline companies, which write products similar to those issued by us and are of comparable size, and were adjusted for the return on equity and the return on tangible equity. The DCF valuation and market multiples are based on projected future results involve a number of estimates that require broad assumptions and significant judgment by management regarding future performance. The key assumptions used in these methods are as follows:


	Commercial Insurance	Personal Insurance

Discounting interest rate	10%	10%
Growth rate – near term	8 - 14%	10 - 23%
Terminal growth rate	3%	3%
Combined ratio(*)	94% - 98%	94% - 98%

F-32

Tower Group, Inc.

Notes to Consolidated Financial Statements

* In the determination of the terminal value we considered a combined ratio of 94% as reasonable for Commercial Insurance and Personal Insurance.

The Company also compared the aggregate fair value of the reporting units to Tower’s overall market capitalization. The aggregate fair value of the reporting units exceeded Tower’s book value by 1% and market capitalization by 42%; management believes that the implied premium of the aggregate fair value over market capitalization is a reasonable valuation for an acquisition control premium (the price in excess of a stock’s market price that investors would typically pay to gain control of an entity).

For the Commercial Insurance reporting unit, the Company determined in Step 1 that the reporting unit’s fair value was less than its carrying value, primarily driven by the overall market capitalization. Accordingly, recoverability was evaluated assuming fair value was allocated to assets and liabilities as if the reporting unit had been acquired in a business combination. In Step 2, the implied value of the Commercial Insurance reporting unit’s goodwill was greater than its goodwill carrying value by $27 million considering an acquisition control premium of 42%; therefore, goodwill was not impaired and no write-down was required; however, the Step 1 comparison indicates a greater risk of future impairment for this reporting unit’s goodwill.

For the Personal Insurance reporting unit, management determined in Step 1 that the reporting unit’s fair value was in excess of its carrying value by 9% or $21 million considering an acquisition control premium of 42%; and therefore goodwill was not impaired.

As discussed in “Note 1 – Nature of the Business,” in the second quarter of 2013, subsequent to December 31, 2012, significant business developments resulted in the management assessing its goodwill balances for impairment as of June 30, 2013. The Company impaired all goodwill allocated to its Commercial Insurance reporting unit. No impairment charge was required for the Personal Insurance reporting unit goodwill.

Subsequent Personal Insurance reporting unit goodwill assessments could result in impairment due to the impact of a volatile financial market on earnings, discount assumptions, liquidity and market capitalization. Management will continue to monitor its goodwill for possible future impairments.

Intangible Assets

Intangible assets consist of finite and indefinite life assets. Finite life intangible assets include customer relationships and trademarks. Insurance company licenses and management contracts are considered indefinite life intangible assets subject to annual impairment testing.

The components of intangible assets and their useful lives, accumulated amortization, and net carrying value as of December 31, 2012 and 2011 are as follows:


		December 31, 2012							December 31, 2011

($ in thousands)	Useful Life (in-yrs)	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount

Insurance licenses	-	$	19,003	$	-		$	19,003	$	19,003	$	-		$	19,003
Management contracts	-		54,600		-			54,600		54,600		-			54,600
Customer relationships	10-25		57,890		(26,754	)		31,136		57,890		(19,427	)		38,463
Trademarks	5		5,290		(3,261	)		2,029		5,290		(2,436	)		2,854

Total		$	136,783	$	(30,015	)	$	106,768	$	136,783	$	(21,863	)	$	114,920

Tower		$	128,283	$	(28,369	)	$	99,914	$	130,883	$	(20,802	)	$	110,081
Reciprocal Exchanges			8,500		(1,646	)		6,854		5,900		(1,061	)		4,839

Total		$	136,783	$	(30,015	)	$	106,768	$	136,783	$	(21,863	)	$	114,920

F-33

Tower Group, Inc.

Notes to Consolidated Financial Statements

The activity in the components of intangible assets for the years ended December 31, 2012 and 2011 consisted of intangible assets acquired from business combinations and amortization expense as shown in the table below:


($ in thousands)	Insurance Licenses		Management Contracts		Customer Relationships			Trademarks			Total

Balance, January 1, 2011	$	19,003	$	54,600	$	46,492		$	3,725		$	123,820
Additions		-		-		-			-			-
Deductions (a)		-		-		(8,029	)		(871	)		(8,900)

Balance, December 31, 2011	$	19,003	$	54,600	$	38,463		$	2,854		$	114,920

Tower	$	18,603	$	54,600	$	35,594		$	1,284		$	110,081
Reciprocal Exchanges		400		-		2,869			1,570			4,839

Total, December 31, 2011	$	19,003	$	54,600	$	38,463		$	2,854		$	114,920

Additions		-		-		-			-			-
Deductions (a)		-		-		(7,327	)		(825	)		(8,152)

Balance, December 31, 2012	$	19,003	$	54,600	$	31,136		$	2,029		$	106,768

Tower	$	16,003	$	54,600	$	28,600		$	711		$	99,914
Reciprocal Exchanges (b)		3,000		-		2,536			1,318			6,854

Total, December 31, 2012	$	19,003	$	54,600	$	31,136		$	2,029		$	106,768

(a) Amortization

(b) In 2012, Tower transferred a licensed insurance subsidiary shell to the Reciprocal Exchanges, as discussed in Note 2-Accounting Policies and Basis of Presentation. This resulted in classifying $2.6 million insurance licenses out of Tower and into the Reciprocal Exchange.

Intangible asset impairment testing and amortization

The Company performs an analysis annually as of September 30 to identify potential impairment of intangible assets with both definite and indefinite lives and measures the amount of any impairment loss that may need to be recognized. Intangible asset impairment testing requires an evaluation of the estimated fair value of each identified intangible asset to its carrying value. An impairment charge could be recorded if the estimated fair value is less than the carrying amount of the intangible asset. No impairments have been identified in the years ended December 31, 2012, 2011 and 2010.

The Company recorded amortization expense related to intangible assets with definite lives of $8.2 million, $8.9 million and $6.6 million in the years ended December 31, 2012, 2011 and 2010, respectively. The estimated amortization expense associated with these intangible assets for each of the next five years is:


			Reciprocal
($ in thousands)	Tower		Exchanges		Total

2013	$	6,791	$	517	$	7,308
2014		2,804		466		3,270
2015		2,253		405		2,658
2016		1,932		354		2,286
2017		1,716		311		2,027

F-34

Tower Group, Inc.

Notes to Consolidated Financial Statements

Note 10 - Deferred Acquisition Costs (“DAC”)

Acquisition costs incurred and policy-related ceding commission revenue are deferred and amortized to income on property and casualty business for the year ended December 31, 2012, 2011 and 2010 as follows:


	Year Ended December 31,

	2012									2011									2010

($ in thousands)	Tower (restated)			Reciprocal Exchanges			Total (restated)			Tower			Reciprocal Exchanges			Total			Tower			Reciprocal Exchanges			Total

Deferred acquisition costs, net, January 1	$	156,992		$	11,866		$	168,858		$	145,917		$	18,206		$	164,123		$	126,307		$	-		$	126,307
Acquisition date value of business acquired (“VOBA”) of acquired entities		-			-			-			-			-			-			23,492			17,301			40,793
Cost incurred and deferred:
Commissions and brokerage		298,701			31,266			329,967			279,699			31,837			311,536			240,428			20,465			260,893
Other underwriting and acquisition costs		68,238			7,467			75,705			64,416			5,896			70,312			87,715			13,500			101,215
Ceding commission revenue		(25,052	)		(15,878	)		(40,930	)		(20,082	)		(11,446	)		(31,528	)		(32,526	)		(7,232	)		(39,758)

Net costs incurred and deferred		341,887			22,855			364,742			324,033			26,287			350,320			295,617			26,733			322,350
Amortization		(329,045	)		(23,357	)		(352,402	)		(312,958	)		(32,627	)		(345,585	)		(299,499	)		(25,828	)		(325,327)

Deferred acquisition costs, net, December 31,	$	169,834		$	11,364		$	181,198		$	156,992		$	11,866		$	168,858		$	145,917		$	18,206		$	164,123

Note 11 - Reinsurance

The Company utilizes various excess of loss, quota share and catastrophe reinsurance programs to limit its exposure to a maximum loss on any one risk.

Under the terms of the excess of loss programs in 2012, Tower was at risk of loss for $5.0 million on property, $3.5 million on workers’ compensation and $2.5 million on umbrella. The Company then had reinsurance coverage up to $30 million for property, $60 million for workers’ compensation, and $5 million for umbrella. In addition, the Company also had “clash coverage” in effect for 2012 for a limit of $5 million in excess of $5 million which applies to the aggregate liability for liability losses from multiple insureds involved in the same occurrence.

Tower’s 2012 quota share reinsurance cedes 35.5% of the homeowners business written by the companies obtained in the OBPL transaction. This coverage has a $288 million per occurrence cap.

The Company also purchases property catastrophe reinsurance on an excess of loss basis above a specified retention to protect itself from an accumulation of losses resulting from a catastrophic event. At the July 1, 2012 renewal of its property catastrophe program, the Company maintained a retention of $75 million per catastrophe, had 100% catastrophe protection for the next $75 million of loss above the $75 million, 70% catastrophe protection for the next $75 million of loss over $150 million and 100% catastrophe protection for the next $700 million of loss in excess of $225 million.

In 2012 Tower purchased an Original Insured Market Loss Warranty basis, whereby the Company can recover up to the limit of the contract for its ultimate net loss arising from the windstorm peril in the Northeast in an event where the insured market loss exceeds a specified threshold.

In 2011, Tower was at risk of loss for the first $5.0 million on property, $2.5 million on workers’ compensation and $2.5 million on umbrella. The Company then had reinsurance coverage up to $30 million for property, $50 million for workers’ compensation, and $5 million for umbrella. In addition, the Company also had “clash coverage” in effect for 2012 for a limit of $5 million in excess of $5 million which applies to the aggregate liability for liability losses from multiple insureds involved in the same occurrence. The property catastrophe program renewed on July 1, 2011 had a retention of $75 million per catastrophe, had 60% catastrophe protection for the next $50 million of loss above the $75 million, and 100% percent catastrophe protection for the next $775 million of loss in excess of $125 million.

The Company maintains funds held liabilities under the liability quota share reinsurance agreements written in 2010 and prior years and is required to credit interest to the reinsurers with annual effective yields ranging from 2.5% to 4.0% on the monthly balance in the funds held liability accounts. The amounts credited for 2012, 2011 and 2010 were $3.9 million, $3.6 million and $2.7 million, respectively, and have been recorded as interest expense.

The Reciprocal Exchanges are not party to the reinsurance agreements discussed above, except for the homeowners quota share treaty whereby they cede 35.5% of homeowners business written. The Reciprocal Exchanges were covered under this treaty in 2012, 2011 and 2010. The Reciprocal Exchanges are also protected under a property catastrophe reinsurance cover placed on an excess of loss basis. In 2012, 2011 and 2010, this coverage was for 100% of $150 million in excess of a $10 million retention.

F-35

Tower Group, Inc.

Notes to Consolidated Financial Statements

Impact of Reinsurance on Premiums

The table below shows direct, assumed and ceded premiums for the years ended December 31, 2012, 2011 and 2010:


($ in thousands)	Direct (restated)			Assumed			Ceded			Net (restated)

2012
Premiums written	$	1,755,157		$	215,915		$	231,691		$	1,739,381
Change in unearned premiums		3,969			(31,370	)		(9,884	)		(17,517)

Premiums earned	$	1,759,126		$	184,545		$	221,807		$	1,721,864


2011
Premiums written	$	1,692,282		$	118,642		$	172,333		$	1,638,591
Change in unearned premiums		(8,262	)		(12,890	)		23,589			(44,741)

Premiums earned	$	1,684,020		$	105,752		$	195,922		$	1,593,850


2010
Premiums written	$	1,432,177		$	64,194		$	182,307		$	1,314,064
Change in unearned premiums		(2,927	)		26,195			44,663			(21,395)

Premiums earned	$	1,429,250		$	90,389		$	226,970		$	1,292,669

Reinsurance Balances

As of December 31, 2012 and 2011, the Company had $495.9 million and $333.0 million, respectively, of reinsurance recoverables with reinsurers rated A- or higher by A.M. Best. These represented 91.7% and 90.1%, respectively, of the Company’s total reinsurance recoverables as of those dates. As of December 31, 2012 and 2011, the largest reinsurance recoverable balance with any one reinsurer was approximately 8.6% and 9.4% of the Company’s stockholders’ equity.

The Company did not record any modifications of its reinsurance recoverables on paid or unpaid losses in the years ended December 31, 2012, 2011 or 2010. The Company recorded no allowance for credit losses on its reinsurance recoverables on paid or unpaid losses as of December 31, 2012 or 2011. The Company did not consider that any of its undisputed reinsurance recoverables on paid or unpaid losses as of years ended December 31, 2012 and 2011 to be past due. As discussed in “Note 18 – Contingencies”, certain reinsurance agreements are subject to legal proceedings.

Under certain reinsurance agreements, collateral and letters of credit (“collateral”) are held to secure performance of reinsurers in meeting their obligations. The amount of such collateral was $189.6 million and $161.9 million at December 31, 2012 and 2011, respectively. The collateral we hold does not apply to our entire outstanding reinsurance recoverable. Rather, collateral is provided on an individual basis. For each individual reinsurer, the collateral held may exceed or fall below the total outstanding recoverable from that individual reinsurer.

Ceding Commission Revenue

The Company earns ceding commission revenue under certain quota share reinsurance agreements. In addition, the commission revenue earned on prior reinsurance agreements continue to be adjusted based on a sliding scale of commission rates and ultimate treaty year loss ratios on the policies reinsured under each of these agreements. The sliding scale includes minimum and maximum commission rates in relation to specified ultimate loss ratios. The commission rate and ceding commissions earned increase when the estimated ultimate loss ratio decreases, and conversely, the commission rate and ceding commissions earned decrease when the estimated ultimate loss ratio increases.

The estimated ultimate loss ratios are the Company’s best estimate based on facts and circumstances known at the end of each period that losses are estimated. The estimation process is complex and involves the use of informed estimates, judgments and actuarial methodologies relative to future claims severity and frequency, the length of time for losses to develop to their ultimate level, possible changes in law and other external factors. The same uncertainties associated with estimating loss and loss adjustment expense reserves affect the estimates of ceding commissions earned. The Company monitors and adjusts the ultimate loss ratio on a quarterly basis to determine the effect on the commission rate and ceding commissions earned. The decrease in estimated ceding commission income relating to prior years recorded in 2012, 2011 and 2010 was $4.5 million, $0.1 million and $2.2 million, respectively.

F-36

Tower Group, Inc.

Notes to Consolidated Financial Statements

Note 12—Loss and Loss Adjustment Expense

The components of the liability for loss and LAE expenses and related reinsurance recoverables for the years ended December 31, 2012 and 2011 are as follows:


	Tower				Reciprocal Exchanges				Total
($ in thousands)	Gross Liability (restated)		Reinsurance Recoverable (restated)		Gross Liability		Reinsurance Recoverable		Gross Liability (restated)		Reinsurance Recoverable (restated)

December 31, 2012
Case-basis reserves	$	913,411	$	79,911	$	63,465	$	10,160	$	976,876	$	90,071
IBNR reserves		846,477		327,157		72,326		42,229		918,803		369,386
Recoverable on paid losses		-		16,927		-		682		-		17,609

Total, December 31, 2012	$	1,759,888	$	423,995	$	135,791	$	53,071	$	1,895,679	$	477,066

December 31, 2011
Case-basis reserves	$	766,275	$	135,686	$	82,203	$	7,916	$	848,478	$	143,602
IBNR reserves		729,564		145,282		54,071		3,337		783,635		148,619
Recoverable on paid losses		-		17,793		-		5,670		-		23,463

Total, December 31, 2011	$	1,495,839	$	298,761	$	136,274	$	16,923	$	1,632,113	$	315,684

The following tables provide a reconciliation of the beginning and ending consolidated balances for unpaid losses and LAE for the years ended December 31, 2012, 2011 and 2010:


	Year Ended December 31,
	2012									2011
($ in thousands)	Tower (restated)			Reciprocal Exchanges			Total (restated)			Tower (restated)			Reciprocal Exchanges			Total (restated)

Balance at January 1,	$	1,495,839		$	136,274		$	1,632,113		$	1,439,106		$	171,315		$	1,610,421
Less reinsurance recoverables on unpaid losses		(280,968	)		(11,253	)		(292,221	)		(265,592	)		(11,384	)		(276,976)

		1,214,871			125,021			1,339,892			1,173,514			159,931			1,333,445
Net reserves, at fair value, of acquired entities		-			-			-			-			-			-
Incurred related to:
Current year		1,066,411			118,099			1,184,510			933,791			142,254			1,076,045
Prior years unfavorable/(favorable) development		88,129			(8,881	)		79,248			38,776			(37,835	)		941

Total incurred		1,154,540			109,218			1,263,758			972,567			104,419			1,076,986
Paid related to:
Current year		431,437			98,682			530,119			337,268			59,078			396,346
Prior years		585,154			52,155			637,309			593,942			80,251			674,193

Total paid		1,016,591			150,837			1,167,428			931,210			139,329			1,070,539

Net balance at end of period		1,352,820			83,402			1,436,222			1,214,871			125,021			1,339,892
Add reinsurance recoverables on unpaid losses		407,068			52,389			459,457			280,968			11,253			292,221

Balance at December 31,	$	1,759,888		$	135,791		$	1,895,679		$	1,495,839		$	136,274		$	1,632,113



	2010
($ in thousands)	Tower (revised)			Reciprocal Exchanges			Total (revised)

Balance at January 1,	$	1,131,989		$	-		$	1,131,989
Less reinsurance recoverables on unpaid losses		(199,687	)		-			(199,687)

		932,302			-			932,302
Net reserves, at fair value, of acquired entities		193,484			158,652			352,136
Incurred related to:
Current year		724,254			72,059			796,313
Prior years unfavorable/(favorable) development		3,273			(9,857	)		(6,584)

Total incurred		727,527			62,202			789,729
Paid related to:
Current year		278,859			46,276			325,135
Prior years		400,940			14,647			415,587

Total paid		679,799			60,923			740,722

Net balance at end of period		1,173,514			159,931			1,333,445
Add reinsurance recoverables on unpaid losses		265,592			11,384			276,976

Balance at December 31,	$	1,439,106		$	171,315		$	1,610,421

F-37

Tower Group, Inc.

Notes to Consolidated Financial Statements

Incurred losses and LAE for the year ended December 31, 2012 attributable to insured events of prior years increased by $79.2 million. Excluding the Reciprocal Exchanges the incurred losses and LAE increased by $88.1 million.

The consolidated net loss ratio, which includes the Reciprocal Exchanges, was 73.4% and 67.6% for the years ended December 31, 2012 and 2011, respectively. Excluding the Reciprocal Exchanges, the net loss ratio was 74.1% and 69.1% for the years ended December 31, 2012 and 2011, respectively. The Reciprocal Exchanges’ net loss ratio was 66.7% and 55.8% for the years ended December 31, 2012 and 2011, respectively.

Excluding the Reciprocal Exchanges, the 2012 net loss and loss adjustment expenses included $101.0 million from claims related to Superstorm Sandy.

Excluding the Reciprocal Exchanges, there was reserve strengthening of $88.1 million for the year ended December 31, 2012 comprised of reserve strengthening in Personal Insurance of $4.0 million and adverse development in Commercial Insurance of $84.1 million.

The reserve strengthening in Commercial Insurance included $56.6 million in workers compensation, $22.5 million in commercial automobile liability and $5.0 million in other lines. The reserve strengthening in Personal Insurance was comprised mainly of $4.6 million for homeowners, $1.2 million for other liability, and $5.4 million for other lines, partially offset by $7.2 million for amortization of reserves risk premium, principally relating to reserves acquired in the OBPL transaction. For the Reciprocal Exchanges, the favorable development was $8.9 million, comprised of favorable development of $3.1 million for homeowners, $1.6 million for private passenger automobile liability, $1.7 million for other lines, and $2.5 million for amortization of reserves risk premium.

Prior year development is based upon numerous estimates by line of business and accident year. No additional premiums or return premiums have been accrued as a result of the prior year effects, although we recorded changes in ceding commissions on reinsurance treaties for which the ceding commissions depend in part on loss experience. The Company’s management continually monitors claims activity to assess the appropriateness of carried case and incurred but not reported (“IBNR”) reserves, giving consideration to Company and industry trends.

Incurred losses and LAE for the years ended December 31, 2012 and 2011 included reductions in loss and loss expense reserves pertaining to the amortization of the reserve risk premium on loss reserves recorded in connection with the Company’s acquisitions in prior years. Excluding the Reciprocal Exchanges these reductions in loss reserves were $7.2 million and $3.7 million, respectively, for 2012 and 2011. The Reciprocal Exchanges had reductions in loss reserves of $2.5 million and $1.2 million, respectively, for 2012 and 2011.

Loss and loss adjustment expense reserves. The reserving process for loss and LAE reserves provides management’s best estimate at a particular point in time of the ultimate unpaid cost of all losses and LAE incurred, including settlement and administration of losses, and is based on facts and circumstances then known and including losses that have been incurred but not yet reported. The process includes using actuarial methodologies to assist in establishing these estimates, judgments relative to estimates of future claims severity and frequency, the length of time before losses will develop to their ultimate level and the possible changes in the law and other external factors that are often beyond our control. There are various actuarial methods that are appropriate for the different lines of business, and our actuaries’ use of a particular method or weighting of methods depends in part on the maturity of each accident year by line of business, the limits of liability covered under the policies, the presence or absence of large claims in the experience, and other considerations. In general, the various actuarial methods can be grouped into three categories: loss ratio projection, loss development methods, and the Bornhuetter-Ferguson (“B-F”) method. For the most recent accident year, and especially for liability lines of business, the actuarial method given the most weight is usually the loss ratio method, since the percentage of ultimate claims reported to date is expected to be low and the immature reported claims experience is not a reliable indicator of ultimate losses for that accident year. For property lines of business for the most recent accident year, the B-F method is usually given the most weight, because experience typically shows that there is a small percentage of claims reported in the subsequent period due to normal lags in reporting and processing of claims in these lines of business that can be relatively reliably estimated as a percentage of premiums, which is reflected in the B-F method. For each line of business, the actuarial reserving method usually given the most weight shifts from the loss ratio projection to the B-F method to the incurred loss projection as each accident year matures. These methods are described in “Business—Loss and Loss Adjustment Expense Reserves.”

F-38

Tower Group, Inc.

Notes to Consolidated Financial Statements

In most cases, our data are sufficiently credible to determine loss development factors utilizing our own data. In some cases, we supplement our own loss development experience with industry data and utilize historical loss development experience for particular books of business, programs or treaties obtained from our sources. The loss development factors are reviewed at least annually, and whenever there is a significant change in the underlying business. Each quarter we test the loss development by analyzing actual emerging claims compared to expected development.

Because of the nature of the business historically written, the Company’s management believes that the Company has limited exposure to environmental claim liabilities.

F-39

Tower Group, Inc.

Notes to Consolidated Financial Statements

Note 13—Stockholders’ Equity

Shares of Common Stock Issued

For the years ended December 31, 2012 and 2011, 0 and 39,215 new common shares, respectively, were issued as the result of employee stock option exercises and 422,176 and 741,185 new common shares, for the same periods, respectively, were issued as the result of restricted stock grants.

For the years ended December 31, 2012 and 2011, 117,377 and 89,203 shares, respectively, of common stock were purchased from employees in connection with the vesting of restricted stock issued under the 2004 Long Term Equity Compensation Plan (the “Plan”). The shares were withheld at the direction of employees as permitted under the Plan in order to pay the expected amount of tax liability owed by the employees from the vesting of those shares. In addition, for the years ended December 31, 2012 and 2011, 28,513 and 21,346 shares, respectively, of common stock were surrendered as a result of restricted stock forfeitures.

Share Repurchase Program

The Board of Directors of Tower approved a $100 million share repurchase program on March 3, 2011. This authorization is in addition to the $100 million share repurchase program approved on February 26, 2010. Purchases under both programs can be made from time to time in the open market or in privately negotiated transactions in accordance with applicable laws and regulations. The new share repurchase program will expire on March 4, 2013. In the year ended December 31, 2012, 1.2 million shares of common stock were purchased under these programs at an aggregate consideration of $21.0 million. In the year ended December 31, 2011, 3.3 million shares were purchased under these programs at an aggregate consideration of $64.6 million. As of December 31, 2012, the original $100 million share purchase program had been fully utilized and $26.4 million remained available for future share repurchases under the new program.

Dividends Declared

Dividends on common stock and unvested participating restricted stock of $29.1 million, $27.9 million and $16.6 million for the years ended December 31, 2012, 2011 and 2010, respectively, were declared and paid.

On January 30, 2013, the Board of Directors approved a quarterly dividend of $0.1875 per share (or, $0.165 after adjusting for the Merger Transaction conversion ratio of 1.1330) payable on February 28, 2013 to stockholders of record as of February 14, 2013.

Note 14—Debt

The Company’s borrowings consisted of the following at December 31, 2012 and 2011:


	December 31, 2012				December 31, 2011
($ in thousands)	Carrying Value		Fair Value		Carrying Value		Fair Value

Credit facility	$	70,000	$	70,000	$	50,000	$	50,000
Convertible senior notes		144,673		152,063		141,843		150,743
Subordinated debentures		235,058		232,678		235,058		234,550

Total	$	449,731	$	454,741	$	426,901	$	435,293

The fair value of the convertible senior notes are determined utilizing recent transaction prices for these securities between third-party market participants and the fair value of the subordinated debentures are based on discounted cash flow analysis. The significant inputs used for fair value are considered Level 2 in the fair value hierarchy.

F-40

Tower Group, Inc.

Notes to Consolidated Financial Statements

Aggregate Scheduled Maturities and Interest Expense

Aggregate scheduled maturities of the Company’s borrowings at December 31, 2012 are:


($ in thousands)

2013	$	70,000
2014		150,000 (a)
2033		20,620
2034		25,775
2035		13,403
2036		123,713
2037		51,547

	$	455,058

(a) Amount reflected in balance sheet for convertible senior notes is net of unamortized original issue discount of $5.3 million

Total interest expense incurred, including interest expense on the funds held liabilities disclosed in “Note 11 – Reinsurance”, was $32.6 million, $34.3 million and $24.2 million for the years ended December 31, 2012, 2011 and 2010, respectively.

Subordinated Debentures

The Company and its wholly-owned subsidiaries have issued trust preferred securities through wholly-owned Delaware statutory business trusts. The trusts use the proceeds of the sale of the trust preferred securities and common securities that the Company acquired from the trusts to purchase junior subordinated debentures from the Company with terms that match the terms of the trust preferred securities. Interest on the junior subordinated debentures and the trust preferred securities is payable quarterly. In some cases, the interest rate is fixed for an initial period of five years after issuance and then floats with changes in the London Interbank Offered Rate (“LIBOR”) and in other cases the interest rate floats with LIBOR without any initial fixed-rate period. The principal terms, before any effects of interest rate swaps, of the outstanding trust preferred securities, including those which were assumed by the Company through acquisitions, are summarized in the following table:

($ in millions)

Issue Date

Issuer

Maturity Date

Early

Redemption

Interest Rate

Amount of
Investment
in Common
Securities
of Trust

Principal
Amount of
Junior
Subordinated
Debenture
Issued to
Trust

May 2003

Tower Group Statutory Trust I

May 2033

At our option at par on or after May 15, 2008

Three-month LIBOR plus 410 basis points

$0.3

$10.3

September 2003

Tower Group Statutory Trust II

September 2033

At our option at par on or after September 30, 2008

Three-month LIBOR plus 400 basis points

$0.3

$10.3

May 2004

Preserver Capital Trust I

May 2034

At our option at par on or after May 24, 2009

Three-month LIBOR plus 425 basis points

$0.4

$12.4

December 2004

Tower Group Statutory Trust III

December 2034

At our option at par on or after December 15, 2009

Three-month LIBOR plus 340 basis points

$0.4

$13.4

December 2004

Tower Group Statutory Trust IV

March 2035

At our option at par on or after March 15, 2010

Three-month LIBOR plus 340 basis points

$0.4

$13.4

March 2006

Tower Group Statutory Trust V

April 2036

At our option at par on or after April 7, 2011

Three-month LIBOR plus 330 basis points

$0.6

$20.6

January 2007

Tower Group Statutory Trust VI

March 2037

At our option at par on or after March 15, 2012

8.16% until March 14, 2012; three-month LIBOR plus 300 basis points thereafter

$0.6

$20.6

September 2007

CastlePoint Bermuda Capital Trust I

December 2037

At our option at par on or after December 15, 2012

8.39% until December 14, 2012; three-month LIBOR plus 350 basis points thereafter.

$0.9

$30.9

December 2006

CastlePoint Management Statutory Trust II

December 2036

At our option at par on or after December 15, 2011

Three-month LIBOR plus 350 basis points

$1.6

$51.6

December 2006

CastlePoint Management Statutory Trust I

December 2036

At our option at par on or after December 15, 2011

Three-month LIBOR plus 350 basis points

$1.6

$51.6

Total

$7.1

$235.1

F-41

Tower Group, Inc.

Notes to Consolidated Financial Statements

Interest Rate Swaps

In October 2010, the Company entered into interest rate swap contracts (the “Swaps”) with $190 million notional value to manage interest costs and cash flows associated with the floating rate subordinated debentures. The Swaps have terms of five years. The majority of the Swaps is forward starting and become effective when the respective subordinated debentures change from fixed to floating rates and convert the subordinated debentures to fixed rates ranging from 5.1% to 5.9%. As of December 31, 2012 and 2011, the Swaps had a fair value of $9.0 million and $7.4 million, respectively, in a liability position and are reported in Other Liabilities.

The Company has designated and accounts for the Swaps as cash flow hedges. The Swaps are considered to have no ineffectiveness and changes in their fair values will be recorded in Accumulated Other Comprehensive Income (“AOCI”), net of tax. For the years ended December 31, 2012, 2011 and 2010, $1.6 million, $0.4 million and $18,000, respectively, was reclassified from AOCI to interest expense for the effects of the hedges. As of December 31, 2012 and 2011, the Company had collateral on deposit with the counterparty amounting to $9.1 million and $7.0 million, respectively, pursuant to its Credit Support Annex.

Credit Facility

On February 15, 2012, the Company amended its $125.0 million credit facility with Bank of America, N.A. and the other lenders named therein by increasing borrowing capacity up to $150 million, extending the maturity date to February 15, 2016, and resetting borrowing fees to more favorable current market terms. The credit facility is used for general corporate purposes. The original credit facility was entered into on May 14, 2010 and had an expiration date of May 14, 2013.

On November 26, 2012, the Company further amended its credit facility whereby the lenders provided consent to the proposed merger of the Company with a subsidiary of Canopius Holdings Bermuda Limited that the Company expects to consummate (see “Note 4-Investment in Canopius Group Limited and Exercise of Merger Option”). The second amendment also increases the Company’s maximum revolving commitment by $70 million to $220 million upon the effectiveness of the Merger and the satisfaction of certain other conditions set forth in the Second Amendment.

The credit facility contains customary covenants for facilities of this type, including restrictions on indebtedness and liens, limitations on mergers, dividends and the sale of assets, and requirements to maintain certain consolidated net worth, debt to capitalization ratios, minimum risk-based capital and minimum statutory surplus. The credit facility also provides for customary events of default, including failure to pay principal when due, failure to pay interest or fees within three days after becoming due, failure to comply with covenants, any representation or warranty made by the Company being false in any material respect, default under certain other indebtedness, certain insolvency or receivership events affecting the Company and its material subsidiaries, the occurrence of certain material judgments, or a change in control of the Company, and upon an event of default the administrative agent (subject to the consent of the requisite percentage of the lenders) may immediately terminate the obligations to make loans and to issue letters of credit, declare the Company’s obligations under the credit facility to become immediately due and payable, and require the Company to deposit in a collateral account cash collateral with a value equal to the then outstanding amount of the aggregate face amount of any outstanding letters of credit. The Company was in compliance with all covenants under the credit facility at December 31, 2012.

Fees payable by the Company under the credit facility include a fee on the daily unused portion of each letter of credit, a letter of credit fronting fee with respect to each fronted letter of credit and a commitment fee.

The Company had $70.0 million and $50.0 million outstanding as of December 31, 2012 and 2011, respectively. The weighted average interest rate on the amount outstanding as of December 31, 2012 and 2011 was 2.0% and 3.5%, respectively.

See Liquidity in “Note 1—Nature of Business” for more detail.

Convertible Senior Notes

In September 2010, the Company issued $150.0 million principal amount of 5.0% convertible senior notes (“the Notes”), which mature on September 15, 2014. Interest on the Notes is payable semi-annually in arrears on March 15 and September 15 of each year, commencing March 15, 2011. Holders may convert their Notes into cash or common shares, at the Company’s option, at any time on or after March 15, 2014 or earlier under certain circumstances determined by: (i) the market price of the Company’s stock, (ii) the trading price of the Notes, or (iii) the occurrence of specified corporate transactions. Upon conversion, the Company intends to settle its obligation either entirely or partially in cash.

The adjusted conversion rate at December 31, 2012 is 37.1689 shares of common stock per $1,000 principal amount of the Notes (equivalent to a conversion price of $26.90 per share), subject to further adjustment upon the occurrence of certain events,

F-42

Tower Group, Inc.

Notes to Consolidated Financial Statements

including the following: if Tower issues shares of common stock as a dividend or distribution on shares of the common stock , or if Tower effects a share split or share combination; if Tower issues to all or substantially all holders of common stock any rights, options or warrants entitling them, for a period of not more than 45 calendar days after the announcement date of such issuance, to subscribe for or purchase shares of the common stock at a price per share that is less than the average of the last reported sales price of the common stock for the ten consecutive trading day period ending on the date of announcement of such issuance; if Tower distributes shares of its capital stock, other indebtedness, other assets or property of Tower or rights, options or warrants to acquire capital stock or other securities of Tower, to all or substantially all holders of capital stock; if any cash dividend or distribution is made to all or substantially all holders of the common stock, other than a regular quarterly cash dividend that does not exceed $0.125 per share; if Tower makes a payment in respect of a tender offer or exchange offer for common stock, and the cash and value of any other consideration included in the payment per share of common stock exceeds the last reported sale price of the common stock on the trading day next succeeding the last day on which the tenders or exchange may be made. In February 2013, the conversion rate was adjusted to 37.2895, equivalent to a conversion price of $26.82 per share.

Additionally, in the event of a fundamental change, the holders may require the Company to repurchase the Notes for a cash price equal to 100% of the principal plus any accrued and unpaid interest.

The proceeds from the issuance of the Notes were allocated to the liability component and the embedded conversion option, or equity component. The equity component was reported as an adjustment to paid-in-capital, net of tax, and is reflected as an original issue discount (“OID”). The OID of $11.5 million and $5.0 million of deferred origination costs relating to the liability component are being amortized into interest expense over the term of the Notes. After considering the contractual interest payments and amortization of the original issue discount, the Notes’ effective interest rate is 7.2%. Transaction costs of $0.4 million associated with the equity component were netted with the equity component in paid-in-capital. Interest expense, including amortization of deferred origination costs, recognized on the Notes was $11.6 million for the year ended December 31, 2012.

The following table shows the amounts recorded for the Notes as of December 31, 2012 and 2011:


	December 31,
($ in thousands)	2012			2011

Liability component
Outstanding principal	$	150,000		$	150,000
Unamortized OID		(5,327	)		(8,157)

Liability component		144,673			141,843

Equity component, net of tax	$	7,469		$	7,469

To the extent the market value per share of the Company’s common stock exceeds the conversion price, the Company will use the “treasury stock” method in calculating the dilutive effect on earnings per share.

Convertible Senior Notes Hedge and Warrant Transactions

In connection with the offering of the Notes, the Company also entered into convertible senior notes hedge transactions (the “Note Hedges” or “purchased call options”) and warrant transactions (the “Warrants”) with respect to its common stock with financial institutions. The Note Hedges and Warrants are intended generally to reduce the potential dilution of the Company’s common stock and to offset potential cash payments in excess of the principal of the Notes upon conversion. The Note Hedges and Warrants are separate transactions, entered into by the Company with the financial institutions, and are not part of the terms of the Notes.

In September 2010, the Company paid $15.3 million for the Note Hedges which cover 5.5 million shares of common stock at a strike price of $26.90 per share at December 31, 2012, subject to anti-dilution provisions, and are exercisable upon conversion of the Notes. The Note Hedges have been accounted for as an adjustment to the Company’s paid-in-capital, net of deferred taxes.

In September 2010, the Company received $3.8 million for Warrants sold to the financial institutions. The Warrants provide for the acquisition of 5.5 million shares of common stock at a strike price of $32.71 per share at December 31, 2012, subject to anti-dilution adjustments. The Warrants have been accounted for as an adjustment to the Company’s paid-in-capital.

To the extent the Company’s common stock price is above $26.90 but below the Warrant strike price of $32.71, there is no dilutive effect to common stockholders’ equity because the Note Hedge offsets any shares to be issued under the Notes. If the market value per share of the Company’s common stock exceeds the strike price of the Warrants, the Warrants will have a dilutive effect on the Company’s net income per share.

F-43

Tower Group, Inc.

Notes to Consolidated Financial Statements

Note 15—Stock Based Compensation

2008 Long-Term Equity Compensation Plan (“2008 LTEP”)

In 2008, the Company’s Board of Directors adopted and its stockholders approved the 2008 LTEP, which amended and revised the 2004 Long-Term Equity Compensation Plan.

The 2008 LTEP provides for the granting of non-qualified stock options, incentive stock options (within the meaning of Section 422 of the Code), stock appreciation rights (“SARs”), restricted stock and restricted stock unit awards, performance shares and other cash or share-based awards. The maximum amount of share-based awards authorized is 2,634,730 of which 261,658 are available for future grants as of December 31, 2012.

2013 Long-Term Incentive Plan (“2013 LTIP”)

The Compensation Committee of the Board of Directors has established, beginning in 2013 and subject to stockholder approval, a new Long Term Incentive Plan (the “2013 LTIP”), to replace the Company’s existing 2008 Long Term Equity Compensation Plan.

Shares and Options Granted

The following table provides information with respect to the stock options and shares of the Company’s common stock issued (i) to the Company’s employees under the 2004 LTEP and (ii) to employees and directors of companies acquired by the Company in exchange for the options and shares owned by such employees and directors in such companies at the time of acquisition. The historical shares have been adjusted for the 1.1330 conversion ratio resulting from the Merger Transaction described in “Note 3—Accounting Policies and Procedures.”


	Year Ended December 31,

	2012		2011		2010
	(revised)		(revised)		(revised)

Granted under the Plan (excludes shares and options issued with respect to acquisitions)
Restricted stock		422,176		741,185		402,825
Stock options, at fair value		-		-		-

		422,176		741,185		402,825

Issued restricted stock and stock options from acquisitions		-		-		-

Total		422,176		741,185		402,825

F-44

Tower Group, Inc.

Notes to Consolidated Financial Statements

Restricted Stock

The following table provides an analysis of restricted stock activity for the years ended December 31, 2012, 2011 and 2010:


	Year Ended December 31,

	2012					2011					2010

	Number of Shares			Weighted Average Grant Date Fair Value		Number of Shares			Weighted Average Grant Date Fair Value		Number of Shares			Weighted Average Grant Date Fair Value
	(revised)			(revised)		(revised)			(revised)		(revised)			(revised)

Outstanding, January 1		1,120,090		$	20.69		670,366		$	20.39		537,066		$	21.75
Granted		422,176			19.77		741,185			21.01		402,825			19.28
Vested		(497,851	)		20.94		(270,115	)		20.79		(236,858	)		21.57
Forfeitures		(28,513	)		20.69		(21,346	)		20.84		(32,667	)		20.48

Outstanding, December 31,		1,015,902		$	20.38		1,120,090		$	20.69		670,366		$	20.39

Stock Options

The following table provides an analysis of stock option activity for the years ended December 31, 2012, 2011 and 2010:


	Year Ended December 31,

	2012				2011					2010

	Number of Shares		Average Exercise Price		Number of Shares			Average Exercise Price		Number of Shares			Average Exercise Price
	(revised)		(revised)		(revised)			(revised)		(revised)			(revised)

Outstanding, January 1		969,307	$	17.78		1,039,127		$	17.66		1,571,482		$	17.32
Exercised		-		-		(39,215	)		9.48		(274,377	)		5.86
Forfeitures and expirations		-		-		(30,605	)		24.35		(257,978	)		28.14

Outstanding, December 31		969,307	$	17.78		969,307		$	17.78		1,039,127		$	17.66

Exercisable, December 31		969,307	$	17.78		969,307		$	17.78		976,579		$	17.73

All options outstanding as of December 31, 2012 are fully exercisable as shown on the following table:


	Options Outstanding					Options Exercisable
Range of Exercise Prices	Number of Shares		Average Remaining Contractual Life (Years)	Average Exercise Price		Number of Shares	Average Exercise Price
	(revised)		Average Remaining Contractual Life (Years)	(revised)		(revised)	(revised)

$10.01 - $20.00		778,828	3.6	$	16.33	778,828	$ 16.33
$20.01 - $30.00		188,365	5.1		23.64	188,365	23.64
$30.01 - $40.00		2,114	2.1		30.35	2,114	30.35

Total Options		969,307	3.9	$	17.78	969,307	$ 17.78

F-45

Tower Group, Inc.

Notes to Consolidated Financial Statements

The fair value of the options granted to replace the CastlePoint options was estimated using the Black-Scholes pricing model as of February 5, 2009, the date of conversion from CastlePoint stock options to the Company’s stock options, with the following weighted average assumptions: risk free interest rate of 1.46% to 1.83%, dividend yield of 0.8%, volatility factors of the expected market price of the Company’s common stock of 43.8% to 45.3%, and a weighted-average expected life of the options of 3.3 to 5.3 years.

The fair value of the options granted to replace the SUA options was estimated using the Black-Scholes pricing model as of November 13, 2009, the date of conversion from SUA stock options to the Company’s stock options, with the following weighted average assumptions: risk free interest rate of 1.66%, dividend yield of 1.2%, volatility factors of the expected market price of the Company’s common stock of 43.8%, and a weighted-average expected life of the options of 1.4 years.

The fair value measurement objective of the relevant GAAP guidance is achieved using the Black-Scholes model as the model (a) is applied in a manner consistent with the fair value measurement objective and other requirements of GAAP, (b) is based on established principles of financial economic theory and generally applied in that field and (c) reflects all substantive characteristics of the instrument.

Stock Based Compensation Expense

The following table provides an analysis of stock based compensation expense for the years ended December 31, 2012, 2011 and 2010:


	Year Ended December 31,

($ in thousands)	2012		2011		2010

Restricted stock
Expense, net of tax	$	6,043	$	6,126	$	3,792
Value of shares vested		9,485		5,622		4,673
Value of unvested shares		15,967		19,940		15,147
Stock options
Expense, net of tax		-		105		293
Intrinsic value of outstanding options		1,149		1,150		5,408
Intrinsic value of vested outstanding options		1,149		1,150		5,025
Unrecognized compensation expense
Non-vested stock options, net of tax		-		-		105
Unvested restricted stock, net of tax		8,262		9,617		6,097
Weighted average years expense will be recognized		2.1		2.3		3.1

Note 16—Income Taxes

The Company files a consolidated Federal income tax return. The Reciprocal Exchanges are not included in the Company’s consolidated tax return as the Company does not have an ownership interest in the Reciprocal Exchanges, and they are not a part of the consolidated tax sharing agreement.

The provision for Federal, state and local income taxes consist of the following components for the years ended December 31, 2012, 2011 and 2010:


	Year ended December 31,

	2012						2011						2010

($ in thousands)	Tower (restated)		Reciprocal Exchanges (restated)		Total (restated)		Tower (restated)		Reciprocal Exchanges		Total (restated)		Tower (revised)		Reciprocal Exchanges		Total (revised)

Current Federal income tax expense (benefit)	$	(17,400)	$	593	$	(16,807)	$	6,951	$	1,510	$	8,461	$	(11,186)	$	(2,380)	$	(13,566)
Current state income tax expense (benefit)		200		-		200		(257)		-		(257)		1,292		-		1,292
Deferred Federal and state income tax (benefit)		(9,872)		(2,620)		(12,492)		4,175		1,672		5,847		60,945		917		61,862

Provision for income taxes	$	(27,072)	$	(2,027)	$	(29,099)	$	10,869	$	3,182	$	14,051	$	51,051	$	(1,463)	$	49,588

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 provided benefits from 100% accelerated depreciation of fixed assets. As a result, the Company’s current Federal income tax benefit for the year ended

F-46

Tower Group, Inc.

Notes to Consolidated Financial Statements

December 31, 2011 includes a refund from prior year overpayments and benefits from the 100% acceleration of depreciation of fixed assets placed in service after September 8, 2010 as allowed by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. This 100% acceleration provision expired on December 31, 2011, and the Company is back to a 50% acceleration of depreciation of fixed assets.

Deferred tax assets and liabilities are determined using the enacted tax rates applicable to the period the temporary differences are expected to be recovered. Accordingly, the current period income tax provision can be affected by the enactment of new tax rates. The net deferred income taxes on the balance sheet reflect temporary differences between the carrying amounts of the assets and liabilities for financial reporting purposes and income tax purposes. Significant components of the consolidated deferred tax assets and liabilities are as follows:


	December 31,

	2012									2011

($ in thousands)	Tower (restated)			Reciprocal Exchanges (restated)			Total (restated)			Tower (restated)			Reciprocal Exchanges			Total (restated)

Deferred tax assets:
Claims reserve discount	$	44,528		$	1,747		$	46,275		$	42,018		$	2,691		$	44,709
Unearned premium		55,134			5,928			61,062			53,337			6,139			59,476
Equity compensation plans		6,072			-			6,072			5,806			-			5,806
Investment impairments		2,316			15			2,331			3,754			78			3,832
Net operating loss carryforwards		32,584			4,830			37,414			22,797			2,729			25,526
Convertible senior note and note hedge OID		618			-			618			946			-			946
AMT credits		1,846			508			2,354			197			-			197
Fair value of interest rate swap		3,155			-			3,155			2,584			-			2,584
Bad debt reserves		5,793			22			5,815			4,865			21			4,886
Deferred rent		1,905			-			1,905			74			-			74
Merger Option, SPS Transaction Right and Acquisition Right		3,710			-			3,710			-			-			-
Other		1,489			993			2,482			976			1,071			2,047

Total gross deferred tax assets		159,150			14,043			173,193			137,354			12,729			150,083
Less: valuation allowance		2,258			4,726			6,984			1,896			5,065			6,961

Total deferred tax assets		156,892			9,317			166,209			135,458			7,664			143,122

Deferred tax liabilities:
Deferred acquisition costs net of deferred ceding commission revenue		59,387			3,864			63,251			54,955			4,034			58,989
Depreciation and amortization		44,919			2,357			47,276			40,101			789			40,890
Net unrealized appreciation of securities and deferred intercompany gains		46,953			5,791			52,744			36,085			4,003			40,088
Accrual of bond discount		5,034			-			5,034			5,537			-			5,537
Surplus notes		1,800			17,024			18,824			1,081			17,744			18,825
Unconsolidated affiliate		3,843			-			3,843			-			-			-
Other		-			-			-			37			-			37

Total deferred tax liabilities		161,936			29,036			190,972			137,796			26,570			164,366

Net deferred income tax asset (liability)	$	(5,044	)	$	(19,719	)	$	(24,763	)	$	(2,338	)	$	(18,906	)	$	(21,244)

In assessing the valuation of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible.

Preserver Group, Inc. (“PGI”), acquired by the Company in 2007 and CastlePoint , acquired in 2009, have net operating tax loss carryforwards (“NOLs”). Section 382 of the Internal Revenue Code (“Section 382”) limits ability of a corporation to offset income using NOLs generated prior to a “change in ownership”. We will perform a Section 382 limitation calculation if required based on the change of ownership resulting from the anticipated merger with Canopius. The Company expects the NOLs will be used in the future, subject to change of ownership limitations pursuant to Section 382. As of December 31, 2012, the Tower NOL totaled $93.1 million. This included PGI and CastlePoint NOLs as follows: $33.4 million and $7.1 million, respectively. In addition, the Reciprocal Exchanges have NOLs of $14.2 million.

F-47

Tower Group, Inc.

Notes to Consolidated Financial Statements

Section 382 imposes annual limitations on a corporation’s ability to utilize its NOLs if it experiences an “ownership change.” As a result of the acquisitions, PGI and CastlePoint’s NOLs are subject to annual limitations of $2.8 million and $11.1 million, respectively. Any unused annual limitation may be carried over to later years. The NOLs will expire in years 2019 through 2029.

Additionally, Tower and the Reciprocal Exchanges have an AMT credit of $1.8 million that can be carried over indefinitely.

The Company believes it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets, including the NOLs, except for those associated with the Reciprocal Exchanges. The Company has recorded a valuation allowance of $4.8 million and $5.1 million at December 31, 2012 and 2011, respectively, to reflect the amount of the Reciprocal Exchanges’ deferred taxes that may not be realized.

As of December 31, 2012 and 2011, the Company had no material uncertain tax positions and no adjustments to liabilities or operations were required.

The Internal Revenue Service performed an audit of The Company’s 2006 and 2007 tax years and closed these audits in 2011 with no changes. Additionally, in 2011 the IRS performed an audit of CastlePoint and subsidiary’s federal income tax return for the period ended February 2009 and closed this audit with no changes. CastlePoint’s federal excise tax for the 2009 and 2010 tax years were examined by the IRS in 2012. This audit was closed in 2012 with no changes. One of the Reciprocal Exchanges is currently under an IRS excise tax examination for the 2011 tax year. We expect to close this examination in 2013 with no changes.

The provision for Federal income taxes incurred is different from that which would be obtained by applying the Federal income tax rate to net income before taxes. The items causing this difference at the consolidated level are as follows:


	Year Ended December 31,

	2012									2011									2010

($ in thousands)	Tower (restated)			Reciprocal Exchanges (restated)			Total (restated)			Tower (restated)			Reciprocal Exchanges			Total (restated)			Tower (revised)			Reciprocal Exchanges			Total (revised)

Federal income tax expense at
U.S. statutory rate	$	(21,458	)	$	99		$	(21,359	)	$	19,161		$	4,820		$	23,981		$	54,326		$	(2,519	)	$	51,807
Tax exempt interest		(7,374	)		(901	)		(8,275	)		(6,823	)		(418	)		(7,241	)		(4,685	)		(193	)		(4,878	)
State income taxes net of Federal benefit		130			-			130			488			-			488			840			-			840
Acquisition-related transaction costs		2,261			-			2,261			100			-			100			655			-			655
Prior period adjustment		(619	)		(162	)		(781	)		207			-			207			362			-			362
Valuation Allowance		-			(1,072	)		(1,072	)		-			(1,757	)		(1,757	)		-			1,059			1,059
Other		(12	)		9			(3	)		(2,264	)		537			(1,727	)		(447	)		190			(257	)

Provision for income taxes	$	(27,072	)	$	(2,027	)	$	(29,099	)	$	10,869		$	3,182		$	14,051		$	51,051		$	(1,463	)	$	49,588

Note 17—Employee Benefit Plans

The Company maintains a defined contribution Employee Pretax Savings Plan (401(k) Plan) for its employees. The Company matches 50% of each participant’s contribution up to 8% of the participant’s eligible contribution. The Company incurred $3.6 million, $3.2 million, and $2.7 million of expense in 2012, 2011 and 2010, respectively, related to the 401(k) Plan.

Supplemental Executive Retirement Plan (“SERP”)

The SERP is a non-qualified defined contribution plan effective as of January 1, 2009 that is intended to enhance retirement benefits for the Company’s most senior executives and certain other key employees. Eligibility to participate in the SERP generally requires three years of prior employment with the Company for Executive Vice Presidents and Senior Vice Presidents and between five and 10 years of prior employment with the Company for other key employees. In 2012, all of the Named Executive Officers, as well as certain other key executives selected at the discretion of the Compensation Committee, participated in the SERP. Subject to the approval of the Compensation Committee, the Company may make annual contributions to the SERP on behalf of each participant. The SERP is not a defined benefit plan and such target benefit level cannot be guaranteed. For all participants, the amount of the annual contribution is presently equal to 5.0% of their annual cash compensation. Company contributions for each participant remain unvested until such participant has completed 10 years of service with the Company, and vest in full upon completion of 10 years of service. The Compensation Committee has discretion to terminate the SERP at any time or to adjust upward or downward the level of the Company’s contribution each year.

F-48

Tower Group, Inc.

Notes to Consolidated Financial Statements

Note 18—Contingencies

Legal Proceedings

On May 28, 2009, Munich Reinsurance America, Inc. (“Munich”) commenced an action against Tower Insurance Company of New York (“TICNY”), a wholly-owned subsidiary of Tower Group, Inc., in the United States District Court for the District of New Jersey seeking, inter alia, to recover $6.1 million under various retrocessional contracts pursuant to which TICNY reinsures Munich. On June 22, 2009, TICNY filed its answer, in which it, inter alia, asserted two separate counterclaims seeking to recover $2.8 million under various reinsurance contracts pursuant to which Munich reinsures TICNY. (A separate action commenced by Munich against TICNY on June 17, 2009 in the United States District Court for the District of New Jersey seeking a declaratory judgment that Munich is entitled to access to TICNY’s books and records pertaining to various quota share agreements, to which TICNY filed its answer on July 7, 2009, was subsequently dismissed pursuant to the stipulation of the parties on March 17, 2010). On July 15, 2011, TICNY paid $3.3 million to Munich to resolve a portion of the dispute. On December 22, 2011, the court granted partial summary judgment with respect to certain of the claims and defenses in the litigation. On March 23, 2012, the Court ruled that Munich was entitled to approximately $168,000 from TICNY in pre-judgment interest on the amount of $3.3 million that TICNY had paid to Munich on July 15, 2011, which was expensed in the first quarter of 2012. Trial was scheduled for October 15, 2012, but during the third quarter of 2012, the parties have reached a settlement of the action for $2.9 million after-tax which is included as a charge in other operating expenses. On October 9, 2012, the Court entered an order dismissing certain claims with prejudice and other claims without prejudice.

On May 12, 2010, Mirabilis Ventures, Inc. (“Mirabilis”) commenced an action against Specialty Underwriters’ Alliance Insurance Co. (“SUA”, now known as CastlePoint National Insurance Company (“CNIC”), a subsidiary of Tower Group, Inc.) and Universal Reinsurance Co., Ltd., an unrelated entity, in the United States District Court for the Middle District of Florida. The Complaint is based upon a Worker’s Compensation/Employer’s Liability policy issued by SUA to AEM, Inc. (“AEM”), to whose legal rights Mirabilis is alleged to have succeeded as a result of the Chapter 11 bankruptcy of AEM. The Complaint, which includes claims against SUA for breach of contract and breach of the duty of good faith, alleges that SUA failed to properly audit AEM’s operations to determine AEM’s worker’s compensation exposure for two policy years, in order to compute the premium owed by AEM, such that SUA owes Mirabilis the principal sum of $3.4 million for one policy year and $0.6 million for the other policy year, plus interest and costs. On July 30, 2010, CNIC answered the Complaint and asserted nine separate counterclaims, to which Mirabilis responded on September 3, 2010. Since that time, Mirabilis has filed an amended complaint that failed to add any defenses against Mirabilis, and CNIC subsequently filed a motion for summary judgment on all of Mirabilis’ claims. On March 15, 2012, Mirabilis and CNIC entered into a settlement agreement and mutual release, pursuant to which Mirabilis agreed to withdraw all of its claims against CNIC and CNIC agreed to withdraw its counterclaims against Mirabilis. Neither party was required to pay any money under the terms of the settlement. On March 20, 2012, the Court ordered dismissal of the case. On March 26, 2012, CNIC filed a stipulation of final order and the case was dismissed with prejudice and terminated.

Leases

The Company has various lease agreements for office space, furniture and equipment. The terms of the office space lease agreements provide for annual rental increases and certain lease incentives including initial free rent periods and cash allowances for leasehold improvements.

The Company amortizes scheduled annual rental increases and lease incentives ratably over the term of the lease. The Company’s future minimum lease payments are as follows:


($ in thousands)	Operating Leases		Capital Leases		Total

2013	$	9,654	$	9,466	$	19,120
2014		10,278		11,022		21,300
2015		10,167		15,865		26,032
2016		9,981		1,533		11,514
2017		8,926		1,671		10,597
Thereafter		32,904		54		32,958

	$	81,910	$	39,611	$	121,521

Total rental expense was $9.7 million, $11.1 million and $10.0 million in 2012, 2011 and 2010, respectively.

F-49

Tower Group, Inc.

Notes to Consolidated Financial Statements

Assessments

Tower’s insurance subsidiaries are also required to participate in various mandatory insurance facilities or in funding mandatory pools, which are generally designed to provide insurance coverage for consumers who are unable to obtain insurance in the voluntary insurance market. The insurance subsidiaries are subject to assessments in New York, Florida, New Jersey, Georgia, California and other states for various purposes, including the provision of funds necessary to fund the operations of the New York Insurance Department and the New York Property/Casualty Insurance Security Fund, which pays covered claims under certain policies provided by impaired, insolvent or failed insurance companies and various funds administered by the New York Workers’ Compensation Board, which pays covered claims under certain policies provided by impaired, insolvent or failed insurance companies.

The Company paid $4.8 million, $5.1 million and $4.8 million in 2012, 2011 and 2010, respectively, for its proportional share of the operating expenses of the New York Insurance Department. Property casualty insurance company insolvencies or failures may result in additional security fund assessments to the Company at some future date. At this time the Company is unable to estimate the possible amounts, if any, of such assessments. Accordingly, the Company is unable to determine the impact, if any; such assessments may have on financial position or results of operations of the Company. The Company is permitted to assess premium surcharges on workers’ compensation policies that are based on statutorily enacted rates. Actual assessments have resulted in differences to the original estimates based on permitted surcharges of $0 million, $1.1 million and $4.1 million in 2012, 2011 and 2010, respectively. The Company estimates its liability for future assessments based on actual written premiums and historical rates and available information. As of December 31, 2012, the liability for the various workers’ compensation funds, which includes amounts assessed on workers’ compensation policies, was $7.5 million. This amount is expected to be paid over an eighteen month period ending June 30, 2013. As of December 31, 2011, the liability for the various workers’ compensation funds was $8.2 million.

Note 19—Statutory Financial Information and Accounting Policies

United States

For regulatory purposes, the Company’s U.S.-based insurance subsidiaries, excluding the Reciprocal Exchanges, prepare their statutory basis financial statements in accordance with practices prescribed or permitted by the state they are domiciled in (“statutory basis” or “SAP”). The more significant SAP variances from GAAP are as follows:

•

Policy acquisition costs are charged to operations in the year such costs are incurred, rather than being deferred and amortized as premiums are earned over the terms of the policies.

•

Ceding commission revenues are earned when ceded premiums are written except for ceding commission revenues in excess of anticipated acquisition costs, which are deferred and amortized as ceded premiums are earned. GAAP requires that all ceding commission revenues be earned as the underlying ceded premiums are earned over the term of the reinsurance agreements.

•

Certain assets including certain receivables, a portion of the net deferred tax asset, prepaid expenses and furniture and equipment are not admitted.

•

Investments in fixed-maturity securities are valued at NAIC value for statutory financial purposes, which is primarily amortized cost. GAAP requires investments in fixed-maturity securities classified as available for sale, to be reported at fair value.

•

For SAP purposes, changes in deferred income taxes relating to temporary differences between net income for financial reporting purposes and taxable income are recognized as a separate component of gains and losses in surplus rather than included in income tax expense or benefit as required under GAAP.

•

Investments in stocks of subsidiaries are carried as assets on the statutory basis balance sheet. Under GAAP, investments in stocks of subsidiaries are generally consolidated if the investor owns greater than fifty percent or otherwise demonstrates control of the subsidiary.

In preparing its statutory basis financial statements, the Company does not use any prescribed or permitted statutory accounting practices.

State insurance laws restrict the ability of our insurance subsidiaries to declare dividends. State insurance regulators require insurance companies to maintain specified levels of statutory capital and surplus. Generally, dividends may only be paid out of earned surplus, and the amount of an insurer’s surplus following payment of any dividends must be reasonable in relation to the insurer’s outstanding liabilities and adequate to meet its financial needs. Further, prior approval of the insurance department of its state of domicile is required before any of our insurance subsidiaries can declare and pay an “extraordinary dividend” to the Company.

F-50

Tower Group, Inc.

Notes to Consolidated Financial Statements

For the years ended December 31, 2012, 2011 and 2010, the Company’s insurance subsidiaries had SAP net (loss) income of $(42.3) million, $52.0 million and $76.0 million, respectively. At December 31, 2012 and 2011 the Company’s insurance subsidiaries had reported SAP capital and surplus of $594.2 million and $686.8 million, respectively, as filed with the insurance regulators.

The Company is required to maintain minimum capital and surplus for each of its insurance subsidiaries. Management determined the minimum capital and surplus requirement to be above “Company Action Level.” Company Action Level is calculated as two times the insurance subsidiaries’ “authorized control level risk-based capital”, which is calculated from a risk-based model adopted by the state insurance regulators. As of December 31, 2012 and 2011, the aggregate Company Action Level capital and surplus requirements for the insurance subsidiaries was $281.1 million and $231.3 million, respectively. None of the individual insurance subsidiaries fell below their respective Company Action Level requirements.

The Company’s U.S.-based insurance subsidiaries paid $10.2 million, $15.0 million and $4.7 million in dividends and or return of capital to the holding company in 2012, 2011 and 2010, respectively. As of December 31, 2012, $563.3 million of the Company’s net statutory assets held at the U.S. insurance subsidiaries was unavailable for distribution or advances to Tower. The maximum distribution that Tower’s insurance subsidiaries could pay without prior regulatory approval was $30.9 million and as such, was available to pay dividends to Tower’s shareholders as of December 31, 2012.

Bermuda

CastlePoint Reinsurance Company (“CastlePoint Re”) is registered as a Class 3 reinsurer under The Insurance Act 1978 (Bermuda), amendments thereto and related regulations (the “Insurance Act”). Under the Insurance Act, CastlePoint Re is required to prepare Statutory Financial Statements and to file a Statutory Financial Return. The Insurance Act also requires CastlePoint Re to maintain minimum share capital and surplus, and it has met these requirements as of December 31, 2012.

For Bermuda registered companies, there are some differences between financial statements prepared in accordance with GAAP and those prepared on a Bermuda statutory basis. The more significant Bermuda SAP variances from GAAP are as follows:

•

Deferred policy acquisition costs have been fully expensed to income.

•

Prepaid expenses and fixed assets have been removed from the statutory balance sheet.

•

Investments in fixed-maturity securities are carried at amortized cost. GAAP requires investments in fixed-maturity securities classified as available for sale to be reported at fair value.

•

Deferred income taxes, intangible assets and goodwill are not included in the Bermuda statutory capital and surplus balances.

•

For the year ended December 31, 2012, CastlePoint Re had statutory net income of $8.3 million and at December 31, 2012, had statutory surplus of $285.8 million. The statutory capital surplus amounts as of December 31, 2012 and 2011 include $150.5 million and $158.7 million, respectively, from U.S.-based insurance subsidiaries that are owed to CastlePoint Re. CastePoint Re’s minimum capital and surplus requirement as of December 31, 2012 was $140.6 million.

CastlePoint Re paid $2.5 million, $20.0 million and $0 million in dividends and/or return of capital to the holding company in 2012, 2011 and 2010, respectively. As of December 31, 2012, $234.0 of the Company’s net statutory assets held at its Bermuda based insurance subsidiaries was unavailable for distributions or advances to Tower. Maximum dividend and return of capital to Tower without Bermuda regulatory permission was $51.8 million, and as such, was available to pay dividends to Tower’s shareholders as of December 31, 2012.

Reciprocal Exchanges

The Reciprocal Exchanges prepare their statutory basis financial statements in accordance with SAP. The more significant SAP variances from GAAP are consistent with those discussed above for the U.S.-based insurance subsidiaries.

For the years ended December 31, 2012, 2011 and 2010, the Reciprocal Exchanges had combined SAP net income (loss) of $7.4 million, $16.5 million and $(10.9) million, respectively. At December 31, 2012 and 2011 the Reciprocal Exchanges had combined capital and surplus of $91.4 million and $91.0 million, respectively.

The Reciprocal Exchanges are required to maintain minimum capital and surplus. The minimum capital and surplus requirements were determined to be above Company Action Level. As of December 31, 2013 and 2012, the combined Company Action Level capital and surplus requirement for Adirondack was $38.1 million and $32.5 million, respectively. As of December 31, 2013 and 2012, the combined Company Action Level capital and surplus requirement for New Jersey Skylands was $10.2 million and $13.7 million, respectively.

The Reciprocal Exchanges are not owned by the Company, but managed through management agreements. Accordingly, the Reciprocal Exchanges’ net assets are not available to the Company. In addition, no dividends can be paid from the Reciprocal Exchanges to Tower.

Note 20—Fair Value of Financial Instruments

GAAP guidance requires all entities to disclose the fair value of financial instruments, both assets and liabilities recognized and not recognized in the balance sheet, for which it is practicable to estimate fair value. The Company uses the following methods and assumptions in estimating its fair value disclosures for financial instruments:

Fixed maturity and equity securities: Fair value disclosures for investments are included in “Note 8—Fair Value Measurements.”

Other invested assets: The fair value of securities which are reported under the fair value option are included in “Note 8—Fair Value Measurements.

Premiums receivable and reinsurance recoverable: The carrying values reported in the accompanying balance sheets for these financial instruments approximate their fair values.

Debt: Fair value disclosures for debt are included in “Note 14—Debt.” The Company uses a discounted cash flow model to fair value the subordinated debentures. Market quotes are used to fair value the senior convertible notes.

Reinsurance balances payable and funds held under reinsurance contracts: The carrying value reported in the balance sheet for these financial instruments approximates fair value.

Note 21—Earnings (loss) per Share

Undistributed net earnings (net income less dividends declared during the period) are allocated to both common stock and unvested share-based payment awards (“unvested restricted stock”). Because the common shareholders and unvested restricted stock holders share in dividends on a 1:1 basis, the earnings per share on undistributed earnings is equivalent, however, undistributed losses are allocated only to common stock holders. Undistributed earnings are allocated to all outstanding share-based payment awards, including those for which the requisite service period is not expected to be rendered.

The following table shows the computation of the earnings per share (historical earnings per share amounts have been adjusted for the 1.1330 share conversion ratio in connection with the Merger Transaction):

F-51

Tower Group, Inc.

Notes to Consolidated Financial Statements


	Year Ended December 31,

($ in thousands, except per share amounts)	2012 (restated)			2011 (restated)			2010 (revised)

Numerator
Net income (loss) attributable to Tower Group Inc.	$	(34,234	)	$	44,435		$	104,830
Less: Allocation of income for unvested participating restricted stock		-			(370	)		(1,217)
Less: Dividends on unvested participating restricted stock		(686	)		(679	)		(244)

Net income available to common shareholders - Basic		(34,920	)		43,386			103,369

Reallocation of income for unvested participating restricted stock		-			(1	)		(19)

Net income available to common shareholders - Diluted		(34,920	)		43,385			103,350

Denominator
Basic earning per share denominator		42,902			45,226			48,561
Effect of dilutive securities		-			111			211

Diluted earnings per share denominator		42,902			45,337			48,772

Earnings (loss) per share attributable to Tower Group Inc. - Basic
Common stock:
Distributed earnings	$	0.66		$	0.61		$	0.34
Undistributed earnings (loss)	$	(1.47	)	$	0.35		$	1.79

Total	$	(0.81	)	$	0.96		$	2.13

Earnings (loss) per share attributable to Tower Group Inc. - Diluted	$	(0.81	)	$	0.96		$	2.12

The computation of diluted earnings (loss) per share excludes outstanding options and other common stock equivalents in periods where inclusion of such potential common stock instruments would be anti-dilutive. For the years ended December 31, 2012, 2011 and 2010, 0, 166,700 and 193,000, respectively, options and other common stock equivalents to purchase Tower shares were excluded from the computation of diluted earnings (loss) per share because the exercise price of the options was greater than the average market price.

F-52

Tower Group, Inc.

Notes to Consolidated Financial Statements

Note 22—Segment Information

The Personal Insurance segment includes revenues and expenses associated with the Reciprocal Exchanges, including fees paid to Tower for underwriting, claims, investment management and other services provided pursuant to management services agreements with the Reciprocal Exchanges. The Insurance Services segment reports revenues earned by Tower from the Reciprocal Exchanges as management fee income, which is calculated as a percentage of the Reciprocal Exchanges’ gross written premiums. The effects of these management services agreements between Tower and the Reciprocal Exchanges are eliminated in consolidation to derive consolidated net income. However, the management fee income is reported in net income attributable to Tower Group, Inc. and included in basic and diluted earnings per share.

Segment performance is evaluated based on segment profit, which excludes investment income, realized gains and losses, interest expense, income taxes and incidental corporate expenses. Assets, other than intangible assets and goodwill, are not allocated to segments because investments and assets other than intangible assets and goodwill are considered in total by management for decision-making purposes.

F-53

Tower Group, Inc.

Notes to Consolidated Financial Statements

Business segments results are as follows:


		Year Ended December 31,

		2012			2011			2010
($ in thousands)		(restated)			(restated)			(revised)

Commercial Insurance Segment
Revenues
Premiums earned	$		1,224,566		$	1,087,911		$	941,015
Ceding commission revenue			7,702			14,786			33,247
Policy billing fees			5,467			4,345			2,742

Total revenues			1,237,735			1,107,042			977,004

Expenses
Loss and loss adjustment expenses			912,682			758,211			595,028
Underwriting expenses			432,633			364,691			346,457

Total expenses			1,345,315			1,122,902			941,485


Underwriting profit (loss)	$		(107,580	)	$	(15,860	)	$	35,519


Personal Insurance Segment
Revenues
Premiums earned	$		497,298		$	505,939		$	351,654
Ceding commission revenue			24,633			19,182			6,056
Policy billing fees			7,148			6,189			3,513

Total revenues			529,079			531,310			361,223

Expenses
Loss and loss adjustment expenses			351,076			318,775			194,701
Underwriting expenses			239,023			228,435			159,013

Total expenses			590,099			547,210			353,714


Underwriting profit (loss)	$		(61,020	)	$	(15,900	)	$	7,509

Tower	$		(42,476	)	$	(21,280	)	$	16,737
Reciprocal Exchanges			(18,544	)		5,380			(9,228)

Total underwriting profit (loss)	$		(61,020	)	$	(15,900	)	$	7,509


Insurance Services Segment
Revenues
Management fee income	$		30,150		$	29,303		$	17,752
Other revenue			3,420			1,570			2,171

Total revenues			33,570			30,873			19,923

Expenses
Other expenses			23,695			19,331			5,760

Total expenses			23,695			19,331			5,760


Insurance services pretax income	$		9,875		$	11,542		$	14,163

F-54

Tower Group, Inc.

Notes to Consolidated Financial Statements

The following table reconciles revenue by segment to consolidated revenues:


		Year Ended December 31,

		2012			2011			2010
($ in thousands)		(restated)			2011			2010

Commercial insurance segment	$		1,237,735		$	1,107,042		$	977,004
Personal insurance segment			529,079			531,310			361,223
Insurance services segment			33,570			30,873			19,923

Total segment revenues			1,800,384			1,669,225			1,358,150
Elimination of management fee income			(30,150	)		(29,303	)		(17,754)
Net investment income			127,165			126,474			107,265
Net realized gains (losses) on investments, including other-than-temporary impairments			25,476			9,394			14,653

Consolidated revenues	$		1,922,875		$	1,775,790		$	1,462,314

The following table reconciles the results of the Company’s individual segments to consolidated income before income taxes:


		Year Ended December 31,

		2012			2011			2010
($ in thousands)		(restated)			(restated)			(revised)

Commercial insurance segment underwriting profit (loss)	$		(107,580	)	$	(15,860	)	$	35,519
Personal insurance segment underwriting profit (loss)			(61,020	)		(15,900	)		7,509
Insurance services segment pretax income			9,875			11,542			14,163
Net investment income			127,165			126,474			107,265
Net realized gains on investments, including other-than-temporary impairments			25,476			9,394			14,653
Corporate expenses			(11,603	)		(11,519	)		(4,177)
Acquisition-related transaction costs			(9,229	)		(360	)		(2,369)
Interest expense			(32,630	)		(34,290	)		(24,223)
Other income (expense)			(1,470	)		-			-

Income (loss) before income taxes	$		(61,016	)	$	69,481		$	148,340

Note 23—Unaudited Quarterly Financial Information

The following table presents the unaudited quarterly financial information for the Company, as reflected after the revisions and restatements discussed in Note 2:


	As of and for the three months ended March 31, 2012								As of and for the three months ended March 31, 2011
($ in thousands)	Original			Revised			Effect of Adjustments		Original			Revised			Effect of Adjustments


Total assets	$	4,477,215		$	4,441,126		$	(36,089)	$	4,144,293		$	4,134,548		$	(9,745	)
Total liabilities		3,386,696			3,374,655			(12,041)		3,093,764			3,090,503			(3,261	)

Total stockholders’ equity	$	1,090,519		$	1,066,471		$	(24,048)	$	1,050,529		$	1,044,045		$	(6,484	)


Total revenues	$	466,223		$	466,223		$	-	$	430,719		$	430,719		$	-
Total expenses		(434,822	)		(434,822	)		-		(390,692	)		(390,692	)		-
Other income (expenses)		-			-			-		-			-			-
Income tax (expense) benefit		(9,224	)		(9,224	)		-		(9,178	)		(9,178	)		-

Net Income	$	22,177		$	22,177		$	-	$	30,849		$	30,849		$	-


Net Income Attributable to Tower Group, Inc.	$	19,166		$	19,166		$	-	$	26,521		$	26,521		$	-

Net Income (loss) per share attributable to Tower stockholders:
Basic (1)	$	0.43		$	0.43		$	-	$	0.56		$	0.56		$	-
Diluted (1)	$	0.43		$	0.43		$	-	$	0.56		$	0.56		$	-

F-55

Tower Group, Inc.

Notes to Consolidated Financial Statements


	As of and for the three months ended June 30, 2012								As of and for the three months ended June 30, 2011
($ in thousands)	Original			Revised			Effect of Adjustments		Original			Revised			Effect of Adjustments


Total assets	$	4,516,940		$	4,480,851		$	(36,089)	$	4,230,858		$	4,221,113		$	(9,745	)
Total liabilities		3,463,840			3,451,799			(12,041)		3,141,207			3,137,946			(3,261	)

Total stockholders’ equity	$	1,053,100		$	1,029,052		$	(24,048)	$	1,089,651		$	1,083,167		$	(6,484	)


Total revenues	$	506,392		$	506,392		$	-	$	434,855		$	434,855		$	-
Total expenses		(531,683	)		(531,683	)		-		(395,038	)		(395,038	)		-
Other income (expenses)		-			-			-		-			-			-
Income tax (expense) benefit		8,919			8,919			-		(12,711	)		(12,711	)		-

Net Income (loss)	$	(16,372	)	$	(16,372	)	$	-	$	27,106		$	27,106		$	-


Net Income (Loss) Attributable to Tower Group, Inc.	$	(16,809	)	$	(16,809	)	$	-	$	24,407		$	24,407		$	-

Net Income (loss) per share attributable to Tower stockholders:
Basic (1)	$	(0.39	)	$	(0.39	)	$	-	$	0.52		$	0.52		$	-
Diluted (1)	$	(0.39	)	$	(0.39	)	$	-	$	0.52		$	0.52		$	-

	As of and for the three months ended September 30, 2012								As of and for the three months ended September 30, 2011
($ in thousands)	Original			Revised			Effect of Adjustments		Original			Revised			Effect of Adjustments


Total assets	$	4,684,433		$	4,648,737		$	(35,696)	$	4,362,237		$	4,352,492		$	(9,745	)
Total liabilities		3,585,159			3,573,511			(11,648)		3,325,565			3,322,304			(3,261	)

Total stockholders’ equity	$	1,099,274		$	1,075,226		$	(24,048)	$	1,036,672		$	1,030,188		$	(6,484	)


Total revenues	$	474,891		$	474,891		$	-	$	455,295		$	455,295		$	-
Total expenses		(439,930	)		(439,930	)		-		(473,078	)		(473,078	)		-
Other income (expenses)		-			-			-		-			-			-
Income tax (expense) benefit		(9,014	)		(9,014	)		-		5,370			5,370			-

Net Income (loss)	$	25,947		$	25,947		$	-	$	(12,413	)	$	(12,413	)	$	-


Net Income (Loss) Attributable to Tower Group, Inc.	$	21,629		$	21,629		$	-	$	(15,733	)	$	(15,733	)	$	-

Net Income (loss) per share attributable to Tower stockholders:
Basic (1)	$	0.50		$	0.50		$	-	$	(0.35	)	$	(0.35	)	$	-
Diluted (1)	$	0.50		$	0.50		$	-	$	(0.35	)	$	(0.35	)	$	-


	As of and for the three months ended December 31, 2012								As of and for the three months ended December 31, 2011
($ in thousands)	Original			Restated			Effect of Adjustments		Original			Restated			Effect of Adjustments


Total assets	$	4,749,014		$	4,711,772		$	(37,242)	$	4,457,658		$	4,421,569		$	(36,089	)
Total liabilities		3,733,516			3,727,554			(5,962)		3,396,479			3,384,438			(12,041	)

Total stockholders’ equity	$	1,015,498		$	984,218		$	(31,280)	$	1,061,179		$	1,037,131		$	(24,048	)


Total revenues	$	475,047		$	475,369		$	322	$	454,921		$	454,921		$	-
Total expenses		(565,639	)		(575,986	)		(10,347)		(421,364	)		(447,501	)		(26,137	)
Other income (expenses)		(2,534	)		(1,470	)		1,064		-			-			-
Income tax (expense) benefit		36,040			38,419			2,379		(7,623	)		2,468			10,091

Net Income (loss)	$	(57,086	)	$	(63,668	)	$	(6,582)	$	25,934		$	9,888		$	(16,046	)


Net Income (Loss) Attributable to Tower Group, Inc.	$	(52,140	)	$	(58,219	)	$	(6,079)	$	25,286		$	9,240		$	(16,046	)

Net Income (loss) per share attributable to Tower stockholders:
Basic (1)	$	(1.23	)	$	(1.38	)	$	(0.15)	$	0.56		$	0.21		$	(0.35	)
Diluted (1)	$	(1.23	)	$	(1.38	)	$	(0.15)	$	0.56		$	0.20		$	(0.36	)

⁽¹⁾

Since the weighted-average shares for the quarters are calculated independently of the weighted-average shares for the year, quarterly earnings (loss) per share may not total to annual earnings per share. Earnings (loss) per share has been calculated using weighted-average shares that have been adjusted for the 1.1330 share conversion ratio resulting from the Merger Transaction.

F-56

Tower Group, Inc.

Notes to Consolidated Financial Statements

Note 24—Subsequent Events (unaudited)

Merger Transaction

On August 20, 2012, TGI closed on its previously announced $74.9 million acquisition of a 10.7% stake in Canopius Group Limited (“Canopius Group”), a privately owned Lloyd’s insurance holding company domiciled in Guernsey, Channel Islands. In connection with this acquisition, TGI also entered into an agreement dated April 25, 2012 (the “Master Transaction Agreement”) under which Canopius Group committed to assist TGI with the establishment of a presence at Lloyd’s of London through a special purpose syndicate (“SPS Transaction Right and Acquisition Right”) (subject to required approvals) and granted TGI an option (the “Merger Option”) to combine with Canopius Bermuda. On July 30, 2012, TGI announced that it had exercised the Merger Option and executed an Agreement and Plan of Merger (the “Original Merger Agreement”) with Canopius Bermuda pursuant to which a wholly-owned subsidiary of Canopius Bermuda would acquire all of TGI’s common stock. TGI paid Canopius Group a fee of $1,000,000 to exercise the Merger Option. On November 8, 2012, the Original Merger Agreement was amended by Amendment No. 1 to the Agreement and Plan of Merger to reflect changes to the merger consideration to be received by TGI shareholders (the Original Merger Agreement as so amended, the “Merger Agreement”).

On March 13, 2013, Canopius Bermuda and TGI consummated the Merger Transaction contemplated by the Merger Agreement. Canopius Bermuda was re-named TGIL and became the ultimate parent company of TGI, with TGI becoming its indirect wholly-owned subsidiary. Pursuant to the terms of the Merger Agreement, among other things, (i) 100% of the issued and outstanding shares of TGI common stock was cancelled and automatically converted into the right to receive 1.1330 common shares of the Company, par value $0.01 per share (the “ Common Shares”), (ii) each outstanding option to acquire TGI common stock, whether vested or unvested and whether granted under TGI’s 2008 Long-Term Equity Compensation Plan or otherwise, automatically vested, free of any forfeiture conditions, and constituted a fully vested option to acquire that number of Common Shares (rounded down to the nearest whole number) equal to the number of shares of TGI common stock subject to such option multiplied by 1.1330, on the same terms and conditions (other than vesting and performance conditions) as were applicable to such TGI stock option immediately prior to the Merger Transaction, with the exercise price of such option adjusted to be the original exercise price divided by 1.1330, and (iii) substantially all issued and outstanding shares of TGI restricted stock, whether granted under TGI’s 2008 Long-Term Equity Compensation Plan or otherwise, automatically vested, free of any forfeiture conditions, and was converted into the right to receive, as soon as reasonably practicable after the effective time, 1.1330 Common Shares.

Immediately after giving effect to the issuance of Common Shares to the former TGI shareholders in the Merger Transaction, approximately 57,432,150 Common Shares were outstanding, of which 76% were held by the former TGI shareholders. The remaining 24% of Common Shares outstanding immediately after giving effect to the Merger Transaction were held by third party investors. As the Company is the successor issuer to TGI, succeeding to the attributes of TGI as registrant, including TGI’s SEC filer code, its Common Shares trade on the same exchange, the NASDAQ Global Select Market, and under the same trading symbol, “TWGP,” that the shares of TGI common stock traded on and under prior to the Merger Transaction.

The Merger Transaction is expected to advance the Company’s strategy and create a more efficient global, diversified specialty insurance company consisting of commercial, specialty and personal lines, reinsurance and international specialty products. In addition, the establishment of a Bermuda domicile provides the Company with an international platform through which it accesses the U.S., Bermuda and the Lloyd’s of London (“Lloyd’s”) markets.

F-57

Tower Group, Inc.

Notes to Consolidated Financial Statements

Share Repurchase Program

As part of Tower’s capital management strategy, Tower’s Board of Directors approved on May 7, 2013 a $50 million share repurchase program. Purchases will be made from time to time in the open market or in privately negotiated transactions in accordance with applicable laws and regulations.

TGI’s previously approved share repurchase program was terminated as a result of the Merger Transaction.

Miscellaneous

On August 19, 2013, Tower announced it terminated its previously announced agreement to acquire American Safety Reinsurance, Ltd., the Bermuda-based reinsurance subsidiary of American Safety Insurance Holdings, Ltd., from Fairfax Financial Holdings Limited. Tower received $5 million in exchange for the termination of such agreement.

In August 2013, management has begun to reorganize the way in which it will manage the business for operating decisions and assessing profitability. This reorganization is attributed to events occurring subsequent to the second quarter of 2013. As a result, the Company will reassess its segment reporting for the third quarter 2013 financial reporting purposes.

Legal Proceedings

F-58

Tower Group, Inc.

Notes to Consolidated Financial Statements

F-59

Tower Group, Inc.

Notes to Consolidated Financial Statements

Regulation

F-60

Item 9A. Controls and Procedures

(a)

Disclosure Controls and Procedures

The Company’s management is responsible for establishing and maintaining disclosure controls and procedures designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Securities Exchange Act of 1934, as amended (Exchange Act), is recorded, processed, summarized, and reported within time periods specified in the rules and forms of the SEC. The Company’s disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is accumulated and communicated to management, including the principal executive officer and principal financial officer, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure.

The Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)), as of December 31, 2012, the end of the period covered by this report. The Company’s CEO and CFO had previously concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2012; however, subsequent to the filing of the Company’s Amendment No. 1 to Form 10-K on March 13, 2013 (Original Filing) and as completed in connection with and as of the date of this Form 10-K/A, the Company’s CEO and CFO concluded that the Company’s disclosure controls and procedures were not effective as of December 31, 2012 because of the material weaknesses in internal control over financial reporting discussed below.

(b)

Management’s Report on Internal Control over Financial Reporting (as restated)

Management is responsible for establishing and maintaining adequate internal control over financial reporting for Tower as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. Our internal control over financial reporting is a process designed by or under the supervision of our principal executive and principal financial officers, or persons performing similar functions, and effected by the Company’s board of directors, management and other personnel 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. Our internal control over financial reporting includes policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on our financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree or compliance with the policies or procedures may deteriorate. Management of the Company has assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012. In making its assessment of internal control over financial reporting, management used the criteria described in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In Management’s Report on Internal Control over Financial Reporting included in the Original Filing, management, including our CEO and CFO concluded that we maintained effective internal control over financial reporting as of December 31, 2012. Management has subsequently concluded that the material weaknesses described below existed as of December 31, 2012. As a result, we have concluded that we did not maintain effective internal control over financial reporting as of December 31, 2012, based on the criteria in Internal Control—Integrated Framework issued by the COSO. Accordingly, management has restated its report on internal control over financial reporting.

The Company’s CEO and CFO, in consultation with the Audit Committee, have concluded that as a result of inadvertent mistakes in the loss reserving process, the Company’s loss reserves were understated by $37 million and $27 million as of December 31, 2012 and 2011, respectively and the Company’s premiums receivable was overstated by $11 million and $10 million as of December 31, 2012 and December 31, 2011, respectively. These errors contributed to the restatement as discussed further in Note 2 to the consolidated financial statements and resulted from two material weaknesses in the Company’s internal control over financial reporting. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.

(1)

We did not maintain effective controls over the effectiveness of the loss reserve estimation process. Specifically, although the loss reserve committee evaluated the vast majority of methods, significant assumptions and data used to determine the actuarial central estimate, it did not evaluate all methods, significant assumptions and data, or otherwise determine that data used was appropriate, including reconciliation of assumed earned premium to the Company’s underlying systems, at a level of precision that would necessarily detect a material misstatement.

(2)

We did not maintain effective controls over the effectiveness of the premium receivable account reconciliation. Specifically, although the vast majority of items identified in premiums receivable account analyses were evaluated and resolved, not all items that could result in a material misstatement were investigated and resolved on a timely basis.

Additionally, these control deficiencies could result in misstatements of the aforementioned accounts that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, management has determined that these control deficiencies constitute material weaknesses.

The effectiveness of the Company’s internal control over financial reporting as of December 31, 2012 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.

(c)

Remediation Steps to Address the Material weaknesses

Management and the Board of Directors are committed to remediation of the material weaknesses as well as the continued improvement of the Company’s overall system of internal controls over financial reporting. Management believes that the remediation procedures described below will remediate the identified control deficiencies and strengthen the Company’s internal control over financial reporting. As management continues to evaluate and works to enhance its internal control over financial reporting, it may be determined that additional measures must be taken to remediate these control deficiencies or it may be determined that the Company needs to modify or otherwise adjust the remediation procedures described below.

Subsequent to the period covered by the report, management is implementing measures to remediate the material weaknesses in internal controls over financial reporting described above. Specifically, management is seeking to improve communications among its actuarial, underwriting, financial, and claims personnel involved on the loss reserve committee regarding the importance of documentation of its assessments and conclusions of its meetings, as well as supporting analyses. Management also continues to improve its systems to facilitate the gathering of underlying data used in the actuarial reserving process. Until such time as management and the Board have concluded that this process is performing effectively, management intends to engage external consulting resources that will perform a quarterly actuarial study to assist the Company in estimating its loss reserves, and reviewing and critiquing the loss reserve committee documentation during the financial reporting process. Also, the Company is reassessing the structure of the loss reserve committee to enhance its effectiveness.

F-61

In addition, the Company has obtained additional resources and enhanced the production of key reports to improve the accuracy of the elements used in its premiums receivable reconciliation process and timely evaluation and disposal of the reconciling items noted during the premiums reconciliation process.

(d)

Changes in internal control over financial reporting

The Company evaluated the changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2012 and concluded that the following matters have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

The Company made the following changes to its internal control over financial reporting to remediate the material weakness reported in Amendment No. 1 to Form 10-Q/A for the quarter ended September 30, 2012:

The Company formalized its cross-functional communications and holds quarterly meetings to identify transactions that may have a tax impact. Senior management has formalized its role in the oversight of the reporting of deferred taxes on business combinations.

The Company instituted a more rigorous approach to addressing deferred tax accounting matters in business combinations and the related tax impact on purchase price allocation, opening GAAP balance sheet and subsequent adjustments to those items. A more robust analysis process has been implemented which includes the involvement of the Chief Accounting Officer, in consultation with external tax specialists to review the new accounting basis as a result of business combination accounting.

The Company completed the documentation and testing of the corrective processes described above and, as of December 31, 2012, has concluded that the steps taken have remediated the material weakness related to accounting for income taxes previously disclosed in Amendment No. 1 to the Company’s 2012 Forms 10-Q/As.

PART IV

Item 15. Exhibits, Financial Statement Schedules


A.	(1)	The financial statements and notes to financial statements are filed as part of this report in “Item 8. Financial Statements and Supplementary Data.”

	(2)	The financial statement schedules are listed in the Index to Consolidated Financial Statement Schedules.

	(3)	The exhibits are listed in the Index to Exhibits

The following entire exhibits are included:

	Exhibit 21.1		Subsidiaries of Tower Group, Inc.

	Exhibit 31.1		Certification of CEO to Section 302(a)

	Exhibit 31.2		Certification of CFO to Section 302(a)

	Exhibit 32		Certification of CEO and CFO to Section 906

The following exhibits are filed electronically herewith:

	EX-101		INSTANCE DOCUMENT

	EX-101		SCHEMA DOCUMENT

	EX-101		CALCULATION LINKBASE DOCUMENT

	EX-101		LABELS LINKBASE DOCUMENT

	EX-101		PRESENTATION LINKBASE DOCUMENT

	EX-101		DEFINITION LINKBASE DOCUMENT

F-62

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.


	Tower Group International, Ltd. (as successor to Tower Group, Inc.)
	Registrant

Date: November 26, 2013		/s/ Michael H. Lee
		Michael H. Lee
		Chairman of the Board, President and Chief Executive Officer

Pursuant to the requirements of the Securities Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities indicated.


Signature	Title	Date

/s/ MICHAEL H. LEE	Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer)	November 26, 2013
Michael H. Lee		November 26, 2013

/s/ WILLIAM E. HITSELBERGER	Executive Vice President, Chief Financial	November 26, 2013
William E. Hitselberger	Officer (Principal Financial Officer, Principal Accounting Officer)	November 26, 2013

/s/ WILLIAM W. FOX, JR.	Director	November 26, 2013
William W. Fox, Jr.		November 26, 2013

/s/ WILLIAM A. ROBBIE	Director	November 26, 2013
William A. Robbie		November 26, 2013

/s/ STEVEN W. SCHUSTER	Director	November 26, 2013
Steven W. Schuster		November 26, 2013

/s/ ROBERT S. SMITH	Director	November 26, 2013
Robert S. Smith		November 26, 2013

/s/ JAN R. VAN GORDER	Director	November 26, 2013
Jan R. Van Gorder		November 26, 2013

/s/ AUSTIN P. YOUNG, III	Director	November 26, 2013
Austin P. Young, III		November 26, 2013

Tower Group, Inc.

Index to Financial Statement Schedules


Schedules		Pages

I	Summary of Investments—other than investments in related parties	S-2
II	Condensed Financial Information of the Registrant as of and for the years ended December 31, 2012 and 2011	S-3
III	Supplementary Insurance Information for the years ended December 31, 2012, 2011, and 2010	S-8
IV	Reinsurance for the years ended December 31, 2012, 2011, and 2010	S-9
V	Valuation and Qualifying Accounts for the years ended December 31, 2012, 2011, and 2010	S-10
VI	Supplemental Information Concerning Insurance Operations for the years ended December 31, 2012, 2011, and 2010	S-11

S-1

Tower Group, Inc.

Schedule I - Summary of Investments - Other Than Investments in Related Parties


		December 31, 2012
						Amount
				Fair		Reflected on
		Cost		Value		Balance Sheet
($ in thousands)				(restated)		(restated)

Fixed maturities:
Available for sale:
U.S. Treasury securities and obligations of U.S. Government agencies	$		281,964	$	287,726	$	287,726
Corporate securities			698,012		746,665		746,665
Mortgage-backed securities			576,837		624,277		624,277
Municipal securities			633,373		686,043		686,043

Total fixed maturities			2,190,186		2,344,711		2,344,711
Preferred stocks			31,272		31,521		31,521
Common stock:
Public utilities, industrial and other			118,076		114,737		114,737

Total equities			149,348		146,258		146,258

Short-term investments			4,749		4,750		4,750
Other invested assets			57,786		57,786		57,786

Total investments	$		2,402,069	$	2,553,505	$	2,553,505


		December 31, 2011
($ in thousands)		Cost		Fair Value		Amount Reflected on Balance Sheet

Fixed maturities:
Available for sale:
U.S. Treasury securities and obligations of U.S. Government agencies	$		268,841	$	273,332	$	273,332
Corporate securities			750,220		777,723		777,723
Mortgage-backed securities			627,859		665,905		665,905

Municipal securities			688,192		736,714		736,714


Total fixed maturities			2,335,112		2,453,674		2,453,674

Preferred stocks			24,083		23,510		23,510

Common stock:

Public utilities, industrial and other			68,951		65,835		65,835


Total equities			93,034		89,345		89,345


Other invested assets			44,347		44,347		44,347


Total investments	$		2,472,493	$	2,587,366	$	2,587,366

S-2

Tower Group, Inc.

Schedule II - Condensed Financial Information of the Registrant

Condensed Balance Sheets


		December 31,
		2012		2011
($ in thousands)		(restated)		(restated)

Assets
Fixed-maturity securities, available-for-sale, at fair value (amortized cost of $7,656 and $5,938)	$		8,121	$	5,937
Equity securities, available-for-sale, at fair value (cost of $0 and $9,649)			-		9,960
Other invested assets			2,045		10,458
Cash and cash equivalents			17,130		12,882
Investment in subsidiaries			1,250,436		1,247,218

Investment in unconsolidated affiliate			71,894		-
Federal and state taxes recoverable			-		-
Deferred income taxes			15,879		2,714
Investment in statutory business trusts, equity method			2,664		2,664

Due from affiliate			-		1,231
Other assets			69,172		46,100

Total assets	$		1,437,341	$	1,339,164

Liabilities
Accounts payable and accrued expenses	$		25,622	$	16,293
Due to affiliates			75,823		27,542
Deferred rent liability			4,537		5,071
Federal and state income taxes payable			-		-
Debt			381,301		280,507

Total liabilities			487,283		329,413

Stockholders’ equity			950,058		1,009,751

Total liabilities and stockholders’ equity	$		1,437,341	$	1,339,164

The condensed financial information should be read in conjunction with the notes to the condensed financial information of the registrant and the consolidated financial statements and the notes thereto.

S-3

Tower Group, Inc.

Schedule II - Condensed Financial Information of the Registrant

Condensed Statements of Income


		Year Ended December 31,
		2012			2011			2010
($ in thousands)		(restated)			(restated)			(revised)

Revenues
Net realized gains (losses) on investments	$		(1,570	)	$	(264	)	$	201
Investment income			815			1,394			1,000
Equity in net earnings (losses) of subsidiaries			(6,254	)		61,681			119,149

Total revenues			(7,009	)		62,811			120,350
Expenses
Other operating expenses			11,754			10,067			2,891
Interest expense			18,782			17,843			9,685

Total expenses			30,536			27,910			12,576
Other Income
Equity income in unconsolidated affiliate			(1,470	)		-			-
Gain on investment in acquired unconsolidated affiliate			-			-			-
Acquisition related transaction costs			(9,229	)		(360	)		(2,369)

Income (loss) before income taxes			(48,244	)		34,541			105,405
Provision/(benefit) for income taxes			(14,010	)		(9,894	)		575

Net income (loss)	$		(34,234	)	$	44,435		$	104,830

S-4

Tower Group, Inc.

Schedule II - Condensed Financial Information of the Registrant

Condensed Statements of Comprehensive Income


		Year Ended December 31,
		2012			2011			2010
($ in thousands)		(restated)			(restated)			(revised)

Net income (loss)	$		(34,234	)	$	44,435		$	104,830
Other comprehensive income (loss) before tax
Gross unrealized investment holding gains (losses) arising during the period			62,325			50,851			45,912
Less: reclassification adjustment for (gains) losses included in net income			(25,475	)		(9,394	)		(14,653)
Portion of other-than-temporary impairment losses included in net income			(286	)		(264	)		(11,909)
Cumulative translation adjustment			1,852			-			-
Deferred gain (loss) on cash flow hedge			(2,422	)		(10,541	)		3,223

Other comprehensive income (loss) before tax			35,994			30,652			22,573
Income tax (expense) benefit related to items of other comprehensive income
Unrealized investment holdings gains (losses) arising during periods			(22,184	)		(9,430	)		(14,081)
Reclassification adjustment for (gains) losses included in net income			8,917			1,742			4,494
Portion of other-than-temporary impairment losses recognized in other comprehensive income			100			49			3,652
Cumulative translation adjustment			(648	)		-			-
Deferred gain (loss) on cash flow hedge			571			1,955			(988)

Other comprehensive income (loss) net of tax			22,750			24,968			15,650
Less amount attributable to Reciprocal Exchanges			2,684			10,194			2,646

Comprehensive income (loss)	$		(14,168	)	$	59,209		$	117,834

S-5

Tower Group, Inc.

Schedule II - Condensed Financial Information of the Registrant

Condensed Statements of Cash Flows


		Year Ended December 31,
		2012			2011			2010
($ in thousands)		(restated)			(restated)			(revised)

Cash flows provided by (used in) operating activities:
Net income (loss)	$		(34,234	)	$	44,435		$	104,830
Adjustments to reconcile net income to net cash provided by (used) in operations:
(Gain) loss on sale of investments			1,570			264			(201)
Dividends received from consolidated subsidiaries			22,954			55,400			12,200
Equity in undistributed net income of subsidiaries			2,088			(62,189	)		(117,767)
Depreciation and amortization			4,388			3,362			1,627
Amortization of debt issuance costs			2,830			2,635			711
Amortization of restricted stock			9,283			10,292			8,694
Deferred income tax			(13,165	)		(3,836	)		6,032
Excess tax benefits from share-based payment arrangements			(345	)		(162	)		1,302
Change in operating assets and liabilities
Investment income receivable			-			173			(315)
Federal and state income tax recoverable			(18,409	)		15,998			(8,817)
Equity loss (income) in unconsolidated affiliate			1,746			-			-
Other assets			(20,639	)		(16,763	)		(14,482)
Accounts payable and accrued expenses			57,610			6,089			158
Deferred rent			(534	)		(581	)		(380)

Net cash flows provided by (used in) operations			15,143			55,117			(6,408)
Cash flows provided by (used in) investing activities:
Investment in unconsolidated affiliate			(71,512	)		-			-
Acquisition of AequiCap II			-			-			(12,000)
Sale or maturity - fixed-maturity securities			3,947			58,367			65,292
Purchase of fixed assets			-			-			-
Purchase - fixed-maturity securities			(6,117	)		(46,848	)		(90,200)
Purchase - equity securities			-			(4,224	)		-
Purchase of other invested assets			8,413			(10,458	)		-
Sale - equity securities			8,390			1,304			-

Net cash flows provided by (used in) investing activities			(56,879	)		(1,859	)		(36,908)
Cash flows provided by (used in) financing activities:
Proceeds from credit facility borrowings			20,000			67,000			56,000
Repayment of credit facility borrowings			-			(17,000	)		(56,000)
Proceeds from convertible senior notes			-			-			145,634
Proceeds from intercompany borrowings			77,968			-			-
Payment for convertible senior notes hedge			-			-			(15,300)
Proceeds from issuance of warrants			-			-			3,800
Exercise of stock options and warrants			(2,263	)		373			1,590
Excess tax benefits from share-based payment arrangements			345			161			(1,302)
Treasury stock acquired-net employee share-based compensation			(4	)		(1,834	)		(1,750)
Repurchase of common stock			(20,987	)		(64,572	)		(88,034)
Dividends paid			(29,075	)		(27,894	)		(16,551)

Net cash flows provided by (used in) financing activities			45,984			(43,766	)		28,087

Increase (decrease) in cash and cash equivalents			4,248			9,492			(15,229)
Cash and cash equivalents, beginning of year			12,882			3,390			18,619

Cash and cash equivalents, end of year	$		17,130		$	12,882		$	3,390

S-6

Tower Group, Inc.

Schedule II – Condensed Financial Information of the Registrant

Notes to Condensed Financial Information

The accompanying condensed financial statements of Tower Group, Inc. (parent company) should be read in conjunction with the consolidated financial statements and notes thereto of Tower Group, Inc.

Note 1 – Debt

The information relating to debt is incorporated by reference from “Note 13 – Debt” in the consolidated financial statements.

Note 2 – Income Taxes

Tower Group, Inc. files a consolidated Federal income tax return. The Reciprocal Exchanges are not included in Tower Group, Inc’s consolidated tax return as it does not have an ownership interest in the Reciprocal Exchanges, and they are not a part of the consolidated tax sharing agreement. The Federal income tax provision represents an allocation under the consolidated tax sharing agreement.

Note 3 – Restatement to Previously Issued Financial Statements

These condensed financial information schedules of Tower Group, Inc. have been restated for loss reserve and premium receivable errors discussed in Note 2 to the consolidated financial statements and also corrected for other immaterial adjustments that were initially recorded in the period they were identified.

S-7

Tower Group, Inc.

Schedule III - Supplementary Insurance Information


($ in thousands)	Deferred Acquisition Cost, Net of Deferred Ceding Commission Revenue (restated)		Gross Future Policy Benefits, Losses and Loss Expenses (restated)		Gross Unearned Premiums (restated)		Net Earned Premiums (restated)		Benefits, Losses and Loss Expenses (restated)		Amortization of DAC (restated)			Operating Expenses (restated)		Net Premiums Written

2012
Commercial Insurance	$	129,087	$	1,466,201	$	594,972	$	1,224,566	$	912,682	$	(249,790	)	$	182,852	$	1,225,625
Personal Insurance		52,111		429,478		326,299		497,298		351,076		(102,612	)		136,411		513,757

Total	$	181,198	$	1,895,679	$	921,271	$	1,721,864	$	1,263,758	$	(352,402	)	$	319,263	$	1,739,382


2011
Commercial Insurance	$	120,655	$	1,218,681	$	588,436	$	1,087,911	$	758,211	$	(242,412	)	$	156,078	$	1,152,299
Personal Insurance		48,203		413,432		304,740		505,939		318,775		(103,173	)		127,465		486,292

Total	$	168,858	$	1,632,113	$	893,176	$	1,593,850	$	1,076,986	$	(345,585	)	$	283,543	$	1,638,591


2010
Commercial Insurance	$	131,966	$	1,197,065	$	541,809	$	941,015	$	595,028	$	(283,949	)	$	154,529	$	987,260
Personal Insurance		32,157		413,356		330,217		351,654		194,701		(41,378	)		83,941		326,804

Total	$	164,123	$	1,610,421	$	872,026	$	1,292,669	$	789,729	$	(325,327	)	$	238,470	$	1,314,064

S-8

Tower Group, Inc.

Schedule IV - Reinsurance


($ in thousands)	Gross Amount (restated)		Ceded to Other Companies		Assumed from Other Companies		Net Amount (restated)		Percentage of Amount Assumed to Net (restated)

Year ended December 31, 2012
Premiums
Property and casualty insurance	$	1,759,126	$	221,807	$	184,545	$	1,721,864		10.7%
Accident and health insurance		—		—		—		—		—

Total Premiums	$	1,759,126	$	221,807	$	184,545	$	1,721,864		10.7%

Year ended December 31, 2011
Premiums
Property and casualty insurance	$	1,684,020	$	195,922	$	105,752	$	1,593,850		6.6%
Accident and health insurance		—		—		—		—		—

Total Premiums	$	1,684,020	$	195,922	$	105,752	$	1,593,850		6.6%

Year ended December 31, 2010
Premiums
Property and casualty insurance	$	1,429,250	$	226,970	$	90,389	$	1,292,669		7.0%
Accident and health insurance		—		—		—		—		—

Total Premiums	$	1,429,250	$	226,970	$	90,389	$	1,292,669		7.0%

S-9

Tower Group, Inc.

Schedule V - Valuation and Qualifying Accounts


($ in thousands)	Balance, Beginning of Period (restated)		Additions (restated)		Deletions (restated)			Balance, End of Period (restated)

Year ended December 31, 2012
Premiums receivable	$	14,383	$	6,916	$	(4,790	)	$	16,509
Deferred income taxes, net		6,961		-		(339	)		6,622

Year ended December 31, 2011
Premiums receivable		7,719		9,669		(3,005	)		14,383
Deferred income taxes, net		11,824		-		(4,863	)		6,961

Year ended December 31, 2010
Premiums receivable		8,472		3,735		(4,488	)		7,719
Deferred income taxes, net		1,896		9,928		-			11,824

S-10

Tower Group, Inc.

Schedule VI - Supplemental Information Concerning Insurance Operations


$ in thousands)	Deferred Acquisition Cost		Reserves For Unpaid Claims and Claim Adjustment Expenses		Discounted Reserves		Unearned Premium		Earned Premium		Net Investment Income		Claims and Claims Adjustment Expenses Incurred and Related to					Amortization of DAC			Paid Claims and Claim Adjustment Expenses		Net Premiums Written

													Current Year		Prior Year* Includes PXRE Commutation

2012, as restated
Consolidated Insurance Subsidiaries	$	181,198	$	1,895,679	$	8,354	$	921,271	$	1,721,864	$	127,165	$	1,184,510	$	79,248		$	(352,402	)	$	1,167,428	$	1,739,382
2011, as restated
Consolidated Insurance Subsidiaries		168,858		1,632,113		3,674		893,176		1,593,850		126,474		1,076,045		941			(345,585	)		1,070,539		1,638,591
2010, as revised
Consolidated Insurance Subsidiaries		164,123		1,610,421		3,674		872,026		1,292,669		107,265		796,313		(6,584	)		(325,327	)		740,722		1,314,064

S-11

The exhibits listed below and designated with an asterisk are filed with this report. The exhibits listed below and designated with two asterisks are submitted electronically herewith. The exhibits listed below and not so designated are incorporated by reference to the documents following the descriptions of the exhibits.


Exhibit Number				Description of Exhibits
2.1				Agreement and Plan of Merger, dated as of August 4, 2008, by and among Tower Group, Inc., Ocean I Corporation and CastlePoint Holdings, Ltd., incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K/A filed on August 6, 2008
2.2				Agreement and Plan of Merger, dated as of June 21, 2009, by and among Tower Group, Inc., Tower S.F. Merger Corporation and Specialty Underwriters’ Alliance, Inc., incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8 filed on June 22, 2009
2.3				Amended and Restated Agreement and Plan of Merger, dated as of June 21, 2009, by and among Tower Group, Inc., Tower S.F. Merger Corporation and Specialty Underwriters’ Alliance, Inc., incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K/A filed on July 23, 2009
2.4				Purchase Agreement, dated as of February 2, 2010, by and among Tower Group, Inc., OneBeacon Insurance Group, Ltd., OneBeacon Insurance Group LLC, OneBeacon America Insurance Company, The Employers’ Fire Insurance Company, The Camden Fire Insurance Association, Homeland Insurance Company of New York, OneBeacon Insurance Company, OneBeacon Midwest Insurance Company, Pennsylvania General Insurance Company and The Northern Assurance Company of America, incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on February 3, 2010
2.5				Agreement and Plan of Merger, dated as of July 30, 2012, by and among Tower Group, Inc., Canopius Holdings Bermuda Limited, Canopius Mergerco, Inc. and Condor 1 Corporation, incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on July 31, 2012 incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on July 31, 2012
2.6				Letter Agreement, dated as of July 30, 2012, by and among Tower Group, Inc., Canopius Holdings Bermuda Limited, Canopius Mergerco, Inc. and Canopius Group Limited incorporated by reference to Exhibit 2.2 to the Company’s Current Report on Form 8-K filed on July 31, 2012
2.7				Amendment No. 1 to Agreement and Plan of Merger, dated as of November 8, 2012, by and among Tower Group, Inc., Canopius Holdings Bermuda Limited, Canopius Mergerco, Inc. and Condor 1 Corporation, with respect to the Agreement and Plan of Merger, dated as of July 30, 2012, filed as Exhibit 2.1 to Form 8-K filed on November 13, 2012
3.1				Amended and Restated Certificate of Incorporation of Tower Group, Inc., incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1 (Amendment No. 2) (No. 333-115310) filed on July 23, 2004
3.2				Certificate of Amendment to Amended and Restated Certificate of Incorporation of Tower Group, Inc., incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-8 (No. 333-115310) filed on February 5, 2009
3.3				Certificate of Designations of Preferred Stock, incorporated by reference to the Company’s Current Report on Form 8-K filed on December 8, 2006
3.4				Certificate of Designations of Series A-1 Preferred Stock of Tower Group, Inc. incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on January 12, 2007
3.5				Amended and Restated By-laws of Tower Group, Inc. as amended November 3, 2011, incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on November 9, 2011
4.1				Specimen Common Stock Certificate, incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-1 (Amendment No. 6) (No. 333-115310) filed on September 30, 2004
4.2				Warrant issued to Friedman, Billings, Ramsey & Co., Inc., incorporated by reference to Exhibit 4.3 to the Company’s Registration Statement on Form S-1 (Amendment No. 3) (No. 333-115310) filed on August 25, 2004
4.3				Indenture, dated as of September 20, 2010, between Tower Group, Inc. and U.S. Bank National Association relating to the 5.00% Convertible Senior Notes due 2014, incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on September 20, 2010
4.4				Base Call Option Confirmation, dated as of September 14, 2010, between Bank of America, N.A. and Tower Group, Inc. relating to the 5.00% Convertible Senior Notes due 2014, incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on September 20, 2010
4.5				Base Call Option Confirmation, dated as of September 14, 2010, between JPMorgan Chase Bank, National Association, London Branch and Tower Group, Inc. relating to the 5.00% Convertible Senior Notes due 2014, incorporated by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on September 20, 2010
4.6				Additional Call Option Confirmation, dated as of September 15, 2010, between Bank of America, N.A. and Tower Group, Inc relating to the 5.00% Convertible Senior Notes due 2014, incorporated by reference to Exhibit 4.4 to the Company’s Current Report on Form 8-K filed on September 20, 2010
4.7				Additional Call Option Confirmation, dated as of September 15, 2010, between JPMorgan Chase Bank, National Association, London Branch and Tower Group, Inc. relating to the 5.00% Convertible Senior Notes due 2014, incorporated by reference to Exhibit 4.5 to the Company’s Current Report on Form 8-K filed on September 20, 2010

162


Exhibit Number				Description of Exhibits
4.8				Base Warrant Confirmation, dated as of September 14, 2010, between Bank of America, N.A. and Tower Group, Inc. relating to the 5.00% Convertible Senior Notes due 2014, incorporated by reference to Exhibit 4.6 to the Company’s Current Report on Form 8-K filed on September 20, 2010
4.9				Base Warrant Confirmation, dated as of September 14, 2010, between JPMorgan Chase Bank, National Association, London Branch and Tower Group, Inc. relating to the 5.00% Convertible Senior Notes due 2014, incorporated by reference to Exhibit 4.7 to the Company’s Current Report on Form 8-K filed on September 20, 2010
4.10				Additional Warrant Confirmation, dated as of September 15, 2010, between Bank of America, N.A. and Tower Group, Inc relating to the 5.00% Convertible Senior Notes due 2014, incorporated by reference to Exhibit 4.8 to the Company’s Current Report on Form 8-K filed on September 20, 2010
4.11				Additional Warrant Confirmation, dated as of September 15, 2010, between JPMorgan Chase Bank, National Association, London Branch and Tower Group, Inc. relating to the 5.00% Convertible Senior Notes due 2014, incorporated by reference to Exhibit 4.9 to the Company’s Current Report on Form 8-K filed on September 20, 2010
9.1				Voting Agreement, dated August 4, 2008, between Tower Group, Inc. and Michael H. Lee, incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on August 5, 2008
10.1				Employment Agreement, dated as of February 27, 2012, by and between Tower Group, Inc. and Michael H. Lee, incorporated by reference to Exhibit 10.1 to the Company’s Annual Report on Form 10-K filed on February 29, 2012
10.2				Employment agreement, dated as of October 18, 2011, by and between Tower Group, Inc, and William F. Dove, incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K filed on October 18, 2011
10.3				Employment Agreement, dated as of November 19, 2009, by and between Tower Group, Inc. and William E. Hitselberger, incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on November 19, 2009
10.4				Employment Agreement, dated as of July 23, 2007, by and between Tower Group Inc. and Gary S. Maier, incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed on November 9, 2007
10.5				2004 Long-Term Equity Compensation Plan, as amended and restated effective May 15, 2008, incorporated by reference to Exhibit 99.1 to the Company’s Registration Statement on Form S-8 (No. 333-115310) filed on June 20, 2008
10.6				2001 Stock Award Plan, incorporated by reference to Exhibit 10.8 to the Company’s Registration Statement on Form S-1 (No. 333-115310) filed on May 7, 2004
10.7				2000 Deferred Compensation Plan, incorporated by reference to Exhibit 10.9 to the Company’s Registration Statement on Form S-1 (Amendment No. 6) (No. 333-115310) filed on September 30, 2004
10.8				Amended & Restated Declaration of Trust, dated as of May 15, 2003, by and between Tower Group, Inc., Tower Statutory Trust I and U.S. Bank National Association, incorporated by reference to Exhibit 10.10 to the Company’s Registration Statement on Form S-1 (No. 333-115310) filed on May 7, 2004
10.9				Indenture, dated as of May 15, 2003, by and between Tower Group, Inc. and U.S. Bank National Association, incorporated by reference to Exhibit 10.11 to the Company’s Registration Statement on Form S-1 (No. 333-115310) filed on May 7, 2004
10.10				Guarantee Agreement, dated as of May 15, 2003, by and between Tower Group, Inc. and U.S. Bank National Association, incorporated by reference to Exhibit 10.12 to the Company’s Registration Statement on Form S-1 (No. 333-115310) filed on May 7, 2004
10.11				Amended and Restated Trust Agreement, dated as of September 30, 2003, by and between Tower Group, Inc., JPMorgan Chase Bank, Chase Manhattan Bank USA, National Association and Michael H. Lee, Steven G. Fauth and Francis M. Colalucci as Administrative Trustees of Tower Group Statutory Trust II, incorporated by reference to Exhibit 10.13 to the Company’s Registration Statement on Form S-1 (No. 333-115310) filed on May 7, 2004
10.12				Junior Subordinated Indenture, dated as of September 30, 2003, by and between Tower Group, Inc. and JPMorgan Chase Bank, incorporated by reference to Exhibit 10.14 to the Company’s Registration Statement on Form S-1 (No. 333-115310) filed on May 7, 2004
10.13				Guarantee Agreement, dated as of September 30, 2003, by and between Tower Group, Inc. and JPMorgan Chase Bank, incorporated by reference to Exhibit 10.15 to the Company’s Registration Statement on Form S-1 (No. 333-115310) filed on May 7, 2004
10.14				Service and Expense Sharing Agreement, dated as of December 28, 1995, by and between Tower Insurance Company of New York and Tower Risk Management Corp., incorporated by reference to Exhibit 10.16 to the Company’s Registration Statement on Form S-1 (No. 333-115310) filed on May 7, 2004
10.15				Real Estate Lease and amendments thereto, by and between Broadpine Realty Holding Company, Inc. and Tower Insurance Company of New York, incorporated by reference to Exhibit 10.17 to the Company’s Registration Statement on Form S-1 (Amendment No. 1) (No. 333-115310) filed on June 24, 2004

163


Exhibit Number				Description of Exhibits
10.16				Third Amendment to Lease between Tower Insurance Company of New York and 120 Broadway Holdings, LLC executed September 1, 2005, incorporated by reference to Exhibit 10.01 to the Company’s Current Report on Form 8-K filed on August 26, 2005
10.17				License and Services Agreement, dated as of June 11, 2002, by and between AgencyPort Insurance Services, Inc. and Tower Insurance Company of New York, incorporated by reference to Exhibit 10.18 to the Company’s Registration Statement on Form S-1 (Amendment No. 3) (No. 333-115310) filed on August 25, 2004
10.18				Agreement, dated as of April 17, 1996, between Morstan General Agency, Inc. and Tower Risk Management Corp., incorporated by reference to Exhibit 10.19 to the Company’s Registration Statement on Form S-1 (No. 333-115310) filed on May 7, 2004
10.19				Amended and Restated Declaration of Trust, dated December 15, 2004, by and among Wilmington Trust Company, as Institutional Trustee; Wilmington Trust Company, as Delaware Trustee; Tower Group, Inc., as Sponsor; and the Trust Administrators Michael H. Lee, Francis M. Colalucci and Steve G. Fauth, incorporated by reference to Exhibit 10.04 to the Company’s Current Report on Form 8-K filed on December 20, 2004
10.20				Indenture between Tower Group, Inc. and Wilmington Trust Company, as Trustee, dated December 15, 2004, incorporated by reference to Exhibit 10.03 to the Company’s Current Report on Form 8-K filed on December 20, 2004
10.21				Guarantee Agreement dated December 15, 2004, by and between Tower Group, Inc. and Wilmington Trust Company, incorporated by reference to Exhibit 10.02 to the Company’s Current Report on Form 8-K filed on December 20, 2004
10.22				Amended and Restated Declaration of Trust, dated December 21, 2004, by and among JPMorgan Chase Bank, National Association, as Institutional Trustee, Chase Manhattan Bank USA, National Association, as Delaware Trustee; Tower Group, Inc., as Sponsor; and the Trust Administrators Michael H. Lee, Francis M. Colalucci and Steve G. Fauth, incorporated by reference to Exhibit 10.04 to the Company’s Current Report on Form 8-K filed on December 23, 2004
10.23				Indenture between Tower Group, Inc. and JPMorgan Chase Bank, National Association, as Trustee, dated December 21, 2004, incorporated by reference to Exhibit 10.03 to the Company’s Current Report on Form 8-K filed on December 23, 2004
10.24				Guarantee Agreement dated December 21, 2004, by and between Tower Group, Inc. and JPMorgan Chase Bank, National Association, incorporated by reference to Exhibit 10.02 to the Company’s Current Report on Form 8-K filed on December 23, 2004
10.25				Amended and Restated Declaration of Trust, dated March 31, 2006, by and among Wells Fargo Bank, National Association, as Institutional Trustee; Wells Fargo Delaware Trust Company, as Delaware Trustee; Tower Group, Inc., as Sponsor; and the Trust Administrators Francis M. Colalucci and Steve G. Fauth, incorporated by reference to Exhibit 10.04 to the Company’s Current Report on Form 8-K filed on April 6, 2006
10.26				Indenture between Tower Group, Inc. and Wells Fargo Bank, National Association, as Trustee, dated March 31, 2006, incorporated by reference to Exhibit 10.03 to the Company’s Current Report on Form 8-K filed on April 6, 2006
10.27				Guarantee Agreement dated March 31, 2006, by and between Tower Group, Inc. and Wells Fargo Delaware Trust Company, incorporated by reference to Exhibit 10.02 to the Company’s Current Report on Form 8-K filed on April 6, 2006
10.28				Stock Purchase Agreement by and among Tower Group, Inc. and Preserver Group, Inc. dated November 13, 2006, incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on November 17, 2006
10.29				Exchange Agreement by and among Tower Group, Inc. and CastlePoint Management Corp. dated January 11, 2007 incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on January 12, 2007
10.30				Master Agreement dated April 4, 2006 by and among Tower Group, Inc., Tower Insurance Company of New York, Tower National Insurance Company, CastlePoint Holdings, Ltd. and CastlePoint Management Corp. incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on January 22, 2007
10.31				Addendum No. 1 to the Master Agreement by and among Tower Group, Inc. and CastlePoint Holdings, Ltd. incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on January 22, 2007
10.32				Amended and Restated Declaration of Trust, dated January 25, 2007, by and among Wilmington Trust, as Institutional Trustee and as Delaware Trustee; Tower Group, Inc., as Sponsor; and the Trust Administrators Michael H. Lee, Francis M. Colalucci and Stephen L. Kibblehouse, incorporated by reference to Exhibit 10.02 to the Company’s Current Report on Form 8-K filed on January 26, 2007
10.33				Indenture between Tower Group, Inc. and Wilmington Trust Company, as Trustee, dated January 25, 2007, incorporated by reference to Exhibit 4.01 to the Company’s Current Report on Form 8-K filed on January 26, 2007
10.34				Guarantee Agreement dated January 25, 2007, by and between Tower Group, Inc. and Wilmington Trust Company, incorporated by reference to Exhibit 10.01 to the Company’s Current Report on Form 8-K filed on January 26, 2007
10.35				Management Agreement, dated July 1, 2007, by and between CastlePoint Insurance Company and Tower Risk Management Corp., incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on November 9, 2007

164


Exhibit Number				Description of Exhibits
10.36				Fourth Amendment to Lease between Tower Insurance Company of New York and 120 Broadway Holdings, LLC dated July 25, 2006, incorporated by reference to Exhibit 10.49 to the Company’s Annual Report on Form 10-K filed on March 14, 2008
10.37				Fifth Amendment to Lease between Tower Insurance Company of New York and 120 Broadway Holdings, LLC dated December 20, 2006, incorporated by reference to Exhibit 10.50 to the Company’s Annual Report on Form 10-K filed on March 14, 2008
10.38				Service Agreement dated May 1, 2007 by and among Tower Risk Management Corp. and CastlePoint Management Corp., incorporated by reference to Exhibit 10.59 to the Company’s Annual Report on Form 10-K filed on March 14, 2008
10.39				Form of Tower Group, Inc. 2004 Long Term Equity Compensation Plan Restricted Stock Award Agreement, incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on March 18, 2008
10.40				Form of Tower Group, Inc. 2004 Long Term Equity Compensation Plan Performance Shares Award Agreement, incorporated by reference to Exhibit 10.50 to the Company’s Annual Report on Form 10-K filed on March 16, 2009
10.41				Form of Tower Group, Inc. 2004 Long Term Equity Compensation Plan, as amended and restated effective May 15, 2008, Restricted Stock Units Award Agreement, incorporated by reference to Exhibit 10.63 to the Company’s Annual Report on Form 10-K filed on March 14, 2008
10.42				Stock Purchase Agreement dated August 27, 2008 between CastlePoint Reinsurance Company, Ltd., HIG, Inc. and Brookfield US Corporation, incorporated by reference to Exhibit 2.1 to CastlePoint Holdings, Ltd.’s Current Report on Form 8-K filed on September 2, 2008
10.43				Asset Purchase Agreement, dated as of August 26, 2008, by and among CastlePoint Reinsurance Company, Ltd., Tower Insurance Company of New York, Tower National Insurance Company, Preserver Insurance Company, Mountain Valley Insurance Company, North East Insurance Company and Tower Risk Management Corp., incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed August 27, 2008
10.44				Limited Waiver Agreement, dated as of August 26, 2008, by and among Tower Group, Inc., Ocean I Corporation and CastlePoint Holdings, Ltd., incorporated by reference to Exhibit 2.2 to the Company’s Current Report on Form 8-K filed August 27, 2008
10.45				Parent Guarantee Agreement, dated as of December 1, 2006, between CastlePoint Holdings, Ltd. and Wilmington Trust Company, incorporated by reference to Exhibit 10.32 to CastlePoint Holdings Ltd.’s Registration Statement on Form S-1 (No. 333-139939) filed on January 11, 2007
10.46				Guarantee Agreement, dated as of December 1, 2006, between CastlePoint Management Corp. and Wilmington Trust Company, incorporated by reference to Exhibit 10.33 to CastlePoint Holdings Ltd.’s Registration Statement on Form S-1 (No. 333-139939) filed on January 11, 2007
10.47				Indenture, dated as of December 1, 2006, between CastlePoint Management Corp. and Wilmington Trust Company, incorporated by reference to Exhibit 10.34 to CastlePoint Holdings Ltd.’s Registration Statement on Form S-1 (No. 333-139939) filed on January 11, 2007
10.48				Amended and Restated Declaration of Trust, dated as of December 1, 2006, among Wilmington Trust Company as Institutional Trustee, Wilmington Trust Company, as Delaware Trustee, CastlePoint Management Corp., as Sponsor, and Joel Weiner, James Dulligan and Roger Brown, as Administrators, incorporated by reference to Exhibit 10.35 to CastlePoint Holdings Ltd.’s Registration Statement on Form S-1 (No. 333-139939) filed on January 11, 2007
10.49				Parent Guarantee Agreement, dated as of December 14, 2006, between CastlePoint Holdings, Ltd. and Wilmington Trust Company, incorporated by reference to Exhibit 10.36 to CastlePoint Holdings Ltd.’s Registration Statement on Form S-1 (No. 333-139939) filed on January 11, 2007
10.50				Guarantee Agreement of CastlePoint Management Corp., dated as of December 14, 2006, between CastlePoint Management Corp. and Wilmington Trust Company, incorporated by reference to Exhibit 10.37 to CastlePoint Holdings Ltd.’s Registration Statement on Form S-1 (No. 333-139939) filed on January 11, 2007
10.51				Indenture, dated as of December 14, 2006, between CastlePoint Management Corp. and Wilmington Trust Company, incorporated by reference to Exhibit 10.38 to CastlePoint Holdings Ltd.’s Registration Statement on Form S-1 (No. 333-139939) filed on January 11, 2007
10.52				Amended and Restated Declaration of Trust, dated as of December 14, 2006, among Wilmington Trust Company as Institutional Trustee, Wilmington Trust Company, as Delaware Trustee, CastlePoint Management Corp., as Sponsor, and Joel Weiner, James Dulligan and Roger Brown, as Administrators, incorporated by reference to Exhibit 10.39 to CastlePoint Holdings Ltd.’s Registration Statement on Form S-1 (No. 333-139939) filed on January 11, 2007
10.53				CastlePoint Holdings, Ltd. 2006 Long-Term Equity Compensation Plan, incorporated by reference to Exhibit 10.4 to CastlePoint Holdings Ltd.’s Registration Statement on Form S-1 (File No. 333-134628) filed on June 1, 2006
10.54				Amendment No. 1 to CastlePoint Holdings, Ltd. 2006 Long-Term Equity Compensation Plan, incorporated by reference to Exhibit 4.5 to CastlePoint Holdings Ltd.’s Registration Statement on Form S-8 (File No. 333-134628) filed on December 5, 2007

165


Exhibit Number				Description of Exhibits
10.55				Form of Stock Option Agreement for Executive Employee Recipients of Options under 2006 Long-Term Equity Compensation Plan, incorporated by reference to Exhibit 10.5 to CastlePoint Holdings Ltd.’s Registration Statement on Form S-1 (File No. 333-134628) filed on June 1, 2006
10.56				Form of Stock Option Agreement for Non-Employee Director Recipients of Options under 2006 Long-Term Equity Compensation Plan, incorporated by reference to Exhibit 10.6 to CastlePoint Holdings Ltd.’s Registration Statement on Form S-1 (File No. 333-134628) filed on June 1, 2006
10.57				Indenture between CastlePoint Bermuda Holdings, Ltd. and Wilmington Trust Company, as Trustee, dated September 27, 2007, incorporated by reference to Exhibit 4.1 to CastlePoint Holdings Ltd.’s Current Report on Form 8-K filed on October 1, 2007
10.58				Guarantee Agreement dated September 27, 2007 by and between CastlePoint Bermuda Holdings, Ltd. and Wilmington Trust Company, incorporated by reference to Exhibit 4.2 to CastlePoint Holdings Ltd.’s Current Report on Form 8-K filed on October 1, 2007
10.59				Amended and Restated Declaration of Trust, dated September 27, 2007, by Wilmington Trust, as Institutional Trustee and as Delaware Trustee; CastlePoint Bermuda Holdings, Ltd. as Sponsor, and Trust Administrators Roger A. Brown, Joel S. Weiner and James Dulligan, incorporated by reference to Exhibit 4.3 to CastlePoint Holdings Ltd.’s Current Report on Form 8-K filed on October 1, 2007
10.60				Fixed/Floating Rate Junior Subordinated Deferrable Interest Debenture, dated September 27, 2007 by CastlePoint Bermuda Holdings, Ltd. in favor of Wilmington Trust Company as institutional trustee, incorporated by reference to Exhibit 4.4 to CastlePoint Holdings Ltd.’s Current Report on Form 8-K filed on October 1, 2007
10.61				Supplemental Guarantee, dated as of February 5, 2009, by and among Ocean I Corporation, CastlePoint Holdings, Ltd. and Wilmington Trust Company (related to that certain Parent Guarantee Agreement, dated as of December 1, 2006, between CastlePoint Holdings, Ltd. and Wilmington Trust Company), incorporated by reference to Exhibit 10.71 to the Company’s Annual Report on Form 10-K filed on March 16, 2009
10.62				Supplemental Guarantee, dated as of February 5, 2009, by and among Ocean I Corporation, CastlePoint Holdings, Ltd. and Wilmington Trust Company (related to that certain Parent Guarantee Agreement, dated as of December 14, 2006, between CastlePoint Holdings, Ltd. and Wilmington Trust Company), incorporated by reference to Exhibit 10.72 to the Company’s Annual Report on Form 10-K filed on March 16, 2009
10.63				Supplemental Guarantee, dated as of February 5, 2009, by and among Ocean I Corporation, CastlePoint Holdings, Ltd. and Wilmington Trust Company (related to that certain Parent Guarantee Agreement, dated as of November 8, 2007, between CastlePoint Holdings, Ltd. and Wilmington Trust Company), incorporated by reference to Exhibit 10.73 to the Company’s Annual Report on Form 10-K filed on March 16, 2009
10.64				Separation Agreement, dated as of February 27, 2009, by and between Tower Group, Inc. and Patrick J. Haveron, incorporated by reference to Exhibit 10.75 to the Company’s Annual Report on Form 10-K filed on March 16, 2009
10.65				Consulting Agreement, dated as of February 27, 2009, by and between Tower Group, Inc. and Patrick J. Haveron, incorporated by reference to Exhibit 10.76 to the Company’s Annual Report on Form 10-K filed on March 16, 2009
10.66				Letter of Amendment dated February 23, 2009 to Stock Purchase Agreement dated August 27, 2008 between CastlePoint Reinsurance Company, Ltd., HIG, Inc. and Brookfield US Corporation, incorporated by reference to Exhibit 10.77 to the Company’s Annual Report on Form 10-K filed on March 16, 2009
10.67				Credit Agreement dated as of May 14, 2010 by and among Tower Group, Inc., Bank of America, N.A., JPMorgan Chase Bank, N.A., KeyBank National Association, PNC Bank, National Association, J.P. Morgan Securities Inc. and Banc of America Securities LLC, incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on May 17, 2010
10.68				Investment and Shareholders’ Agreement dated as of April 25, 2012 by and among Tower Group, Inc. and the principal shareholders of Canopius Group, Ltd., incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on April 25, 2012
10.69				Master Transaction Agreement, dated as of April 25, 2012, by and among Tower Group, Inc., Canopius Holdings Bermuda Limited, Canopius Mergerco, Inc. and Canopius Group Limited incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on April 25, 2012
10.70				Employment agreement, dated as of December 1, 2008, by and between Tower Group, Inc, and Elliot S. Orol, incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on November 9, 2012
10.71				Amendment to Employment agreement, dated as of November 16, 2012, by and between Tower Group, Inc, and Elliot S. Orol, incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed on November 9, 2012
10.72				Amendment to Employment agreement, dated as of November 16, 2012, by and between Tower Group, Inc, and Gary S. Maier, incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q filed on November 9, 2012
10.73				Second Amendment to Credit Agreement and Consent, dated as of November 26, 2012, by and among Tower Group, Inc., Bank of America, N.A., JPMorgan Chase Bank, N.A., KeyBank National Association, PNC Bank, National Association, J.P. Morgan Securities Inc. and Banc of America Securities LLC, incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on November 28, 2012

166


Exhibit Number				Description of Exhibits
16				Letter from Johnson, Lambert & Co. LLP regarding change in certifying accountant, incorporated by reference to Exhibit 16.1 to the Company’s Current Report on Form 8-K filed on March 5, 2010
21.1				Subsidiaries of the registrant*
31.1				Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by Michael H. Lee*
31.2				Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by William E. Hitselberger*
32				Certification of Chief Executive Officer and Chief Financial Officer, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
EX-101				INSTANCE DOCUMENT**
EX-101				SCHEMA DOCUMENT**
EX-101				CALCULATION LINKBASE DOCUMENT**
EX-101				LABELS LINKBASE DOCUMENT**
EX-101				PRESENTATION LINKBASE DOCUMENT**
EX-101				DEFINITION LINKBASE DOCUMENT**

167