Annual Report

10-K 1 d10k.htm ANNUAL REPORT Annual Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTIONS 13 or 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2006

Commission File Number - 1-6026

THE MIDLAND COMPANY

Incorporated in Ohio

I.R.S. Employer Identification No. 31-0742526

7000 Midland Boulevard

Amelia, Ohio 45102-2607

Tel. (513) 943-7100

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


Title of each class		Name of each exchange on which registered
Common Stock, no par value		The NASDAQ Stock Market LLC (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 the Securities Act. Yes ¨ No x

Indicated by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x

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

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 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, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨

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

The aggregate market value of the voting and non-voting common stock held by nonaffiliates, which excludes shares held by executive officers and directors, of the registrant at June 30, 2006 was $389,918,822 based on a closing price of $37.98 per share.

As of February 28, 2007, 19,281,909 shares of no par value common stock were issued and outstanding.

Documents Incorporated by Reference

Portions of the Registrant’s Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held April 26, 2007 are incorporated by reference into Part III.

THE MIDLAND COMPANY

FORM 10-K

FOR FISCAL YEAR ENDED DECEMBER 31, 2006

Certain statements made in this report are forward-looking and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements include, but are not limited to, certain discussions relating to future revenue, underwriting income, premium volume, investment income and other investment results, business strategies, profitability, liquidity, capital adequacy, anticipated capital expenditures and business relationships, as well as any other statements concerning the year 2007 and beyond. In some cases you can identify forward-looking statements by such terms as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “project,” “predict,” “potential,” “likely,” “target” and similar expressions or the negative versions of such expressions. These forward-looking statements reflect The Midland Company’s current views about future events, are based on assumptions and are subject to known and unknown risks and uncertainties that may cause results to differ materially from those anticipated in those statements. Many of the factors that will determine future events or achievements are beyond Midland’s ability to control or predict. Factors that might cause results to differ from those anticipated include, without limitation, adverse weather conditions, changes in underwriting results affected by adverse economic conditions, fluctuations in the investment markets, changes in the retail marketplace, changes in the laws or regulations affecting the operations of the Company or its subsidiaries, changes in exposures to assessments and surcharges for guaranty funds, second injury funds and other mandatory pool arrangements, changes in the business tactics or strategies of the Company, its subsidiaries or its current or anticipated business partners, the financial condition of the Company’s business partners, acquisitions or divestitures, changes in market forces, litigation and the other risk factors that have been identified in the Company’s filings with the SEC, any one of which might materially affect the operations of the Company or its subsidiaries. Any forward-looking statements speak only as of the date made. We undertake no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made. You should read this Form 10-K and the documents referenced herein and filed as exhibits herewith completely and with the understanding that Midland’s actual future results may be materially different from what Midland expects. Midland qualifies all of its forward-looking statements by these cautionary statements.

PART I

ITEM 1.

Business.

The Midland Company (“Midland” or the “Company”) hereby incorporates by reference Item 7 of this Form 10-K. The Midland Company was incorporated in Ohio in 1968 with its original predecessor company dating back to 1938. The approximate number of persons employed by Midland was 1,200 at December 31, 2006. The Midland Company is a highly focused provider of specialty insurance products and services through its American Modern Insurance Group, Inc. (“AMIG” or “American Modern”) subsidiary, which contributes approximately 94 percent of the company’s revenues. The Company also maintains an investment in a niche river transportation business, M/G Transport Services Inc. The Company has divided its insurance products into four distinct groups: residential property, recreational casualty, financial institutions, and all other insurance products. The discussions of “Results of Operations” and “Liquidity, Capital Resources and Changes in Financial Condition” address these four reportable insurance segments and our transportation business. A summary description of the operations of each of these segments is included below.

Our residential property segment includes primarily manufactured housing and site-built dwelling insurance products. Approximately 41% of American Modern’s property and casualty and credit life gross written premium relates to physical damage insurance and related coverages on manufactured homes, generally written for a term of 12 months with many coverages similar to homeowner’s insurance policies. Our recreational casualty segment includes specialty insurance products such as motorcycle, watercraft, recreational vehicle, collector car and snowmobile. Our financial institutions segment includes specialty insurance products such as mortgage fire, collateral protection and debt cancellation, which are sold to financial service institutions or their customers. The all other insurance segment includes products such as credit life, long-haul truck physical damage, commercial, excess and surplus lines and also includes the results of our fee producing subsidiaries.

Our specialty insurance operations are conducted through our wholly-owned American Modern subsidiary which controls eight property and casualty insurance companies, seven credit life insurance companies, three licensed insurance agencies and three service companies. American Modern is licensed, through its subsidiaries, to write insurance premiums in all 50 states and the District of Columbia.

American Modern generates its insurance premiums through multiple distribution channels. For the year ended December 31, 2006, 41 percent of American Modern’s business was written through its agency channels (both independent agents and general agents), 20 percent through point of sale, 23 percent through financial institutions, 11 percent through lenders and 6 percent from other sources.

Listed below is financial information required to be reported for each industry segment. Certain amounts are allocated and certain amounts are not allocated (e.g., assets and investment gains) to each segment for management review. Operating segment information based upon how it is reviewed by the Company is as follows for the years ended December 31, 2006, 2005 and 2004 (amounts in 000’s):


	Insurance Group
	Residential Property		Recreational Casualty		Financial Institutions		All Other Insurance		Unallocated Insurance Amounts		Transportation		Corporate and All Other			Intersegment Elimination			Total
2006
Revenues—External customers	$	398,886	$	97,271	$	103,831	$	88,681			$	49,807	$	124					$	738,600
Net investment income		21,376		5,614		5,106		8,310	$	342				2,899		$	(1,424	)		42,223
Net realized investment gains										8,445										8,445
Interest expense										1,130		945		5,055			(1,966	)		5,164
Depreciation and amortization		3,419		1,357		378		960				2,429		850						9,393
Income before taxes		42,554		10,186		12,507		26,751		7,715		7,842		(9,701	)					97,854
Income tax expense										28,684		2,734		(4,259	)					27,159
Acquisition of fixed assets										16,802		17,374		16,656						50,832
Identifiable assets										1,419,716		51,435		111,732			(13,355	)		1,569,528
2005
Revenues—External customers	$	384,053	$	105,607	$	78,424	$	76,414			$	42,185	$	(34	)				$	686,649
Net investment income		20,682		6,000		4,194		7,627	$	216				2,544		$	(744	)		40,519
Net realized investment gains										6,262										6,262
Interest expense										1,737		761		4,375			(906	)		5,967
Depreciation and amortization		3,903		1,501		419		939				2,923		836						10,521
Income before taxes		45,755		12,693		9,471		19,903		5,877		4,886		(5,684	)					92,901
Income tax expense										28,159		1,720		(2,304	)					27,575
Acquisition of fixed assets										18,085		13,172		1,178						32,435
Identifiable assets										1,295,938		50,400		102,859			(21,084	)		1,428,113
2004
Revenues—External customers	$	406,544	$	121,432	$	86,803	$	76,405			$	45,379	$	180					$	736,743
Net investment income		19,120		6,107		3,615		6,902	$	172				1,546		$	(297	)		37,165
Net realized investment gains										19,623				43			(9,733	)		9,933
Interest expense										2,038		856		2,730			(455	)		5,169
Depreciation and amortization		4,238		1,836		275		570				2,296		1,652						10,867
Income before taxes		47,418		4,987		6,991		12,396		17,816		1,689		(4,460	)		(9,733	)		77,104
Income tax expense										27,662		599		(1,989	)		(3,406	)		22,866
Acquisition of fixed assets										9,392		2,160		147						11,699
Identifiable assets										1,248,521		38,869		113,716			(36,422	)		1,364,684

The amounts shown for residential property, recreational casualty, financial institutions, all other insurance and unallocated insurance comprise the consolidated amounts for Midland’s insurance operations subsidiary, American Modern Insurance Group, Inc. Intersegment revenues were not significant for 2006, 2005 or 2004. During 2004 the Midland parent company purchased 492,634 shares of U.S. Bancorp common stock from American Modern Insurance Group, Inc. The effects of this transaction were eliminated from consolidated net realized investment gains, income before taxes and income tax expense.

Revenues reported above, by definition, exclude investment income and realized gains. For income before taxes reported above, insurance investment income is allocated to the insurance segments while realized gains and losses are included in Unallocated Insurance Amounts. The Company allocates insurance investment income to the segments based primarily on written premium volume. The Company does not allocate realized gains or losses to the segments as the Company evaluates the performance of the segments exclusive of the impact of realized gains or losses due to potential timing issues. Certain other amounts are also not allocated to segments by the Company.

No single customer contributed in excess of 10% of consolidated revenues in 2006, 2005 or 2004.

Property and Casualty Loss Reserves

Our loss reserves are comprised of two main components, case base loss reserves and incurred-but-not-reported loss reserves. Loss reserves include both loss and loss adjustment expense and are reported net of salvage and subrogation.

Case base loss reserves are estimated liabilities set for specifically identified outstanding losses incurred to date to be paid in the future. Case base loss reserves are based on the specific facts and circumstances of reported claims, but still require a significant amount of judgment. Case base reserves are established after notice of loss is received. The initial amount of the case base reserve is based on the policy coverages and limits, loss description, exposure information (i.e., insured product and insured value), cause of loss and historical loss cost information. The claim reserves are subsequently adjusted by claims personnel as more information becomes available in the claim adjustment process, through such procedures as a physical inspection of the loss. In many of our property lines of business, our adjusters utilize specialized claim estimatic software to assist in the claim estimation process. The claim estimatic software utilizes historical information and considers factors such as the region to assist in the estimated value of such items as materials, labor and depreciation, as applicable. Case base loss reserves are subsequently revised based on additional information until the claim is ultimately paid. The case base claims from our property lines of business tend to be reported and settled rather quickly. We estimate that property claims are reported to us, on average, approximately 30 days after the loss incurred date and approximately 90 percent are settled within 30 days from when they are reported to us. Losses for our liability lines of business are generally reported to us much longer after the loss incurred date as compared to our property lines of business. The majority of our liability claims are settled within 90 days of being reported to us. However, it is not unusual to have liability claims that are not reported to us for as much as several years after the actual loss has occurred and for these claims to take an extended period of time to actually settle. This is particularly true in our exited commercial park and dealer liability business and to a lesser extent, in our excess and surplus lines. We estimate that approximately 55 percent of our case base loss reserves relate to property coverages and 45 percent relate to liability coverages. The Company’s philosophy is to adequately reserve our case base claims in a consistent manner.

The objective of the incurred-but-not-reported loss (IBNR) reserve is to establish a reserve for claims that have been incurred by our policyholders but not yet been reported to us and to contemplate any deficiency or redundancy in case base loss reserves as of a particular reporting date. In determining the recorded amount for the incurred-but-not-reported loss reserves for a reporting period management considers the following factors to determine if an adjustment to the incurred-but-not-reported loss reserve is necessary:

•

Trends or patterns in claim experience. We regularly review the level of loss reserves against actual loss development. This retrospective review is the primary criteria used in refining the levels of loss reserves recorded in the financial statements.

•

Trends or patterns noted in management’s regular discussions with internal and external consulting actuaries. We meet with our external actuary on a quarterly basis and have ongoing discussions as necessary. We also consider the summarized statistical results from previous meetings with our external actuary in refining our IBNR reserves.

•

Management and the actuaries also meet periodically with Claims and Product personnel to review ongoing business trends, claim frequency and severity statistics and other relevant developmental trends.

•

We consider changes in our business, product mix, current events and any changes in case base claims reserving philosophies.

Based on the factors considered above, management adjusts the recorded balance of loss reserves, as necessary, to reflect their best estimate, which is recorded in the financial statements. In considering whether any adjustments are necessary to the incurred-but-not-reported loss reserve, we contemplate our loss reserves in total.

Management validates the recorded reserve amount by engaging an accredited consulting actuarial specialist. Following the end of each quarterly reporting period, but prior to the issuance of the financial statements, the consulting actuary develops an “acceptable actuarial range” for loss reserves. The external actuary utilizes various statistical models and analyses, in accordance with generally accepted actuarial standards, to determine this acceptable actuarial range. Management compares the recorded amount of loss reserves to the actuarial range. This range typically involves a fluctuation of approximately 10 percent. The loss reserve recorded balance is affirmed if it is within the acceptable actuarial range. If the recorded balance is outside of the actuarial range, management would make the necessary adjustment to the recorded balance. Historically, the recorded balance has been within the acceptable actuarial range, therefore no such adjustment has been necessary. We have consistently applied this approach to estimating loss reserves.

In the loss reserve estimation process, accuracy of the recorded amounts is the primary objective. However, due to the uncertainty inherent in the process, we approach our loss reserves with an implicit degree of caution for adverse deviation although we do not specifically utilize an implicit or explicit provision for uncertainty or adjust any one specific assumption.

Each year, the credentialed consulting actuary computes an acceptable range for property and casualty reserves, which affirms management’s recorded balance if the recorded amount is within the range. At December 31, 2006, our estimate of property and casualty net loss reserves totaled $139.0 million, which was affirmed by the company’s consulting actuary range of $125.9 million to $143.7 million. However, in light of the significant assumptions and judgments used to estimate loss reserves, there can be no assurance that the actual losses ultimately experienced will fall within the consulting actuary’s range. The range is based on a “reasonable best case” and “reasonable worst case” with varying development patterns across our lines of business.

The principal reason for differences between the loss and LAE liability reported in the accompanying consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and that reported in the annual statements filed with state insurance departments in accordance with statutory accounting practices (“SAP”) relates to the reporting of reinsurance recoverables as receivables for GAAP purposes and as a reduction in reserves for SAP purposes.

Changes in Loss and LAE Reserves

Midland’s table outlining changes in loss and LAE expenses is set forth in footnote 11 in Item 8 of this Form 10-K and is hereby incorporated by reference herein. This table is further discussed in Management’s Discussion and Analysis (Item 7) on page 41 of this Form 10-K and is incorporated by reference herein.

Analysis of Loss and LAE Reserve Development

The table on the next page presents the development of Midland’s property and casualty insurance subsidiaries estimated liability for the ten years prior to 2006. The top line of the table illustrates the estimated liability for unpaid losses and LAE recorded at the balance sheet date at the end of each of the indicated years. This liability represents the estimated amount of losses and LAE for claims arising in all prior years that were unpaid at the balance sheet date, including losses that had been incurred but not yet reported.

The upper portion of the table shows the re-estimated amount of the previously recorded liability based on experience as of the end of each succeeding year. The estimate was increased or decreased as more information became known about the frequency and severity of claims for individual years. Conditions and trends that have affected development of the liability in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on this table.

The table shows the cumulative redundancy developed with respect to the previously recorded liability for all years as of the end of 2005. For example, the 2001 reserve of $102,858,000 has been re-estimated as of year-end 2006 to be $99,650,000, indicating a redundancy of $3,208,000.

The lower section of the table shows the cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year. For example, as of December 31, 2006, the Company had paid $93,331,000 of the currently estimated $99,650,000 of losses and LAE that had been incurred as of the end of 2001; thus an estimated $6,319,000 of losses incurred as of the end of 2001 remain unpaid as of the current financial statement date.

In using this information, it should be noted that this table does not present accident or policy year development data which readers may be more accustomed to analyzing. Each amount in each column includes amounts applicable to the year over the column and all prior years. For example, the amounts included in the 2001 column include amounts related to 2001 and all prior years.

With the benefit of hindsight, including one year of actual development patterns observed during 2006, our 2005 loss reserves were subsequently re-estimated to be $138.1 million. This produced a net cumulative redundancy, after one year of development, of $10.0 million. Although the 2005 loss reserves developed favorably in 2006, the redundancy was lower than what was experienced over the last few years. The lower redundancy related to the 2005 loss reserves was due primarily to adverse development in 2006 related to assessments associated with hurricane Katrina, our personal liability lines and our excess and surplus lines of business. The Company continued to see favorable development related to its motorcycle product.

In 2004 and 2005, we experienced more favorable development patterns than we have historically experienced in several of our lines. These lines included the motorcycle and excess and surplus lines as well as personal liability coverages associated with some of our products. The development patterns were more favorable than our historical trends and baseline industry information would have indicated at that time. In addition, during 2004 and 2005, we also experienced a decrease in the non-catastrophe related frequency in our residential property products, such as manufactured housing and site-built dwelling. The actual frequency that we have experienced during these years is below our historical averages, which are included as part of our baseline assumptions. However, we believe that this level of frequency is a short term variation and may not be sustainable over a long period of time.

Analysis of Loss and Loss Adjustment Expense Development

(Amounts in 000s)


December 31	1996			1997		1998		1999		2000		2001		2002			2003		2004		2005		2006
Reserve for Unpaid Losses, net of reinsurance	$	64,784		$	81,901	$	88,267	$	89,325	$	95,022	$	102,858	$	115,584		$	149,478	$	166,302	$	148,066	$	138,985
Net Reserve Re-estimated as of:
One Year Later	$	70,014		$	79,781	$	78,089	$	82,373	$	90,843	$	94,487	$	127,615		$	131,927	$	129,927	$	138,056
Two Years Later		67,310			77,148		77,774		80,928		90,613		101,466		124,498			119,265		127,194
Three Years Later		66,442			76,110		76,477		80,620		91,885		100,727		119,638			116,602
Four Years Later		66,060			76,620		76,833		81,569		91,428		100,320		117,938
Five Years Later		65,674			76,359		76,276		82,136		92,423		99,650
Six Years Later		66,702			76,592		77,082		84,261		94,327
Seven Years Later		66,970			77,192		77,753		86,271
Eight Years Later		67,043			77,555		78,018
Nine Years Later		67,358			77,494
Ten Years Later		67,507
Net Cumulative Redundancy/(Deficiency)	$	(2,723	)	$	4,407	$	10,249	$	3,054	$	695	$	3,208	$	(2,354	)	$	32,876	$	39,108	$	10,010	$	—
Cumulative Amount of Reserve Paid,
Net of Reinsurance Through:
One Year Later	$	37,307		$	42,795	$	40,785	$	43,532	$	52,634	$	54,160	$	70,986		$	68,120	$	73,961	$	76,453
Two Years Later		51,461			57,677		55,959		57,381		66,936		70,997		90,449			87,189		97,545
Three Years Later		58,716			65,610		63,511		65,654		75,447		81,958		100,899			98,717
Four Years Later		61,913			69,376		67,707		71,261		82,226		88,042		108,043
Five Years Later		63,728			71,621		70,683		76,398		86,406		93,331
Six Years Later		64,363			73,237		72,982		79,718		90,175
Seven Years Later		65,066			74,346		74,042		83,022
Eight Years Later		65,813			74,793		75,348
Nine Years Later		65,896			75,574
Ten Years Later		66,578
Net Reserve - December 31	$	64,784		$	81,901	$	88,267	$	89,325	$	95,022	$	102,858	$	115,584		$	149,478	$	166,302	$	148,066	$	138,985
Reinsurance Recoverables		24,208			26,433		20,430		24,114		16,720		19,309		16,119			20,453		31,364		53,844		42,802

Gross Reserve-December 31	$	88,992		$	108,334	$	108,697	$	113,439	$	111,742	$	122,167	$	131,703		$	169,931	$	197,666	$	201,910	$	181,787

Net Re-estimated Reserve	$	67,507		$	77,494	$	78,018	$	86,271	$	94,327	$	99,650	$	117,938		$	116,602	$	127,194	$	138,056
Re-estimated Reinsurance		25,226			25,011		18,058		23,290		16,598		18,707		16,447			15,955		23,988		50,204

Gross Re-estimated Reserve	$	92,733		$	102,505	$	96,076	$	109,561	$	110,925	$	118,357	$	134,385		$	132,557	$	151,182	$	188,260

Gross Cumulative Redundancy/(Deficiency)	$	(3,741	)	$	5,829	$	12,621	$	3,878	$	817	$	3,810	$	(2,682	)	$	37,374	$	46,484	$	13,650

Seasonality

Incurred losses, and thus the results of operations, for Midland are dependent in some respect on seasonal weather patterns. For example, seasonal type insurance products such as the motorcycle and watercraft products increase the seasonality of our product mix as non-catastrophe losses from these products are expected to be higher in the second and third quarters of the year when usage of these products tends to be highest. Residential property catastrophe losses also tend to be greater in the second and third quarters when severe weather conditions are likely to occur. Gross written premium from the motorcycle, watercraft and manufactured housing products amounted to $398.9 million in 2006 which represents 51% of the total property and casualty gross written premium for the year.

Reinsurance

American Modern participates in several reinsurance contracts with various reinsurers. The Company’s primary reasons for entering reinsurance contracts are to reduce its exposure on particular risks and classes of risks as well as to protect against large accumulated losses resulting from catastrophes. In order to limit its exposure to certain levels of risks, the Company cedes varying portions of its written premiums to other insurance companies. As such, the Company limits its loss exposure to that portion of the insurable risk it retains. In addition, the Company pays a percentage of earned premiums to reinsurers in return for coverage against catastrophic losses. Additional reasons for entering reinsurance agreements include the following:

1.	To reduce total statutory liabilities to a level appropriate for American Modern’s capital and surplus.

2.	To provide financial capacity to accept risks and policies involving amounts larger than could otherwise be accepted.

3.	To facilitate relationships with business partners who want to participate in the insurance risk through their own reinsurance companies.

The Company utilizes excess of loss reinsurance programs in order to reduce its exposure on particular risks and classes of risks (excess of loss per risk) as well as to protect against large accumulated losses resulting from catastrophes (excess of loss per occurrence). Under excess reinsurance, the insurer limits its liability to all or a particular portion of a predetermined deductible or retention. Therefore, the reinsurer’s portion of the loss depends on the size of the loss.

Excess of Loss per occurrence reinsurance requires the insurer to pay all claims up to a stated amount or retention limit on all losses arising from a single occurrence. The reinsurer pays claims in excess of the retention limits. The primary purpose of this reinsurance for American Modern is to protect the Company from the accumulation of losses arising from hurricanes or any other widespread weather related disaster. This reinsurance is also known as catastrophe reinsurance.

The Company’s reinsurance treaties are prospective reinsurance agreements, contain no adjustable features, and do not include any profit sharing provisions. The costs associated with these reinsurance treaties are calculated and expensed based on the subject earned premium recorded in revenue multiplied by the corresponding rate. Any ceding commission is recorded according to the terms of the reinsurance treaty based on the percentage of the corresponding premiums. Ceded commissions are deferred and recognized as income over the life of the corresponding policies. The term is typically no more than twelve months due to the short-tail nature of our business. The costs associated with our catastrophe reinsurance program are generally amortized over the term of the coverage on a pro-rata basis.

Due to the nature of our non-catastrophe related reinsurance programs, the results of operations related to these programs did not significantly fluctuate during the three year period ended December 31, 2006.

However, our operating results were impacted to varying degrees by our catastrophe reinsurance program over the past three years. Catastrophe reinsurance costs, including reinstatements, totaled $25.8 million, $31.9 million and $16.9 million during 2006, 2005 and 2004, respectively. The Company’s gross catastrophe losses for 2006, 2005 and 2004 were $41.9 million, $232.1 million and $67.1 million, respectively, of which $7.4 million, $179.4 million and $21.1 million, respectively, were recovered through our catastrophe reinsurers.

Based on our estimates as of December 31, 2006, Hurricane Katrina, the costliest storm in U.S history, exceeded the limits of the Company’s 2005 catastrophe reinsurance program by approximately $8.0 million in 2006 which impacted after tax earnings by approximately $5.2 million.

increase in our base reinsurance cost in 2006 that nearly doubled the base cost of 2005. This increase, along with the additional cover, adversely impacted our 2006 pre-tax earnings by approximately $12.0 million, or $0.40 per share (diluted).

Our 2007 catastrophe reinsurance program is similar to the 2006 structure, but includes an additional $50 million layer of protection on top of our previous $150 million cover. The cost of our base catastrophe reinsurance program, which includes the purchase of the additional cover, will adversely impact our 2007 earnings by approximately $0.16 per share (diluted).

While the hurricane activity over the past couple of years has significantly increased the cost of obtaining reinsurance, our strong relationships with our reinsurers have allowed us to provide exposure management that is consistent with our overall risk management strategy. In addition, our strong relationships with our reinsurers and our disciplined overall exposure management philosophy, combined with the financial strength of these reinsurers (as of December 31, 2006, approximately 85% of the Company’s catastrophe reinsurers had an A.M. Best or S&P rating of “A-” or better), allow us to be confident that we will be able to effectively manage our exposures in the future.

If a reinsurer fails to honor its obligations, American Modern could suffer additional losses as the reinsurance contracts do not relieve American Modern of its obligations to policyholders. American Modern and its independent reinsurance broker regularly conduct “market security” evaluations of both its current and prospective reinsurers. Such evaluations include a complete review of each reinsurer’s financial condition along with an assessment of credit risk concentrations arising from similar geographic regions, activities or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The specific evaluation procedures include, but are not limited to, reviewing the periodic financial statements and ratings assigned to each reinsurer from rating agencies such as S&P, Moody’s and A.M. Best.

In addition, American Modern may, in some cases, require reinsurers to establish trust funds and maintain letters of credit to further minimize possible exposures. All reinsurance amounts owed to American Modern are current and management believes that no allowance for uncollectible accounts related to this recoverable is necessary. Management also believes there is no significant concentration of credit risk arising from any single reinsurer. The Company also assumes a limited amount of business on certain reinsurance contracts. Related premiums and loss reserves are recorded based on records supplied by the ceding companies.

Website Address

Midland’s website address is www.midlandcompany.com. Midland’s annual, quarterly and other periodic filings and current reports on Form 8-K are available free of charge on or through this website as soon as reasonably practicable after Midland files such reports with the SEC.

ITEM 1A.

Risk Factors.

If any of the following risks actually occur, our business, financial condition or results of operations could be materially and adversely affected. The risks and uncertainties described below are not the only ones we may face. Additional risks and uncertainties presently not known to us or that we currently believe to be immaterial may also harm our business.

We could incur substantial losses from catastrophes and weather-related events

American Modern, like other property and casualty insurers, has experienced, and will experience in the future, catastrophe losses, which may materially reduce our financial results and harm our financial condition. Catastrophes can be caused by various natural events, including hurricanes, windstorms, tornadoes, floods, earthquakes, hail, severe winter weather and fires. The incidence and severity of catastrophes are inherently unpredictable.

Hurricanes and earthquakes may produce significant damage in large areas, especially those that are heavily populated. In 2006, approximately 50% of American Modern’s gross property and casualty written premium was derived from the southeastern United States, Oklahoma and Texas. Because of these concentrations of business, American Modern may be more exposed to hurricanes, tornadoes, floods and other weather-related losses than some of its competitors. A single large catastrophe loss, a number of small or large catastrophe losses in a short amount of time or losses from a series of storms or other events that do not constitute a catastrophic event under American Modern’s reinsurance treaties, could have a material adverse effect on our financial condition or results and could result in substantial outflows of cash as losses are paid. American Modern’s ability to write new business could also be affected should such an event result in a material reduction in our statutory surplus. Increases in the value and geographic concentration of insured property and the effects of inflation could increase the severity of claims from catastrophic events in the future.

These factors can contribute to significant quarter-to-quarter and year-to-year fluctuations in the underwriting results of American Modern and our net earnings. Because of the possibility of these fluctuations in underwriting results, historical periodic results of operations may not be predictive of future results of operations. Periodic fluctuations in our operating results could adversely affect the market price of our common stock.

Our results may fluctuate as a result of many factors, including cyclical changes in the insurance industry and general economic conditions

The results of companies in the property and casualty insurance industry historically have been subject to significant fluctuations and uncertainties. Rates for property and casualty insurance are influenced primarily by factors that are outside of our control, including market and competitive conditions and regulatory issues. Our profitability can be affected significantly by:

•

downturns in the economy, which historically result in an increase in the fire loss ratio;

•

higher actual costs that are not known to American Modern at the time it prices its products;

•

volatile and unpredictable developments, including man-made, weather-related and other natural catastrophes;

•

any significant decrease in the rates for property and casualty insurance in the segments American Modern serves or its inability to maintain or increase such rates;

•

changes in loss reserves resulting from the legal environment in which American Modern operates as different types of claims arise and judicial interpretations relating to the scope of the insurer’s liability develop; and

•

fluctuations in interest rates, inflationary pressures and other changes in the investment environment, which affect our return on invested assets.

The demand for property and casualty insurance can also vary significantly, rising as the overall level of economic activity increases and falling as that activity decreases. Due to the concentration of American Modern’s business in the Atlantic Coast states, the southeastern United States, Oklahoma and Texas, changes in the general economy, regulatory environment and other factors specifically affecting that region could adversely affect our financial conditions and results. The property and casualty insurance industry historically is cyclical in nature. These fluctuations in demand and competition could produce underwriting results that could harm our financial condition or results.

The specialty insurance industry is highly competitive and will require significant technology expenditures

The specialty insurance lines offered by American Modern are highly competitive. American Modern competes with national and regional insurers, many of whom have greater financial and marketing resources than American Modern. The types of insurance coverage that American Modern sells are often a relatively small portion of the business sold by some of American Modern’s competitors. Also, other financial institutions, such as banks and brokerage firms, are now able to offer services similar to those offered by American Modern as a result of the Gramm-Leach-Bliley Act, which was enacted in November 1999. New competition from these developments could harm our financial condition or results.

Many of our competitors are better capitalized than we are and may be able to withstand significant reductions in their profit margins to capture market share. If our competitors decide to target American Modern’s customer base with lower-priced insurance, American Modern may decide not to respond competitively, which could result in reduced premium volume.

Changing practices caused by the Internet have led to greater competition in the insurance industry. In response, American Modern has invested substantially in the development of modernLINK™, an enterprise-wide computer network that is being developed in stages and is intended to connect American Modern’s internal systems directly to its sales and distribution channel partners as well as policyholders over the Internet. The cost of this system is significant and its development and installation will decrease operating profits in the short term. This system is in development and its effectiveness has not been proven. Significant changes to the technology interface between American Modern and its distribution channel participants and policyholders could significantly disrupt or alter its distribution channel relationships. Disruptions to our information technology systems could also occur periodically during the installation of the modernLINK™ system and adversely affect our business.

Our results are significantly affected by conditions in the manufactured housing industry

Level of Manufactured Housing Sales

A significant number of the insurance policies American Modern issues each year are written in conjunction with the sale of new manufactured homes. A significant or prolonged downturn in the level of new manufactured housing sales, such as the one which this industry is currently experiencing, could cause a decline in American Modern’s premium volume and income, which could harm our financial condition or results. The market for manufactured housing is affected by many factors, including general economic conditions, interest rate levels, the availability of credit and government regulations. In the current economic environment, lenders have reduced the amount of credit available for manufactured housing purchases. This trend could result in a significant decrease in manufactured housing premium volume for American Modern.

Reduction of Chattel Financing

Manufactured housing sales have traditionally been financed as personal property through a financing transaction referred to as chattel financing. The manufactured housing industry has experienced a substantial reduction in the number of lenders providing chattel or other personal property financing for manufactured housing in recent years. This reduction has resulted in a trend toward traditional mortgage financing for manufactured housing units. Because chattel lenders are an important channel of distribution for American Modern, this trend could harm our financial condition or results. American Modern has historically had strong relationships with the major chattel financing sources. To the extent that the manufactured housing lending market moves away from chattel financing to traditional mortgage financing, American Modern may not be able to replace lost premium volume.

Guaranty Funds and Residual Markets could result in additional assessments

In nearly all states, licensed insurers are subject to assessments by state guaranty funds to cover claims against impaired or insolvent insurers. Insolvencies by other property and casualty insurance companies could result in additional assessments against American Modern and other insurers.

Many states also have statutorily created residual market or pooling facilities (hereinafter “Pools”). The states use the Pools to provide insurance coverage to citizens who are otherwise unable to obtain insurance in the private market. Private market insurers that sell policies in the same class as those provided by the state Pools may be ratably assessed to cover excess Pool losses. The combination of a devastating catastrophic event (or a number of smaller events occurring over a short period of time), coupled with inadequate premiums and inadequate reinsurance, could leave a state Pool unable to pay its claims. The state might then assess licensed private market insurers, including American Modern. These assessments could be significant and might adversely affect the Company’s operating results and possibly its financial condition.

American Modern’s insurance ratings may be downgraded, which would reduce its ability to compete and sell insurance products

Insurance companies are rated by established insurance rating agencies based on the rating agencies’ opinions of the company’s ability to pay claims and on the company’s financial strength. Ratings have become an increasingly important factor in establishing the competitive position of insurance companies. Ratings are based upon factors relevant to policyholders and are not designed to protect shareholders. Rating agencies periodically review their ratings. There can be no assurance that current ratings will be maintained in the future. Most recently, A.M. Best has given a group rating

of “A+ (Superior)” to American Modern’s property and casualty insurance subsidiaries and has given a rating of “A- (Excellent)” to American Modern’s credit life insurance companies. In particular, financial institutions, including banks and credit unions, are sensitive to ratings and may discontinue using an insurance company if the insurance company is downgraded. A downgrade in American Modern’s insurance rating could also have a negative impact on its ability to obtain favorable reinsurance rates and terms. Downgrades in the ratings of American Modern’s insurance company subsidiaries could harm our financial condition or results.

American Modern may be unable to reinsure insurance risks and cannot guarantee that American Modern’s reinsurers will pay claims on a timely basis, if at all

American Modern uses reinsurance to attempt to limit the risks, especially catastrophe risks, associated with its insurance products. The availability and cost of reinsurance are subject to prevailing market conditions and trends. Poor conditions in the reinsurance market could cause American Modern to reduce its volume of business and impact its profitability. American Modern’s reinsurance treaties are generally subject to annual renewal. American Modern may be unable to maintain its current reinsurance treaties or to obtain other reinsurance treaties in adequate amounts and at favorable rates and terms. Recently, the property and casualty industry has experienced significant increases in reinsurance rates. If American Modern is unable or unwilling to renew its expiring treaties or to obtain new reinsurance treaties, either its net exposure to risk would increase or, if American Modern is unwilling to bear an increase in net risk exposures, American Modern would have to reduce the amount of risk it underwrites.

Although the reinsurer is liable to American Modern to the extent of the ceded reinsurance, American Modern remains liable as the direct insurer on all risks reinsured. As a result, ceded reinsurance arrangements do not eliminate American Modern’s obligation to pay claims. Although we record an asset for the amount of claims paid that American Modern expects to recover from reinsurers, we cannot be certain that American Modern will be able to ultimately collect these amounts. The reinsurer may be unable to pay the amounts recoverable, may dispute American Modern’s calculation of the amounts recoverable or may dispute the terms of the reinsurance treaty.

Our investment portfolio could lose value

Market Volatility and Changes in Interest Rates

Midland’s investment portfolio, most of which is held by subsidiaries of Midland, primarily consists of fixed income securities (such as corporate debt securities and U.S. government securities) and publicly traded equity securities. As of December 31, 2006, approximately 78% of Midland’s investment portfolio was invested in fixed income securities and approximately 22% was invested in equity securities. The fair value of securities in Midland’s investment portfolio may fluctuate depending on general economic and market conditions or events related to a particular issuer of securities. In addition, Midland’s fixed income investments are subject to risks of loss upon default and price volatility in reaction to changes in interest rates. Changes in the fair value of securities in Midland’s investment portfolio are reflected in our financial statements and, therefore, could affect our financial condition or results. Furthermore, a decrease in the value of American Modern’s equity securities would also cause a decrease in American Modern’s statutory surplus, which in turn would limit American Modern’s ability to write insurance.

Concentration of Investments

As of December 31, 2006, approximately 39% of Midland’s equity investment portfolio and 9% of its total investment portfolio (approximately $88.8 million in market value) was invested in the common stock of U.S. Bancorp. A material decrease in the price of common stock of U.S. Bancorp would cause the value of Midland’s investment portfolio to decline and would also result in a decrease in American Modern’s statutory surplus.

If American Modern’s loss reserves prove to be inadequate, then we would incur a charge to earnings

American Modern’s insurance subsidiaries regularly establish reserves to cover their estimated liabilities for losses and loss adjustment expenses for both reported and unreported claims. These reserves do not represent an exact calculation of liabilities. Rather, these reserves are management’s estimates of the cost to settle and administer claims. These expectations are based on facts and circumstances known at the time, predictions of future events, estimates of future trends in the

severity and frequency of claims and judicial theories of liability and inflation. The establishment of appropriate reserves is an inherently uncertain process, and we cannot be sure that ultimate losses and related expenses will not materially exceed American Modern’s reserves. To the extent that reserves prove to be inadequate in the future, American Modern would have to increase its reserves and incur a charge to earnings in the period such reserves are increased, which could have a material and adverse impact on our financial condition and results.

Regulatory actions could impair our business

American Modern’s insurance subsidiaries are subject to regulation under the insurance laws of states in which they operate. These laws primarily provide safeguards for policyholders, not shareholders. Governmental agencies exercise broad administrative power to regulate many aspects of the insurance business, including:

•

standards of solvency, including risk-based capital measurements;

•

restrictions on the amount, type, nature, quality and concentration of investments;

•

policy forms and restrictions on the types of terms that American Modern can include in its insurance policies;

•

how we acquire business from agents and how producers are compensated;

•

certain required methods of accounting;

•

reserves for unearned premium, losses and other purposes;

•

premium rates;

•

marketing practices;

•

capital adequacy and the amount of dividends that can be paid;

•

licensing of agents;

•

approval of reinsurance contracts and inter-company contracts;

•

approval of proxies; and

•

potential assessments in order to provide funds to settle covered claims under insurance policies provided by impaired, insolvent or failed insurance companies.

Regulations of state insurance departments may affect the cost or demand for American Modern’s products and may impede American Modern from obtaining rate increases or taking other actions it might wish to take to increase its profitability. Further, American Modern may be unable to maintain all required licenses and approvals and its business may not fully comply with the wide variety of applicable laws and regulations or the relevant authority’s interpretation of the laws and regulations. Also, regulatory authorities have relatively broad discretion to grant, renew or revoke licenses and approvals. If American Modern does not have the requisite licenses and approvals or does not comply with applicable regulatory requirements, insurance regulatory authorities could stop or temporarily suspend American Modern from conducting some or all of its activities or assess fines or penalties against American Modern. In addition, insurance laws or regulations adopted or amended from time to time may result in higher costs to American Modern or may require American Modern to alter its business practices or result in increased competition.

The effects of emerging claim and coverage issues on American Modern’s business are uncertain

As industry practices and legal, judicial, social, environmental and other conditions change, unexpected and unintended issues related to claims and coverages may emerge. These issues can have a negative effect on American Modern’s business by either extending coverage beyond its underwriting intent or by increasing the number or size of claims. For example, there is a growing trend of plaintiffs targeting property and casualty insurers in purported class action litigation relating to claim-handling and other practices, particularly with respect to the handling of personal lines claims. The effects of emerging claim and coverage issues and future unfavorable judicial trends are extremely hard to predict and could harm our financial condition or results.

It would be difficult for a third party to acquire Midland

Controlling Shareholders

Members or trusts of the Hayden and LaBar families beneficially own approximately 44% of our common stock. Some members of these families serve as our executive officers and directors. Through their ownership of common stock and their positions with us, these families have the practical ability to effectively control Midland. They have the practical ability to elect a number of directors and exercise significant influence over the approval or disapproval of mergers or similar transactions and amending our Articles of Incorporation. A third party may need the approval of some members of these families to gain control of Midland.

Anti-Takeover Considerations

Certain provisions of our Articles of Incorporation and Code of Regulations and of Ohio law make it difficult for a third party to acquire control of Midland without the consent of our Board. These anti-takeover defenses may discourage, delay or prevent a transaction involving a change in control of our company. In cases where Board approval is not obtained, these provisions could also discourage proxy contests and make it more difficult for you and other shareholders to elect directors of your choosing and cause us to take other corporate actions you desire. These provisions include:

•

a staggered Board of Directors;

•

the authorization of undesignated preferred stock, the terms of which may be established and shares of which may be issued without shareholder approval;

•

limitations on persons authorized to call a special meeting of shareholders; and

•

advance notice procedures required for shareholders to nominate candidates for election as directors or to bring matters before an annual meeting of shareholders.

We are also subject to the laws of various states that govern insurance companies and insurance holding companies. Under these laws, a person generally must obtain the applicable insurance department’s approval to acquire, directly or indirectly, 5% or 10% or more of our outstanding voting securities or the outstanding voting securities of our insurance subsidiaries. An insurance department’s determination of whether to approve an acquisition would be based on a variety of factors, including an evaluation of the acquirer’s financial stability, the competence of its management and whether competition in that state would be reduced. These laws may delay or prevent a takeover of our company or our insurance company subsidiaries.

Provisions in Ohio law relating to business combinations and interested shareholder transactions may also make it difficult for Midland to be acquired.

Midland and its subsidiaries may be unable to pay dividends

Midland is organized as a holding company. Almost all of our operations are conducted by subsidiaries. For us to pay dividends to our shareholders and meet our other obligations, we must receive management fees and dividends from American Modern and M/G Transport. In order for American Modern to pay dividends and management fees to us and meet its other obligations, American Modern must receive dividends and management fees from its subsidiaries.

Payments of dividends by our insurance subsidiaries are regulated under state insurance laws. The regulations in the states where each insurance company subsidiary is domiciled limit the amount of dividends that can be paid without prior approval from state insurance regulators. In addition, state regulators have broad discretion to limit the payment of dividends by insurance companies. Without regulatory approval, the maximum amount of dividends that can be paid in 2007 by American Modern is $65.5 million. The maximum dividend permitted by law does not necessarily indicate an insurer’s actual ability to pay dividends. Our ability to pay dividends may be further constrained by business and regulatory considerations, such as the impact of dividends on American Modern’s surplus. A decrease in surplus could affect American Modern’s ratings, competitive position, covenants under borrowing arrangements with banks, the amount of premium that can be written and our ability to pay future dividends. A prolonged, significant decline in insurance subsidiary profits or regulatory action limiting dividends could subject us to shortages of cash because our subsidiaries will not be able to pay us dividends.

American Modern depends on agents and distribution partners who may discontinue sales of its policies at any time

American Modern’s relationship with its independent agents and other distribution channel partners is critical to its success. These agencies and other distribution partners are independent and typically offer products of competing companies. They require that American Modern provide competitive product offering, timely application and claims processing, efficient technology solutions and that they receive prompt attention to their questions and concerns. If these agents and distribution partners find it easier to do business with American Modern’s competitors or choose to sell the insurance products of its competitors on the basis of cost, terms or commission structure, American Modern’s sales volume would decrease, harming our financial conditions and results. We cannot be certain that these agents and distribution partners will continue to sell American Modern’s insurance products to the individuals they represent.

We are subject to various forms of litigation

American Modern’s insurance subsidiaries are routinely involved in litigation that arises in the ordinary course of business. It is possible that a court could impose significant punitive, bad faith, extra-contractual or other extraordinary damages against American Modern or one of its subsidiaries. This could harm our financial condition or results.

In addition, a substantial number of civil jury verdicts have been returned against insurance companies in several jurisdictions in the United States, including jurisdictions in which American Modern has business. Some of these verdicts have resulted from suits that allege improper sales practices, agent misconduct, failure to properly supervise agents and other matters. Increasingly, these lawsuits have resulted in the award of substantial judgments against insurance companies. Some of these judgments have included punitive damages that are in high proportion to the actual damages. Any such judgment against American Modern could harm our financial condition or results.

Our relatively low trading volume may limit your ability to sell your shares

Although shares of our common stock are listed on the Nasdaq National Market, on many days in recent months, the daily trading volume for our common stock was less than 30,000 shares. As a result of this low trading volume, you may have difficulty selling a large number of shares of our common stock in the manner or at a price that might be attainable if our common stock were more actively traded.

Our success depends on retaining our key personnel

Our performance depends on the continued service of our senior management. None of our senior management is bound by an employment agreement nor do we have key person life insurance on any of our senior management. Our success also depends on our continuing ability to attract, hire,

train and retain highly skilled managerial, underwriting, claims, risk management, sales, marketing and customer support personnel. In addition, new hires frequently require extensive training before they achieve desired levels of productivity. Competition for qualified personnel is intense, and we may fail to retain our key employees or to attract or retain other highly qualified personnel.

Risks related to M/G Transport

M/G Transport Services, Inc. and MGT Services, Inc. (collectively M/G Transport) operates a fleet of dry cargo barges for the movement of dry bulk commodities such as petroleum coke, ores, barite, sugar and other dry cargoes primarily on the lower Mississippi River and its tributaries and manages river transportation equipment owned by others on a fee based arrangement. Such operations can be dangerous and may, from time to time, cause damage to other vessels and other water facilities. Any damage in excess of insurance coverage could harm our operations. The release of foreign materials into the waterways could cause damage to the environment and subject M/G Transport to remediation costs and penalties. Any such release could harm our financial condition or results.

ITEM 1B.

Unresolved Staff Comments.

None.

ITEM 2.

Properties.

Midland owns its 275,000 square foot principal offices located in Amelia, Ohio. Midland’s insurance subsidiaries lease office space in Amelia, Ohio, Montgomery, Alabama and St. Louis, Missouri. Midland’s transportation subsidiaries lease offices in Metairie, Louisiana and St. Louis, Missouri. As described under “Liquidity, Capital Resources and Changes in Financial Condition” on page 32, Midland intends to complete the expansion of its headquarters in 2007. Midland’s premises are suitable and adequate for their intended use.

ITEM 3.

Legal Proceedings.

There are various actions pending against the Company in the normal course of business. However, management does not expect any of these actions to have a material adverse effect on our consolidated financial statements.

ITEM 4.

Submission of Matters to a Vote of Security Holders.

None during the fourth quarter.

PART II

ITEM 5.

Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Incorporated by reference to pages 77 and 78 (Note 16) and 81 of this Form 10-K. The number of holders of Midland’s common stock at December 31, 2006 was approximately 2,700. Midland’s common stock is registered with the NASDAQ Stock Market LLC to trade on the NASDAQ Global Select Market (MLAN).

Quarterly Data


	2006
	First Quarter		Second Quarter		Third Quarter		Fourth Quarter
Price range of common stock
High	$	37.75	$	44.10	$	43.75	$	47.50
Low	$	31.91	$	32.50	$	34.86	$	39.84
Dividends per common share	$	0.06125	$	0.06125	$	0.06125	$	0.06125


	2005
	First Quarter		Second Quarter		Third Quarter		Fourth Quarter
Price range of common stock
High	$	34.63	$	35.32	$	40.42	$	39.45
Low	$	29.55	$	30.60	$	31.38	$	31.13
Dividends per common share	$	0.05625	$	0.05625	$	0.05625	$	0.05625

The following graph shows a five year comparison of Midland’s cumulative total shareholder return with those of the Russell 2000 Equity Index and the Standard and Poor’s Property and Casualty Group. The graph assumes that $100 was invested on December 31, 2001 in Midland’s Common Stock and in each of the indices as noted below, including reinvestment of dividends. Note that historic stock price performance is not necessarily indicative of future stock price performance.

LOGO

During 2006, the Company did not purchase any of its equity securities pursuant to a publicly announced plan or program. However, the Company acquired 26,693 shares in private transactions from employees in connection with its stock incentive plans during 2006. Such transactions essentially accommodate employees’ funding requirements of the exercise price and tax liabilities arising from the exercise or receipt of equity-based incentive awards. Additionally, pursuant to the Company’s Salaried Employees’ 401(k) Savings Plan, the Company acquired 30,288 shares from the Plan during 2006.

Item 6.

Selected Financial Data


	For the Years Ended December 31,
*(Amounts in thousands, except per share data)*	2006		2005		2004		2003		2002			2001
Income Statement Data
Revenues:
Premiums earned	$	675,864	$	631,864	$	677,584	$	638,038	$	577,668		$	508,233
Other insurance income		12,929		12,600		13,780		14,064		13,756			12,971
Net investment income		42,223		40,519		37,165		33,279		35,899			34,198
Net realized investment gains (losses)(a)		8,445		6,262		9,933		4,566		(6,900	)		2,023
Transportation		49,807		42,185		45,379		28,240		23,285			34,826

Total		789,268		733,430		783,841		718,187		643,708			592,251

Costs and Expenses:
Losses and loss adjustment expenses		307,503		286,662		348,611		392,232		341,015			292,188
Commissions and other policy acquisition costs		209,719		198,585		201,155		177,622		169,477			145,777
Operating and administrative expenses(d)		127,236		112,329		108,536		87,714		80,985			80,316
Transportation operating expenses		41,792		36,986		43,266		26,645		22,641			32,898
Interest expense		5,164		5,967		5,169		3,742		3,849			4,368

Total		691,414		640,529		706,737		687,955		617,967			555,547

Income Before Federal Income Tax and
Cumulative Effect of Change in
Accounting Principle		97,854		92,901		77,104		30,232		25,741			36,704
Provision for Federal Income Tax		27,159		27,575		22,866		6,956		5,437			9,482

Income Before Cumulative Effect of Change in Accounting Principle		70,695		65,326		54,238		23,276		20,304			27,222
Cumulative Effect of Change in Accounting Principle—Net(c)		—		—		—		—		(1,463	)		—

Net Income (d)	$	70,695	$	65,326	$	54,238	$	23,276	$	18,841		$	27,222

Basic Earnings (Losses) Per Share of Common Stock(b)(d):
Income Before Cumulative Effect of Change in Accounting Principle	$	3.70	$	3.46	$	2.91	$	1.34	$	1.17		$	1.58
Cumulative Effect of Change in Accounting Principle(c)		—		—		—		—		(0.08	)		—

Total	$	3.70	$	3.46	$	2.91	$	1.34	$	1.09		$	1.58

Diluted Earnings (Losses) Per Share of Common Stock(b)(d):
Income Before Cumulative Effect of Change in Accounting Principle	$	3.60	$	3.37	$	2.83	$	1.30	$	1.14		$	1.51
Cumulative Effect of Change in Accounting Principle(c)		—		—		—		—		(0.08	)		—

Total	$	3.60	$	3.37	$	2.83	$	1.30	$	1.06		$	1.51

Cash Dividends Per Share of Common Stock(b)	$	0.245	$	0.225	$	0.205	$	0.190	$	0.175		$	0.160


	For the Years Ended December 31,
*(Amounts in thousands, except per share data)*	2006			2005			2004			2003			2002			2001
Balance Sheet Data
Total Cash and Marketable Securities	$	1,036,436		$	950,464		$	978,296		$	848,708		$	745,733		$	715,295
Total Assets		1,569,528			1,428,113			1,364,684			1,192,216			1,101,136			1,060,212
Total Debt		108,445			111,771			115,906			95,842			90,401			84,141
Unearned Insurance Premiums		445,324			395,007			390,447			383,869			406,311			403,855
Loss Reserves		221,639			254,660			232,915			204,833			164,717			148,674
Shareholders’ Equity		574,746			484,377			432,276			356,058			308,908			291,876
Book Value Per Share(b)	$	29.90		$	25.54		$	22.98		$	20.18		$	17.59		$	16.53
Common Shares Outstanding(b)		19,224			18,964			18,807			17,643			17,566			17,660
Other Data
AMIG’s Property and Casualty Operations
Direct and Assumed Written Premiums	$	780,795		$	697,930		$	722,394		$	663,972		$	588,243		$	555,548
Net Written Premium		678,107			619,267			671,985			616,709			561,515			523,105
Loss and Loss Adjustment Expense Ratio (GAAP)		45.5	%		45.3	%		51.7	%		62.0	%		59.3	%		57.8	%
Underwriting Expense Ratio (GAAP)		48.3	%		48.5	%		44.7	%		41.1	%		42.6	%		43.1	%
Combined Ratio (GAAP)		93.8	%		93.8	%		96.4	%		103.1	%		101.9	%		100.9	%
M/G Transport’s Transportation Operations
Net Revenues	$	49,807		$	42,185		$	45,379		$	28,240		$	23,285		$	34,826
Net Income		5,108			3,166			1,090			815			296			1,079
Total Assets		51,435			50,400			38,869			30,990			22,469			24,952
Shareholders’ Equity		18,484			14,676			12,261			11,446			10,805			10,509

Footnotes:

(a)	Net Realized Investment Gains (Losses) in 2006, 2005, 2004, 2003, 2002 and 2001 include the effect of SFAS 133 adjustments of $1.0 million, $0.4 million, $0.8 million, $0.8 million, $(0.2) million and $1.1 million, respectively.

(b)	Previously reported share information has been adjusted to reflect a 2-for-1 stock split effective July 17, 2002.

(c)	On January 1, 2002, the Company adopted SFAS 142 and recorded an impairment charge related to goodwill of $1.5 million, net of tax of $0.8 million.

(d)

The Company adopted SFAS 123(R ) in 2005 which increased stock option expense $2.5 million and $1.9 million in 2006 and 2005, respectively. Net income (after tax) was reduced by $1.6 million and $1.2 million, or $0.08 and $0.06 per share (diluted and basic), in 2006 and 2005, respectively. Prior year results were not restated.

ITEM 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements

Certain statements made in this report are forward-looking and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements include, but are not limited to, certain discussions relating to future revenue, underwriting income, premium volume, investment income and other investment results, business strategies, profitability, liquidity, capital adequacy, anticipated capital expenditures and business relationships, as well as any other statements concerning the year 2007 and beyond. In some cases you can identify forward-looking statements by such terms as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “project,” “predict,” “potential,” “likely,” “target” and similar expressions or the negative versions of such expressions. These forward-looking statements reflect The Midland Company’s current views about future events, are based on assumptions and are subject to known and unknown risks and uncertainties that may cause results to differ materially from those anticipated in those statements. Many of the factors that will determine future events or achievements are beyond Midland’s ability to control or predict. Factors that might cause results to differ from those anticipated include, without limitation, adverse weather conditions, changes in underwriting results affected by adverse economic conditions, fluctuations in the investment markets, changes in the retail marketplace, changes in the laws or regulations affecting the operations of the Company or its subsidiaries, changes in exposures to assessments and surcharges for guaranty funds, second injury funds and other mandatory pool arrangements, changes in the business tactics or strategies of the Company, its subsidiaries or its current or anticipated business partners, the financial condition of the Company’s business partners, acquisitions or divestitures, changes in market forces, litigation and the other risk factors that have been identified in the Company’s filings with the SEC, any one of which might materially affect the operations of the Company or its subsidiaries. Any forward-looking statements speak only as of the date made. We undertake no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made. You should read this document and the documents referenced herein and filed as exhibits herewith completely and with the understanding that Midland’s actual future results may be materially different from what Midland expects. Midland qualifies all of its forward-looking statements by these cautionary statements.

Introduction

The Midland Company (“Midland” or the “Company”) is a highly focused provider of specialty insurance products and services through its American Modern Insurance Group, Inc. (“AMIG” or “American Modern”) subsidiary, which contributes approximately 94 percent of the company’s revenues. The Company also maintains an investment in a niche river transportation business, M/G Transport Services Inc. The Company has divided its insurance products into four distinct groups: residential property, recreational casualty, financial institutions, and all other insurance products. The discussions of “Results of Operations” and “Liquidity, Capital Resources and Changes in Financial Condition” address these four reportable insurance segments and our transportation business. A summary description of the operations of each of these segments is included below.

collateral protection and debt cancellation, which are sold to financial service institutions or their customers. The all other insurance segment includes products such as credit life, long-haul truck physical damage, commercial, excess and surplus lines and also includes the results of our fee producing subsidiaries.

Overview of Recent Trends

Exposure Management

American Modern’s catastrophe reinsurance program is a significant aspect of our exposure management. Our 2006 catastrophe reinsurance structure was similar to the 2005 program with a $3.0 million increase in retention, from $7 million to $10 million, and the purchase of an additional $40 million of protection on top of our previous $110 million cover. Due to the volatile weather patterns of 2005, we absorbed a significant increase in our base reinsurance cost in 2006 that nearly doubled the base cost of 2005. This increase, along with the additional cover, adversely impacted our 2006 pre-tax earnings by approximately $12.0 million, or $0.40 per share (diluted). We have already begun efforts to recoup these costs through appropriate rate increases, commission adjustments and/or product changes. However, this is a process that takes some time, including additional time after state approvals to get the new rates and product changes into place within the renewal book and earned premium. These efforts produced minimal benefit to our 2006 profits, and likely will not be fully realized until 2007.

Diversification – Growth of Non-Manufactured Housing Products

American Modern has continued to experience significant premium growth in non-manufactured housing product lines, including site built dwelling, mortgage fire, credit life and excess and surplus lines. Collectively, our non-manufactured housing direct and assumed written premiums grew 22.6% in 2006 compared to 2005. Non-manufactured housing products represented 59% and 64% of American Modern’s direct and assumed written premiums and related pre-tax profit, respectively, during 2006.

RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2006 COMPARED TO YEAR ENDED DECEMBER 31, 2005

Insurance

Overview of Premium Volume

The following chart shows American Modern’s gross written premium, net written premium and net earned premium by business segment for the years ended December 31, 2006 and 2005 (in millions). Gross written premium, also described as direct and assumed written premium, is the amount of premium charged for policies issued during a fiscal period. Net written premium is the amount of premium that American Modern retains after ceding varying portions of its gross written premium to other insurance companies. Net earned premium is the amount included in our condensed consolidated statements of operations. Premiums for physical damage and other property and casualty related coverages, net of premium ceded to reinsurers, are considered earned and are included in the financial results on a pro-rata basis over the lives of the policies. Credit accident and health and credit life premiums are recognized as income over the lives of the policies in proportion to the amount of insurance protection provided. The portion of written premium applicable to the unexpired terms of the policies is recorded as unearned premium in our condensed consolidated balance sheets.


	December 31, 2006
Business Segment	Gross Written Premium		Net Written Premium		Net Earned Premium
Residential Property	$	449.3	$	402.1	$	392.8
Recreational Casualty		94.3		92.7		95.5
Financial Institutions		122.1		112.7		103.8
All Other Insurance		166.1		86.8		83.8

Total	$	831.8	$	694.3	$	675.9


	December 31, 2005
Business Segment	Gross Written Premium		Net Written Premium		Net Earned Premium
Residential Property	$	421.6	$	381.3	$	378.4
Recreational Casualty		100.5		98.2		103.3
Financial Institutions		79.1		70.8		78.4
All Other Insurance		133.3		77.1		71.8

Total	$	734.5	$	627.4	$	631.9

Gross written premium, net written premium and net earned premium increased 13.2%, 10.7% and 7.0%, respectively, in 2006 compared to 2005. The most significant contributors to the growth in premiums in 2006 were the mortgage fire, site-built dwelling, excess and surplus lines and credit life insurance products.

Residential Property

The following chart is an overview of the results of operations of the company’s residential property segment (in 000’s).


	December 31,
	2006			2005			Change
Residential Property
Direct and Assumed Written Premiums	$	449,270		$	421,631		6.6	%
Net Written Premiums	$	402,056		$	381,304		5.4	%
Net Earned Premium	$	392,762		$	378,402		3.8	%
Service Fees		6,124			5,651		8.4	%

Total Revenues	$	398,886		$	384,053		3.9	%
Income Before Taxes	$	42,554		$	45,755
Combined Ratio		96.2	%		95.4	%

The results from this segment are driven primarily by the manufactured housing and site-built dwelling products. Although the manufactured housing industry continues to be depressed, American Modern’s diverse distribution channels have enabled gross written premiums related to this product to increase to $337.8 million in 2006 compared to $331.5 million in 2005. Site-built dwelling gross written premiums increased 22.2% to $105.6 million in 2006 compared to $86.4 million in 2005.

The manufactured housing combined ratio, including catastrophe losses, increased slightly to 95.8% in 2006 compared to 94.4% in 2005. Excluding catastrophe losses for both years, the combined ratio was 86.3% in 2006 compared to 84.7% in 2005. The increase in combined ratio was due to the substantial increase in American Modern’s reinsurance program costs in 2006 compared to 2005 resulting from the significant hurricane activity in 2005. The site-built dwelling combined ratio improved to 97.6% in 2006 compared to 98.3% in 2005.

Recreational Casualty

The following chart is an overview of the results of operations of the company’s recreational casualty segment (in 000’s).


	December 31,
	2006			2005			Change
Recreational Casualty
Direct and Assumed Written Premiums	$	94,285		$	100,438		(6.1	)%
Net Written Premiums	$	92,725		$	98,209		(5.6	)%
Net Earned Premium	$	95,520		$	103,234		(7.5	)%
Service Fees		1,751			2,373		(26.2	)%

Total Revenues	$	97,271		$	105,607		(7.9	)%
Income Before Taxes	$	10,186		$	12,693
Combined Ratio		97.0	%		96.6	%

Direct and assumed written premiums for our recreational casualty products decreased due primarily to the decreases of $5.6 million and $2.5 million for our watercraft and motorcycle products, respectively. The decrease in motorcycle direct and assumed written premiums was due primarily to the implementation in recent years of new underwriting modifications such as restrictions on certain types of coverages and implementation of a more sophisticated motorcycle

make/model table to improve accuracy of class and identification of ineligible units. The decrease in watercraft direct and assumed written premiums was due primarily to underwriting actions taken to balance our coastal exposures. Although these actions are currently reducing our ability to grow these lines, we believe the recreational casualty products are now better positioned to provide profitable growth in the upcoming years.

Financial Institutions

The following chart is an overview of the results of operations of the company’s financial institutions insurance segment (in 000’s).


	December 31,
	2006			2005			Change
Financial Institutions
Direct and Assumed Written Premiums	$	122,155		$	79,108		54.4	%
Net Written Premiums	$	112,658		$	70,817		59.1	%
Net Earned Premium	$	103,831		$	78,424		32.4	%

Total Revenues	$	103,831		$	78,424		32.4	%
Income Before Taxes	$	12,507		$	9,471
Combined Ratio		92.9	%		93.5	%

The increase in direct and assumed written premiums for our financial institutions insurance products was driven primarily by the mortgage fire product which increased $30.2 million compared to the prior year. The increase in mortgage fire premiums is due to the signing of several new accounts throughout the year. Income increased for our financial institutions insurance products due to the mortgage fire profits generated from the increased written premiums.

All Other Insurance

The following chart is an overview of the results of operations of the company’s other insurance segment (in 000’s).


	December 31,
	2006		2005		Change
All Other Insurance
Direct and Assumed Written Premiums	$	166,088	$	133,304	24.6	%
Net Written Premiums	$	86,821	$	77,040	12.7	%
Net Earned Premium	$	83,756	$	71,810	16.6	%
Agency Revenues		4,918		4,522	8.8	%
Service Fees		7		82	(91.5	)%

Total Revenues	$	88,681	$	76,414	16.1	%
Income Before Taxes	$	26,751	$	19,903

American Modern’s excess and surplus lines and credit life products were the primary drivers of the increase in direct and assumed written premiums in 2006 compared to 2005. A large percentage of the Company’s excess and surplus lines gross written premium is ceded to

reinsurers. In addition, a large percentage of credit life direct and assumed written premium is ceded to an insurance affiliate of the producing agent. The growth in our credit life insurance line was assisted by the acquisition of Southern Pioneer Life Insurance Company in July of 2006. This acquisition contributed $7.8 million of direct and assumed written premiums during the second half of 2006. The improvement in profitability in 2006 compared to 2005 is due primarily to the improved underwriting results related to the long haul truck, credit life and excess and surplus lines business combined with the profits generated from Southern Pioneer Life.

Midland Consolidated

Investment Income and Realized Capital Gains

Although net investment income is allocated to segments and product lines, the investment portfolio is generally managed as a whole and therefore is more meaningfully discussed in total. Net investment income increased to $42.2 million in 2006 from $40.5 million in 2005. This increase was due primarily to an increase in investment yield combined with an increase in invested assets. The annualized pre-tax equivalent investment yield, on a cost basis, of the Company’s fixed income portfolio was 5.9% in 2006 compared to 5.5% in 2005.

Realized investment gains and losses are comprised of three items: capital gains and losses from the sale of securities, derivatives features of certain convertible securities and other-than-temporary impairments. The following chart shows the gain or loss from these sources as well as their impact on diluted earnings per share (amounts in $000’s except per share amounts):


	December 31, 2006
	Pre-Tax Gain (Loss)		After-Tax Gain (Loss)		Earnings Per Share
Capital Gains	$	7,404	$	4,892	$	0.26
Derivatives		1,041		677		0.03
Other-Than-Temporary Impairments		—		—		—

Net Realized Investment Gains	$	8,445	$	5,569	$	0.29


	December 31, 2005
	Pre-Tax Gain (Loss)		After-Tax Gain (Loss)		Earnings Per Share
Capital Gains	$	5,870	$	3,815	$	0.20
Derivatives		392		255		0.01
Other-Than-Temporary Impairments		—		—		—

Net Realized Investment Gains	$	6,262	$	4,070	$	0.21

Derivatives relate to the equity conversion features attributable to the convertible preferred stocks and convertible debentures held by American Modern. The Company’s investment portfolio does not currently include any other types of derivative investments.

Insurance Losses and Loss Adjustment Expenses (LAE)

Overall, American Modern’s losses and loss adjustment expenses increased 7.3% in 2006 to $307.5 million from $286.7 million in 2005. The increase was due primarily to the related 7.0% increase in earned premiums in 2006 compared to 2005 combined with slight increases in loss ratios related to the manufactured housing, collateral protection and excess and surplus lines products. While the overall financial impact of catastrophes in 2006 improved compared to 2005,

due to reinstatement premiums and other catastrophe related items in 2005, loss and loss adjustment expenses due to catastrophes remained relatively constant in 2006 at $34.5 million compared to $34.9 million in 2005.

Insurance Commissions and Other Policy Acquisition Costs

American Modern’s commissions and other policy acquisition costs increased 5.6% in 2006 to $209.7 million from $198.6 million in 2005. This fluctuation is consistent with the increase in net earned premium. However, the majority of the fluctuation related to the increase in performance-based commission expense, with the up-front commissions increasing only slightly. This change in the mix of commission expense is attributable to American Modern’s “Pay for Performance” commission policy, with agents representing the Company, which reduces the up-front commission paid but rewards favorable underwriting and growth performance with a higher performance-based commission.

Operating and Administrative Expenses

The Company’s operating and administrative expenses increased 13.3% to $127.2 million in 2006 compared to $112.3 million in 2005. This increase is due primarily to expenses related to an increase in employee salaries and benefits.

Transportation

M/G Transport, Midland’s transportation subsidiary, contributed $7.8 million of income, before taxes, in 2006 compared to $4.9 million in 2005. In addition, M/G Transport’s revenues increased to $49.8 million in 2006 compared to $42.2 million in 2005. The increases in transportation revenues and pre-tax income are due primarily to an improved freight rate environment that we expect to continue into 2007.

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 2005 COMPARED TO YEAR ENDED DECEMBER 31, 2004

Insurance

Overview of Premium Volume

The following chart shows American Modern’s gross written premium, net written premium and net earned premium by business segment for the years ended December 31, 2005 and 2004 (in millions):


	December 31, 2005
Business Segment	Gross Written Premium		Net Written Premium		Net Earned Premium
Residential Property	$	421.6	$	381.3	$	378.4
Recreational Casualty		100.5		98.2		103.3
Financial Institutions		79.1		70.8		78.4
All Other Insurance		133.3		77.1		71.8

Total	$	734.5	$	627.4	$	631.9


	December 31, 2004
Business Segment	Gross Written Premium		Net Written Premium		Net Earned Premium
Residential Property	$	424.7	$	398.5	$	400.9
Recreational Casualty		111.3		109.6		119.2
Financial Institutions		101.5		99.2		86.8
All Other Insurance		117.0		77.6		70.7

Total	$	754.5	$	684.9	$	677.6

Gross written premium, net written premium and net earned premium decreased 2.7%, 8.4% and 6.7%, respectively, in 2005 compared to 2004. The more significant decrease in net written premium and net earned premium was due partially to a $14.7 million increase in reinstatement premiums in 2005 compared to 2004. Reinstatement premiums, which are netted against net written premium and net earned premium but do not impact gross written premium, related to purchasing additional reinsurance in response to the severe hurricane season experienced in 2005. In addition to the increased reinstatement premiums, the Company experienced growth in several accounts where premium is ceded back to the producing agent.

Residential Property

The following chart is an overview of the results of operations of the company’s residential property segment (in 000’s).


	December 31,
	2005		2004		Change
Residential Property
Direct and Assumed Written Premiums	$	421,631	$	424,656	(0.7	)%
Net Written Premiums	$	381,304	$	398,525	(4.3	)%
Net Earned Premium	$	378,402	$	400,929	(5.6	)%
Service Fees		5,651		5,615	0.6	%

Total Revenues	$	384,053	$	406,544	(5.5	)%
Income Before Taxes	$	45,755	$	47,418

The combined ratio for the residential property segment was 95.2% in 2005 compared to 94.3% in 2004. The results from this segment are driven primarily by the manufactured housing and site-built dwelling products. Although the manufactured housing industry continues to be depressed, American Modern’s gross written premium related to this product remained relatively constant at $331.5 million in 2005 compared to $334.1 million in 2004. Site-built dwelling gross written premiums decreased 2.3% to $86.4 million in 2005 compared to $88.4 million in 2004.

The manufactured housing combined ratio, including catastrophe losses, decreased slightly to 94.4% in 2005 compared to 94.9% in 2004. Excluding catastrophe losses for both years, the combined ratio improved to 84.7% in 2005 from 86.0% in 2004. This improvement was due primarily to rate increases combined with improved underwriting. The site-built dwelling combined ratio increased to 98.3% in 2005 compared to 93.2% in 2004. Excluding catastrophe losses for both years, the combined ratio increased by 2 points to 91.9% in 2005 compared to 89.9% in 2004.

Recreational Casualty

The following chart is an overview of the results of operations of the company’s recreational casualty segment (in 000’s).


	December 31,
	2005		2004		Change
Recreational Casualty
Direct and Assumed Written Premiums	$	100,438	$	111,325	(9.8	)%
Net Written Premiums	$	98,209	$	109,565	(10.4	)%
Net Earned Premium	$	103,234	$	119,151	(13.4	)%
Service Fees		2,373		2,281	4.0	%

Total Revenues	$	105,607	$	121,432	(13.0	)%
Income Before Taxes	$	12,693	$	4,987

Gross written premiums for our recreational casualty products decreased due primarily to the planned decrease in motorcycle premiums as American Modern took the necessary corrective underwriting actions and rate increases to position the motorcycle product for profitability. In addition, we have added expertise to our staff and have refined our product offering to better match the needs of our target market. As a result of these actions, the combined ratio for the motorcycle product improved to 91.1% in 2005 compared to 102.3% in 2004. As American Modern has now properly positioned the motorcycle product, we intend to implement strategies to profitably increase premiums for the product in the upcoming years.

Financial Institutions

The following chart is an overview of the results of operations of the company’s financial institutions insurance segment (in 000’s).


	December 31,
	2005		2004		Change
Financial Institutions
Direct and Assumed Written Premiums	$	79,108	$	101,510	(22.1	)%
Net Written Premiums	$	70,817	$	99,230	(28.6	)%
Net Earned Premium	$	78,424	$	86,803	(9.7	)%

Total Revenues	$	78,424	$	86,803	(9.7	)%
Income Before Taxes	$	9,471	$	6,991

The decrease in gross written premiums for our financial institutions insurance products was driven by the collateral protection and mortgage fire products which decreased $11.0 million and $7.9 million, respectively, compared to the prior year. The decrease in collateral protection gross written premiums in 2005 compared to 2004 was due to the assumption of a $17.6 million book of business during the second quarter of 2004 which included a one-time assumption of unearned premium totaling $13.6 million. The decrease in mortgage fire gross written premiums resulted primarily from the sale of a mortgage portfolio in 2005 which was serviced by one of our agents within this line.

Profits increased for our financial institutions insurance products as this segment was impacted by a $3.4 million loss related to the run-off of a cancelled product line in 2004. No such run-off losses were incurred in 2005.

All Other Insurance

The following chart is an overview of the results of operations of the company’s all other insurance segment (in 000’s).


	December 31,
	2005		2004		Change
All Other Insurance
Direct and Assumed Written Premiums	$	133,304	$	117,005	13.9	%
Net Written Premiums	$	77,040	$	77,584	(0.7	)%
Net Earned Premium	$	71,810	$	70,710	1.6	%
Agency Revenues		4,522		5,562	(18.7	)%
Service Fees		82		133	(38.3	)%

Total Revenues	$	76,414	$	76,405	0.0	%
Income Before Taxes	$	19,903	$	12,396

American Modern’s excess and surplus lines and credit life products were the primary drivers of the increase in gross written premiums in 2005 compared to 2004. A large percentage of the Company’s excess and surplus lines gross written premium is ceded to reinsurers. In addition, a large percentage of credit life gross written premium is ceded to an insurance affiliate of the producing agent. The improvement in profitability in 2005 compared to 2004 is due primarily to the improved underwriting results related to our excess and surplus lines business and our park and dealer business.

Midland Consolidated

Investment Income and Realized Capital Gains

Although net investment income is allocated to segments and product lines, the investment portfolio is generally managed as a whole and therefore is more meaningfully discussed in total. Net investment income increased to $40.5 million in 2005 from $37.2 million in 2004. This increase was due primarily to an increase in investment yield. The annualized pre-tax equivalent investment yield, on a cost basis, of the Company’s fixed income portfolio was 5.5% in 2005 compared to 5.2% in 2004.


	December 31, 2005
	Pre-Tax Gain (Loss)		After-Tax Gain (Loss)		Earnings Per Share
Capital Gains	$	5,870	$	3,815	$	0.20
Derivatives		392		255		0.01
Other-Than-Temporary Impairments		—		—		—

Net Realized Investment Gains	$	6,262	$	4,070	$	0.21


	December 31, 2004
	Pre-Tax Gain (Loss)		After-Tax Gain (Loss)		Earnings Per Share
Capital Gains	$	9,169	$	5,960	$	0.31
Derivatives		764		497		0.03
Other-Than-Temporary Impairments		—		—		—

Net Realized Investment Gains	$	9,933	$	6,457	$	0.34

Insurance Losses and Loss Adjustment Expenses (LAE)

Overall, American Modern’s losses and loss adjustment expenses decreased 17.8% in 2005 to $286.7 million from $348.6 million in 2004. As mentioned in the segment discussions above, the decrease was due primarily to improved underwriting results for the motorcycle, excess and surplus lines, and park and dealer products combined with decreased earned premiums in 2005 compared to 2004. While the overall financial impact of catastrophes in 2005 was worse than 2004, due to reinstatement premiums and other catastrophe related items, loss and loss adjustment expenses due to catastrophes actually decreased in 2005 to $34.9 million compared to $42.7 million in 2004.

During 2005 and 2004 the company experienced favorable loss development, while it experienced unfavorable loss development in 2003. This was attributable to several factors. The company exited a commercial liability product line in 2001 related to manufactured housing park operators and dealers. Original loss reserve estimates in 2001 and 2002 related to this line were not adequate. Loss reserve estimates were increased in 2003 to account for this deficiency. Subsequent settlement of these reserves has been for amounts below the revised loss reserves, resulting in a redundancy in 2004 and 2005. Another factor that contributed to the favorable development was an overestimate of the reserves related to the motorcycle line of business, the excess and surplus lines business and the liability component of our other personal lines products. The liability components associated with these lines are inherently less predictable than the company’s traditional property coverages. The company entered the motorcycle line in 2000 and the excess and surplus lines in 2002. The excess and surplus line has continued to grow at a rapid pace while the motorcycle line contracted in 2004 and 2005.

Insurance Commissions and Other Policy Acquisition Costs

American Modern’s commissions and other policy acquisition costs decreased 1.3% in 2005 to $198.6 million from $201.2 million in 2004. This decrease is attributable to the decrease in net earned premium. However, the decrease was partially offset by an increase in performance-based commission expense as a result of the improved underwriting results achieved in 2005 compared to 2004. The fluctuations in performance-based commission expense are attributable, in part, to American Modern’s “Pay for Performance” commission policy with agents representing the Company which reduces the up-front commission paid but rewards favorable underwriting and growth performance with a higher performance-based commission.

Operating and Administrative Expenses

The Company’s operating and administrative expenses increased 3.5% to $112.3 million in 2005 compared to $108.5 million in 2004. This increase is due primarily to expenses related to modernLINK^®, our proprietary information systems and web enablement initiative, and an

increase in employee salaries and benefits. In addition, the Company adopted Statement of Financial Accounting Standards (“SFAS”) 123(R) in 2005 which resulted in the recognition of $1.9 million in stock option expense.

Transportation

M/G Transport, Midland’s transportation subsidiary, contributed $4.9 million of income, before taxes, in 2005 compared to $1.7 million in 2004. The increased profitability was due partially to significantly improved freight rates during 2005. In addition, M/G Transport focused its resources on shorter, more profitable moves in 2005. This strategy considerably improved M/G Transport’s profitability, but hampered its top line revenues. In fact, M/G Transport’s revenues decreased slightly to $42.2 million in 2005 compared to $45.4 million in 2004.

LIQUIDITY, CAPITAL RESOURCES AND CHANGES IN FINANCIAL CONDITION

Consolidated Operations

Contractual Obligations

We have certain obligations and commitments to make future payments under contracts. As of December 31, 2006, the aggregate obligations on a consolidated basis were as follows (amounts in 000’s):


Payments Due By Period

	Total		Less Than 1 Year		1-3 Years		3-5 Years		After 5 Years
Long-term debt and interest	$	108,908	$	21,422	$	39,584	$	40,282	$	7,620
Other notes payable		17,937		17,937		—		—		—
Annual commitments under non-cancelable leases		33,284		2,886		4,982		5,069		20,347
Purchase obligations		26,524		23,905		2,265		354
Other obligations		268		268
Insurance policy loss reserves		221,639		122,788		64,940		19,948		13,963

Total	$	408,560	$	189,206	$	111,771	$	65,653	$	41,930

The table above excludes contracts and agreements that relate to maintenance and service agreements which, individually and in the aggregate, are not material to the Company’s operations or financial condition and are terminable by the Company with minimal advance notice and little or no cost to the Company.

The interest rates related to portions of the long-term debt in the above table are variable in nature and the interest payments included in the table have been calculated using the rates in effect at December 31, 2006.

The insurance policy loss reserve payment projections in the above table are based on actuarial assumptions. The actual payments will vary, in both amount and time periods, from the estimated amounts represented in this table. See further discussion regarding insurance policy loss reserves under the Critical Accounting Policies section.

Also included in the above table are four fifteen-year operating lease arrangements relating to the lease of 80 barges used in the transportation operations. The barges can be purchased near the end of the fifteen-year terms at predetermined prices or, at the end of each lease period, the company can either return the barges or purchase the equipment at fair market

value. For all of the aforementioned operating leases, the 15-year lease periods were more attractive at the time than the traditional 5-year financing term for conventional long-term debt. As of December 31, 2006 future lease payments required under these operating lease arrangements are (000’s): 2007 – $2,444; 2008 through 2009 – $4,910; 2010 through 2011–$5,069; after 5 years – $20,347. M/G Transport’s operating cash flow is currently sufficient to pay the financial obligations under this agreement. Also included under purchase obligations in the above table is $10.7 million related to a contract to acquire an additional 25 jumbo open barges in 2007.

The Company is in the process of significantly expanding its headquarters. The expansion, which is scheduled for completion in September 2007, will add approximately 205,000 square feet of new office space and will expand an existing training center by approximately 20,000 square feet. The new facility, which is expected to cost approximately $29 million ($17.4 has been capitalized through December 31, 2006 with the remaining $11.6 million included in the purchase obligations line in the above table), will be financed through operating cash flows and short term debt borrowings during the construction phase. The Company is considering various financing options for the building once construction is completed.

Off Balance Sheet Arrangements

We do not utilize any special-purpose financing vehicles or have any undisclosed off balance sheet arrangements. Similarly, the Company holds no fair-value contracts for which a lack of marketplace quotations would necessitate the use of fair value techniques.

Other Items

No shares were repurchased in the open market under the Company’s share repurchase program during 2006. On April 27, 2006, the Company’s Board of Directors approved a two-year extension to the share repurchase program that will run through the date of the Board’s second quarterly meeting in 2008. In addition, 500,000 additional shares were authorized for repurchase bringing the total to 1,086,000 shares that remain authorized for repurchase under terms of this program. The resolution does not require the repurchase of shares, but rather gives management discretion to make purchases based on market conditions and the Company’s capital requirements.

The share repurchase program pertains exclusively to shares to be purchased on the open market. This program specifically excludes shares repurchased in connection with stock incentive plans. The Company may periodically repurchase stock awarded to associates in connection with stock incentive programs. Such repurchase transactions essentially accommodate associates funding of the exercise price and any tax liabilities arising from the exercise or receipt of equity based incentive awards. During 2006, the Company repurchased 30,288 shares for approximately $2.1 million in connection with associate stock programs.

We paid dividends to our shareholders of $4.6 million during 2006, $4.2 million in 2005 and $3.7 million in 2004. In 2007, we expect to pay approximately $7.7 million in dividends to our shareholders due to increasing our annual dividend to $0.40 per share in 2007 compared to $0.245 per share in 2006.

We expect that our existing cash and other liquid investments, coupled with future operating cash flows and our short-term borrowing capacity, will meet our future operating cash requirements.

Holding Company Operations

Midland and American Modern are holding companies which rely primarily on dividends and management fees from subsidiaries to assist in servicing debt, paying operating expenses and paying dividends to the respective shareholders. The payment of dividends to these holding companies from American Modern’s insurance subsidiaries is restricted by state regulatory agencies. Such restrictions, however, have not had, and are not expected to have, a significant impact on our, or American Modern’s, liquidity or our and American Modern’s ability to meet our respective long or short-term operating, financing or capital obligations.

Midland has a commercial paper program under which qualified purchasers may invest in the short-term unsecured notes of Midland. As of December 31, 2006, we had $7.9 million of commercial paper debt outstanding, $6.6 million of which represented notes held either directly or indirectly by our executive officers and directors. The effective annual yield paid to all participants in this program was 5.4% as of December 31, 2006, a rate that is considered to be competitive with the market rates offered for similar instruments. As of December 31, 2006, Midland also had $83.0 million of conventional short-term credit lines available at costs not exceeding prime borrowing rates, of which $10.0 million was outstanding. These lines of credit contain minimal covenants and are typically drawn and repaid over periods ranging from two weeks to three months. We also have a mortgage obligation related to the financing of our corporate headquarters building. As of December 31, 2006, the outstanding balance of this mortgage was $13.9 million. This mortgage obligation includes normal and customary debt covenants for instruments of this type. Monthly interest payments are required until maturity in December 2007. The effective interest rate on this obligation is based on LIBOR plus 1% and was 6.31% at December 31, 2006.

On October 21, 2003 Midland filed a shelf registration statement with the Securities and Exchange Commission. This registration statement will allow the Company to offer from time to time up to $150.0 million in various types of securities, including debt, preferred stock and common stock. On February 5, 2004, Midland sold 1,150,000 shares of its common stock authorized by this shelf registration. The net proceeds received of $25.1 million were used to increase the capital base of its insurance subsidiaries to provide for future growth and for other general corporate purposes.

During the second quarter of 2004, Midland, through wholly owned trusts, issued $24.0 million of junior subordinated debt securities ($12.0 million on April 29 and $12.0 million on May 26). These transactions were part of the Company’s participation in pooled trust preferred offerings. The proceeds from these transactions are available to fund future growth and for general corporate purposes. The debt issues have 30-year terms and are callable any time after five years at the Company’s option. The interest related to the debt is variable in nature. The debt contains certain provisions which are typical and customary for this type of security.

Investment in Marketable Securities

The market value of Midland’s consolidated investment portfolio (comprised primarily of the investment holdings of American Modern) increased 8.9% to $1,031.4 million at December 31, 2006 from $947.1 million at December 31, 2005. This increase was due, in part, to the positive cash flow from operations combined with the reinvestment of interest and dividends received throughout 2006. The increase was also due to the $26.0 million increase in unrealized appreciation in the market value of the securities held at December 31, 2006 compared to year end 2005. The increase in the unrealized appreciation was due to a $25.6 million increase in unrealized appreciation related to the equity portfolio combined with a $0.4 million increase in unrealized appreciation pertaining to the fixed income portfolio. Midland’s largest equity holding, 2.5 million shares of U.S. Bancorp, increased to $88.8 million as of December 31, 2006 from $73.5 million as of December 31, 2005.

Securities with unrealized gains and losses by category (equity and debt) and by time frame are summarized in the chart below (amounts in 000’s):

Unrealized Gain (Loss) as of December 31, 2006


	Unrealized Gain (Loss)			Fair Value		# of Positions
Fixed Income Securities
Total held in a gain position	$	12,154		$	530,221	820
Held in a loss position for less than 3 months		(359	)		73,574	106
Held in a loss position for more than 3 months and less than 9 months		(266	)		12,101	21
Held in a loss position for more than 9 months and less than 18 months		(1,678	)		134,515	155
Held in a loss position for more than 18 months		(1,167	)		41,310	73

Fixed income total	$	8,684		$	791,721	1,175

Equity Securities
Total held in a gain position	$	112,690		$	217,274	167
Held in a loss position for less than 3 months		(163	)		5,482	8
Held in a loss position for more than 3 months and less than 9 months		(86	)		909	6
Held in a loss position for more than 9 months and less than 18 months		(316	)		3,476	7
Held in a loss position for more than 18 months		(89	)		1,388	2

Equity total	$	112,036		$	228,529	190

Total per above	$	120,720		$	1,020,250	1,365

Accrued interest and dividends		—			11,127

Total per balance sheet	$	120,720		$	1,031,377

Based on the above valuations and the application of our other-than-temporary impairment policy criteria, which is more fully discussed in the Critical Accounting Policies section below, we believe the declines in fair value are temporary at December 31, 2006. However, the facts and circumstances related to these securities may change in future periods, which could result in “other-than-temporary” impairment in future periods.

The average duration of the Company’s debt security investment portfolio as of December 31, 2006 was 5.0 years which management believes provides adequate asset/liability matching.

Midland Consolidated

American Modern generates cash inflows primarily from insurance premium, investment income, proceeds from the sale of marketable securities and maturities of debt security investments. The principal cash outflows for the insurance operations relate to the payment of claims, commissions, premium taxes, operating expenses, capital expenditures, income taxes, interest on debt, dividends and inter-company borrowings and the purchase of marketable

securities. In each of the periods presented, funds generated from the insurance operating activities were used primarily to purchase investment grade marketable securities, accounting for the majority of the cash used in investing activities.

The amounts expended for the development costs capitalized in connection with the development of modernLINK®, our proprietary information systems and web enablement initiative, amounted to $10.0 million in 2006 and a total of $40.3 million from inception in 2000 through December 31, 2006. The initiative is being designed, developed and implemented in periodic phases to ensure its cost effectiveness and functionality. This project may involve future cash expenditures in the range of $40 million to $45 million over the next four years, with additional spending thereafter to expand system compatibility and functionality. A portion of such expenditures will be capitalized and amortized over the useful life. However, actual costs may be more or less than what we estimate. The cost of the development and implementation is expected to be funded out of operating cash flow. Significant changes to the technology interface between American Modern and its distribution channel participants and policyholders, while unlikely, could significantly disrupt or alter its distribution channel relationships. If the new information systems are ultimately deemed ineffective, it could result in an impairment charge to our capitalized costs. The unamortized balance of modernLINK®’s software development costs was $28.3 million at December 31, 2006.

American Modern has a $72.0 million long-term credit facility available on a revolving basis at various rates. As of December 31, 2006, there was $36.0 million outstanding under these facilities.

Accounts receivable is primarily comprised of premium due from both policyholders and agents. In the case of receivables due directly from policyholders, policies are cancelable in the event of non-payment and thus offer minimal credit exposure. Approximately 63% of American Modern’s accounts receivables relate to premium due directly from policyholders as of December 31, 2006. In the case of receivables due from agents, American Modern has extended payment terms that are customary and normal in the insurance industry. Management monitors its credit exposure with its agents and related concentrations on a regular basis. However, as collectibility of such receivables is dependent upon the financial stability of the agent, American Modern cannot assure collections in full. Where management believes appropriate, American Modern has provided a reserve for such exposures. Accounts receivable increased $11.1 million to $148.2 million at December 31, 2006 compared to $137.1 million at year end 2005. The increase is due to the corresponding increase in written premiums in 2006 compared to 2005.

Reinsurance recoverables and prepaid reinsurance premiums consisted of the following amounts (amounts in 000’s):


	As of December 31,
	2006		2005
Prepaid reinsurance premiums	$	67,063	$	49,549
Reinsurance recoverables—unpaid losses		54,550		62,241
Reinsurance recoverables—paid losses		6,893		20,947

Total	$	128,506	$	132,737

The decrease in reinsurance recoverables of $21.7 million at December 31, 2006 compared to 2005 is attributable primarily to the settlement of loss recoverables in 2006 related to the 2005 hurricanes. The increase in prepaid reinsurance premiums is due to the related increase in ceded written premiums during 2006.

The increase in property, plant and equipment of $29.0 million at December 31, 2006 compared to 2005 is due to the costs incurred to date related to the expansion of the Company’s headquarters, the continuing investment in modernLINK®, and M/G Transport’s purchase of 15 additional barges.

The $50.3 million increase in unearned insurance premiums at December 31, 2006 compared to year end 2005 is related to the $97.3 million increase in the Company’s direct and assumed written premiums.

The decrease of $33.0 million in insurance loss reserves was due primarily to the settlement of losses in 2006 related to hurricanes Katrina, Rita and Wilma. The following table provides additional detail surrounding the Company’s insurance policy loss reserves at December 31, 2006 and 2005 (amounts in 000’s):


	December 31,
	2006		2005
Gross case base loss reserves:
Residential property	$	43,736	$	57,845
Recreational casualty		23,160		34,742
Financial institutions		11,004		10,289
All other insurance		71,896		58,516
Gross loss reserves incurred but not reported		51,107		54,896
Outstanding checks and drafts		20,736		38,372

Total insurance loss reserves	$	221,639	$	254,660

Cash flow from the insurance operations is expected to remain sufficiently positive to meet American Modern’s future operating requirements and to provide for reasonable dividends to Midland.

Transportation

M/G Transport generates its cash inflows primarily from affreightment revenue. Its primary outflows of cash relate to the payment of barge charter costs, debt service obligations, operating expenses, income taxes, dividends to Midland and the acquisition of capital equipment. Like the insurance operations, cash flow from the transportation subsidiaries is expected to remain sufficiently positive to meet future operating requirements.

M/G Transport entered into a fifteen-year lease in 1999 for transportation equipment. Aggregate rental payments under this operating lease over the next eight years will approximate $4.7 million. M/G Transport also entered into three fifteen-year operating leases related to the leasing of an additional 60 barges during the fourth quarter of 2006. Aggregate rental payments under these operating leases over the next fifteen years will approximate $28.1 million. In addition to the 2006 operating leases, M/G Transport purchased fifteen barges in the fourth quarter of 2006 for approximately $6.3 million.

In 2003, M/G Transport adopted the provisions of FASB Interpretation No. 46 (“FIN” 46), “Consolidation of Variable Interest Entities”, and capitalized an operating lease related to certain transportation equipment. The recorded asset value was subsequently determined to be in excess of its fair market value and impairment charges of $0.8 million (pre-tax) and $0.5 million (pre-tax) were recorded in 2004 and 2003, respectively. Later in 2004, the Company sold the transportation equipment for $1.7 million and recognized a pre-tax gain of $0.2 million. The Company used the proceeds from this sale to eliminate the debt related to the equipment.

As of December 31, 2006, the transportation subsidiaries have $16.6 million of collateralized equipment obligations outstanding.

OTHER MATTERS

Comprehensive Income

The differences between our net income and comprehensive income are changes in unrealized gains on marketable securities, changes in the fair value of the interest rate swap agreement and additional minimum liability requirements related to our defined benefit pension plans. For the years ended December 31, 2006, 2005 and 2004, such changes increased or (decreased), net of related income tax effects, by the following amounts (amounts in 000’s):


	2006		2005			2004
Changes in:
Net unrealized capital gains	$	16,899	$	(13,877	)	$	966
Fair value of interest rate swap hedge		—		280			651
Additional minimum pension liability		1,216		(1,567	)		(2,045	)

Total	$	18,115	$	(15,164	)	$	(428	)

Net unrealized investment gains in equity securities (net of income tax effects) increased $16.6 million in 2006, decreased $2.9 million in 2005 and increased $2.7 million in 2004. For fixed income securities, net unrealized gains increased $0.3 million in 2006, decreased $11.0 million in 2005 and decreased $1.7 million in 2004.

Changes in net unrealized gains on marketable securities result from both market conditions and realized gains recognized in a reporting period. The interest rate swap agreement expired on December 1, 2005. While the interest rate swap agreement was in place, its after-tax fair value varied according to the current interest rate environment relative to the fixed rate of the swap agreement. Changes in the additional minimum pension liability are actuarially determined based on the funded status of the plans and current actuarial assumptions.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. We regularly evaluate our critical accounting policies, assumptions and estimates, including those related to insurance revenue and expense recognition, loss reserves and reinsurance. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances. This process forms the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies require significant judgments and estimates in the preparation of our consolidated financial statements.

Insurance Revenue and Expense Recognition

Premiums for physical damage and other property and casualty related coverages, net of premium ceded to reinsurers, are recognized as income on a pro-rata basis over the lives of the policies. Credit accident and health and credit life premiums are recognized as income over the

lives of the policies in proportion to the amount of insurance protection provided. American Modern generally does not consider anticipated investment income in determining premium deficiencies (if any) on short-term contracts. Policy acquisition costs, primarily commission expenses and premium taxes, are capitalized and expensed over the terms of the related policies on the same basis as the related premiums are earned. Selling and administrative expenses that are not primarily related to premiums written are expensed as incurred.

Transportation Revenue Recognition

Revenues for river transportation activities are recognized when earned. If freight services are in process at the end of a reporting period, an allocation of revenue between reporting periods is made based on relative transit time in each reporting period with expenses recognized as incurred.

Insurance Policy Loss Reserves

•

We consider changes in our business, product mix, current events and any changes in case base claims reserving philosophies.

A summary of our loss reserves at December 31, 2006 and 2005 is included below:


	December 31, 2006		December 31, 2005
Property and casualty net case base reserves	$	103,782	$	103,915
Property and casualty net incurred but not reported reserves		35,204		44,151

Property and casualty net loss reserves	$	138,986	$	148,066

Property and casualty net loss reserves	$	138,986	$	148,066
Property and casualty reinsurance recoverables		42,802		53,844

Property and casualty gross loss reserves		181,788		201,910
Life and other gross loss reserves		19,115		14,378
Outstanding checks and drafts		20,736		38,372

Consolidated gross loss reserves	$	221,639	$	254,660

As noted in the table above, case base loss reserves represent the largest component of our loss reserves at approximately 75 percent of our net property and casualty loss reserves. Primarily composed of case base loss reserves, our total loss reserves are relatively short-tailed in nature and less as a percentage of statutory surplus than the property and casualty industry average. In total, our net property and casualty loss reserves represented 32% and 40% of the statutory property and casualty surplus at December 31, 2006 and 2005, respectively. In comparison, statutory loss reserves approximate 120% of statutory surplus for the property and casualty industry. Case base loss reserves tend to be more mechanical in nature and are based on specific facts and circumstances related to reported claims as compared to IBNR loss reserves, which have a higher degree of estimation and uncertainty.

•

At December 31, 2006, the recorded net property and casualty loss reserves were in the upper half of the acceptable actuarial range.

•

We have considered the acceptable actuarial range. The range is based on a “reasonable best case” and “reasonable worst case” with varying development patterns across our lines of business.

•

We have considered that our historical loss development factors are more fully encompassing favorable development patterns that we have experienced over the last few years.

We have consistently applied our approach to loss reserves. Our estimates for loss reserves utilize historical loss development patterns. As new patterns emerge, they are reflected in our assumptions. Due to the significant amount of judgment and estimation that is required to estimate loss reserves, the actual loss development is likely to be different than the amounts recorded. For example, during the last 10 years we have experienced both favorable and unfavorable development in individual calendar years. Looking back at our net property and casualty loss reserves over the last ten years, we have experienced eight years where redundancy has developed and two years where a deficiency developed. The table below outlines the cumulative (deficiency)/redundancy for the net property and casualty loss reserves since 1996, based on re-estimated amounts at December 31, 2006.


Year	P&C Net Loss Reserves Original Balance		Cumulative (Deficiency) / Redundancy Based on 12/31/2006 Re-estimation			(Deficiency) / Redundancy As Percent of Original Reserves
1996	$	64,784	$	(2,723	)	-4.2	%
1997		81,901		4,407		5.4	%
1998		88,267		10,249		11.6	%
1999		89,325		3,054		3.4	%
2000		95,022		695		0.7	%
2001		102,858		3,208		3.1	%
2002		115,584		(2,354	)	-2.0	%
2003		149,478		32,876		22.0	%
2004		166,302		39,108		23.5	%
2005		148,066		10,010		6.8	%
2006		138,986		NA
10- Year Average						7.0	%

We believe the recent favorable IBNR development was caused, in part, by lower non-catastrophe related frequency patterns than we have experienced historically, a higher level of case base redundancies, and favorable loss development in our newer lines of business. The case base redundancy was due in part to our response to the loss reserve deficiencies for the December 31, 2002 loss reserves that were ultimately discovered during 2003. In response to deficient development of reserves, management strengthened the company’s loss reserves to reflect these changing development trends arriving at a best estimate of how these losses would ultimately settle. The higher levels of loss reserves, and their potential redundancy, were not fully contemplated in the incurred-but-not-reported loss reserves, because our experience had not been validated over an appropriate period of time.

Although we have experienced better than expected claim activity in 2004 and 2005, we believe that several of our lines of business (including excess and surplus lines, personal liability and park and dealer liability) may still experience additional development in the future because of the liability components that are underwritten. Therefore, the 2004 redundancy reflected after one year of development may ultimately be more or less in future years. The potential for future development is evidenced by the fact that we experienced some adverse development related to losses that occurred in 2004 during 2006 in our personal liability and excess and surplus lines business.

Consequently, despite the recent experience, we have not changed our reserving approach or assumptions and we do not anticipate changing our reserving methodology until we believe that development trends have become sustainable. In determining our estimate of loss reserves, we apply caution to short term variations from historical patterns. We believe that short term variations must be viewed with skepticism and history shows that they do not produce data that is actionable until validated for an appropriate period of time. The evaluation of short term variations is highly subjective and often depends on specific facts and circumstances. Generally, to determine if a short term variation requires action, we analyze the specific facts and circumstances of the trend and evaluate data to determine whether the trend is sustainable. We believe that this approach avoids inappropriate volatility to the income statement. In order to determine whether variations from our historical patterns represent ongoing trends, management meets quarterly with Claims and Product personnel to review business developments, claim frequency and severity statistics and other relevant developmental trends. Additionally, management from various areas of the business (including product, claims and underwriting personnel) meet monthly to discuss trends relating to the products. Management also considers changes in our business, product mix and case base claims reserving philosophies when deciding whether the loss development patterns are sustainable.

The loss reserves from the following lines of business tend to be more difficult to predict as compared to the larger property portion of our business.

•

Motorcycle is a less mature product line that we began writing in 2001. We, therefore, did not have as much historical data related to this product. In addition, as we began writing this business, we experienced a very high loss ratio, relative to our, and industry standards. This was largely due to the initial underwriting criteria and our limited claim handling experience. Since 2001, we have made significant underwriting changes to this product and have also developed claim expertise and experience in settling claims related to this line thus causing more favorable development in recent years.

•

Personal liability and park and dealer liability tend to be more volatile due to the liability component of these risks, which has a higher degree of complexity and a longer development period when compared to the larger property portion of our business. We exited the park and dealer liability lines in 2001 and we had experienced several years of volatility and inadequate reserves related to this line at December 31, 2003. Subsequently, we have experienced claims being settled for less than the amount reserved.

•

The excess and surplus lines are new lines of business to the Company. We began writing excess and surplus in 2002 and we therefore do not have a large amount of historical development data. Additionally, the excess and surplus lines contain a higher degree of liability risks and the reserving methodology is more dependent on longer term development patterns.

Essentially, in each of these lines we experienced more favorable development in 2005 than our historical development and baseline industry data would have indicated. The favorable development in 2005 was the result of a combination of redundant case base reserves, where claims were settled for less than the reserved amount, and lower non-catastrophe related

frequency patterns than we have historically experienced. We estimate that redundant case base reserves accounted for approximately 40% of our favorable development with the remaining redundancy attributed primarily to the re-estimate of incurred-but-not-reported loss reserves, after an additional year of development. As discussed above, we believe this IBNR development was caused, in part, by lower non-catastrophe related frequency patterns than we have experienced historically, a higher level of case base redundancies, and favorable loss development in our newer lines of business. The case base redundancy was due in part to our response to the loss reserve deficiencies for the December 31, 2002 loss reserves that were ultimately discovered during 2003. Both our property and liability lines developed a deficiency in 2003. Collectively, the December 31, 2002 loss reserves developed a deficiency of approximately 10 percent, or $12 million, in 2003. This was due in part to the newer lines of business and the more volatile park and dealer liability lines, which we exited in 2001. In response to deficient development of reserves, management strengthened the company’s loss reserves to reflect these changing development trends arriving at a best estimate of how these losses would ultimately settle. The higher levels of loss reserves, and their potential redundancy, were not fully contemplated in the incurred-but-not-reported loss reserves, because our experience had not been validated over an appropriate period of time.

As mentioned above, management considers trends or patterns in claim experience in determining its best estimate of loss reserves. Management regularly reviews the level of loss reserves against actual loss development. As part of the retrospective analysis, management compares actual development to our underlying assumptions and we consider these results in assessing whether any adjustments to the loss reserves are necessary. This retrospective review is the primary criteria used in refining the levels of loss reserves recorded in the financial statements. As part of this review, management also considers trends or patterns noted in management’s regular discussions with internal and external consulting actuaries. We meet with our consulting actuary on a quarterly basis and have ongoing discussions as necessary. During the meetings with our consulting actuary, we use available statistical information to re-estimate prior period loss reserves which includes the development of the case base loss reserves. We also consider the summarized statistical results from previous meetings with our external actuary in refining our IBNR reserves. In addition, management meets quarterly with Claims and Product personnel to review ongoing business trends, claim frequency and severity statistics and other relevant developmental trends. We consider changes in our business, product mix, current events and any changes in case base claims reserving philosophies.

As previously mentioned, management engages a credentialed consulting actuary to affirm the recorded amount of loss reserves with an acceptable actuarial range. The consulting actuarial firm utilizes a variety of actuarial and statistical methods in determining the ultimate liabilities within acceptable actuarial range for loss reserves. These methods include, but are not limited to:

•

The Incurred Loss Development Method

•

The Paid Loss Development Method

•

The Hindsight Average Claim Cost Method

•

Bornhuetter/Ferguson (Paid and Incurred) Methods

The table below provides a summary of these actuarial models along with an outline of the model advantages, disadvantages and the primary use of the model and key assumptions used on the models:


Model	Model Summary	Model Advantages	Model Disadvantages	Primary Use of Model	Key Assumptions

Incurred Loss Development Method	Historical loss reporting pattern is applied directly to the latest cumulative reported losses (paid plus case reserves) to estimate ultimate losses	Tends to be responsive to changes in reported losses. May also provide more accurate estimate of ultimate losses for less mature years if historical levels of reserve accuracy are maintained	May inaccurately react to a change in the adequacy of case reserves	Principally used for property lines of business, including the property components of residential property lines. Model is also used for older accident years for liability components.	Historical loss development growth will be consistent from year to year. Often an average growth development factor will be utilized

Paid Loss Development	Historical loss payment pattern is applied directly to the latest cumulative paid losses to estimate ultimate losses.	Estimates of ultimate losses are independent of case reserve adequacy and are unaffected by changes in case reserving practices	The nature of liability payment patterns requires the application of large development factors to relatively small payments in most immature years	Principally used for liability lines. It is more applicable in middle maturity accident years. This model is also used if there has been a change in case reserving philosophies.	Claims closing rates are consistent

Hindsight Average Claim Cost	An estimate of the remaining reserves is divided by the number of open claims. These average claims costs are trended forward. From this average remaining claim cost we subtract the current average pending claim and then multiply the difference by the number of open claims. The result is a projection of IBNR.	The number of open claims is the basis of this approach and consequently, changes in reserve adequacy will not affect the result of this method	Changes in claim closing rates will cause differences in historical averages (i.e. claim population at the same age of development is different.) This method does not reflect claims adjustment information, which is more important in older years.	Principally used for liability lines of business. It is appropriate for more recent accident years and may also be used if there has been a change in case reserving philosophies.	Ultimate settlement of open claims is consistent with historical trends. Claims closing rates are consistent.

Bornhuetter / Ferguson	This method bases the projection of losses on the loss ratio and percent of losses reported to date for an accident year. This model is often used in newer lines of business and may incorporate industry information.	This method is less sensitive than the incurred loss development method to the volatility that is present in the reported losses in the early stages of development	Ignores current information as it assumes similar exposures and loss potential for all accident years, unless specific adjustments are made to account for changes.	Principally used for liability lines of business, although it may also be used for property lines of business for high catastrophe periods and lines of business that are less mature	The selected initial expected loss ratio is reflective of the actual loss ratio. Reporting and/or payment patterns are consistent.

In determining the appropriate models to utilize for our various lines of business, our consulting actuary considers the following factors:

•

Characteristics of the line of business (property or liability)

•

The history of the lines of business

•

The number of years of company specific historical development data

•

The age of accident year

•

Other specific operating factors, such as changes in claims reserving philosophies or changes in claims personnel management

Generally, the incurred loss development method is the primary method used by our external actuary in determining the ultimate liability for the property lines of business. For our liability lines of business, our consulting actuary will generally utilize estimates from several of the models listed above and develop a blended average. This process requires significant judgment from our credentialed actuary and more emphasis may be applied to one model based on the judgment of the actuary.

The Company’s philosophy is to adequately reserve our case base claims in a consistent manner. We regularly monitor the development of our case base claims and make appropriate adjustments to our recorded reserve balances and in our reserving practices. In addition, the following factors contribute to the variability in establishing case base loss reserves:

•

The timing of information received. As more information becomes available, (i.e., through physical inspections, actual claim settlement, etc.) case base reserves are adjusted appropriately to reflect current information.

•

Liability claims, by their very nature, are less obvious and more complex than property claims and, therefore, the reserving process requires more judgment. Liability losses often involve multiple parties, can more often be subject to litigation and often do not involve immediately apparent property damage. As a consequence, reserving for such losses requires more estimation and judgment than the property lines.

•

The increase in demand for replacement materials and labor (demand surge), specifically after a large scale catastrophic event, which may contribute to inadequate case base reserve.

IBNR loss reserves are approximately 25 percent of the net property and casualty loss reserves, while case base loss reserves represent approximately 75 percent of the net property and casualty reserve balance. The primary criteria that management considers in determining its best estimate for loss reserves includes trends and patterns in the actual claims settling process, historical development patterns, trends and patterns noted in regular discussion with internal and external actuaries, and changes in our business, product mix or our case base claims reserving process.

In order to determine an acceptable actuarial range of loss reserves, the consulting actuary utilizes various statistical models. The most significant assumptions relate to the development factors which are utilized to predict the ultimate losses expected to be incurred. The consulting actuary utilizes historical development factors, including the use of 3- and 5-year historical development averages to estimate the ultimate liability. Our consulting affirming actuary utilizes development factors that are applicable to certain lines of business based on their risk characteristics (i.e., property, liability, motorcycle, excess and surplus). Additionally, development patterns are developed for each accident year. The development factors that are

used by the actuaries are generally based on our historical patterns, rather than the development from any one year, which balances stability and responsiveness in developing age to age factors. For example, in determining the 2005 loss reserves, the most recent favorable one year development patterns were considered as part of historical averages. However, the impacts of the latest one-year favorable development factors were only partially recognized in the external actuary’s contemplation of loss reserves. As development factors continue to emerge they will be a larger part of the historical three- and five-year averages, and will be more heavily weighted when reflected in the range of our affirming external actuary. For example, we have experienced more favorable development patterns over the last couple of years in our motorcycle coverages than our historical patterns would indicate.

Given the way in which we assess the adequacy of our loss reserves, it is not practicable to individually isolate and quantify the impact of specific factors attributable to key assumptions as many of these items are inter-related and are also offset by other significant factors such as frequency and severity.

Both management and the consulting actuary utilize various assumptions for loss adjustment expense and salvage and subrogation, and are based on historical averages. However, these assumptions have not changed significantly and have not materially affected management’s best estimate of loss reserve or the external actuary’s acceptable actuarial range of insurance loss reserves.

Based on the considerations noted above, and our historical loss reserve development patterns, we believe it is reasonably likely that our December 31, 2006 net property and casualty loss reserves will develop with a redundancy in the range of 5 percent to 15 percent, although it is possible that the actual development will be more or less. A chart outlining the after-tax earnings impact of reasonably likely redundancies is shown below. The potential earnings impact of the 2006 loss reserves redundancy on our 2007 after-tax earnings assumes no development, positive or negative, relative to the December 31, 2007 loss reserves.


Potential Percent Redundant	Potential After-Tax Earnings Impact
5%	$	4.5 million
10%	$	9.0 million
15%	$	13.5 million

While management believes the amounts are fairly stated, the ultimate liability, once fully developed, may be more than or less than the recorded amount. If the ultimate pay outs would significantly exceed the expected amounts, the Company has several potential options to utilize in order to satisfy the additional obligations. For example, the Company could liquidate a portion of its investment portfolio or draw on conventional short-term credit lines available, at costs not exceeding prime rates. The Company believes either of these options would be sufficient to meet any increases in required loss payments. Slowness to recognize or respond to new or unexpected loss patterns, such as those caused by the risk factors listed in the Company’s Safe Harbor Statement, could lead to a shortage in reserves, which would lead to a decrease in after-tax earnings.

Reinsurance Risks

Company pays a percentage of earned premiums to reinsurers in return for coverage against catastrophic losses. Additional reasons for entering reinsurance agreements include the following:

To reduce total statutory liabilities to a level appropriate for American Modern’s capital and surplus.

To provide financial capacity to accept risks and policies involving amounts larger than could otherwise be accepted.

To facilitate relationships with business partners who want to participate in the insurance risk through their own reinsurance companies.

However, our operating results were impacted to varying degrees by our catastrophe reinsurance program. Catastrophe reinsurance costs, including reinstatements, totaled $25.8 million, $31.9 million and $16.9 million during 2006, 2005 and 2004, respectively. The Company’s gross catastrophe losses for 2006, 2005 and 2004 were $41.9 million, $232.1 million and $67.1 million, respectively, of which $7.4 million, $179.4 million and $21.1 million, respectively, were recovered through our catastrophe reinsurers.

Based on our estimates as of December 31, 2006, Hurricane Katrina, the costliest storm in U.S history, exceeded the limits of the Company’s 2005 catastrophe reinsurance program by approximately $8.0 million in 2006, which impacted after tax earnings by approximately $5.2 million.

Our 2006 catastrophe reinsurance structure was similar to the 2005 program with a $3.0 million increase in retention, from $7 million to $10 million, and the purchase of an additional $40 million of protection on top of our previous $110 million cover. Due to the volatile weather patterns of 2005, we absorbed a significant increase in our base reinsurance cost in 2006 that nearly doubled the base cost of 2005. This increase, along with the additional cover, adversely impacted our 2006 pre-tax earnings by approximately $12.0 million, or $0.40 per share (diluted).

While the hurricane activity over the past couple of years has significantly increased the cost of obtaining reinsurance, our strong relationships with our reinsurers have allowed us to provide exposure management that is consistent with our overall risk management strategy. In addition, our strong relationships with our reinsurers and our disciplined overall exposure management philosophy, combined with the financial strength of these reinsurers (as of December 31, 2006, approximately 85% of the Company’s catastrophe reinsurers had an A.M. Best rating of “A-” or better), allow us to be confident that we will be able to effectively manage our exposures in the future.

Other-Than-Temporary Impairment of Investment Securities

American Modern invests in various securities including U.S. Government securities, corporate debt securities, and corporate stocks. Investment securities in general are exposed to various risks such as interest rate, credit, and overall market volatility. Due to the level of risk associated with these securities, it is reasonably possible that changes in the value of investment securities will occur in the near term and that such changes could be material.

In order to identify other-than-temporary impairments, we conduct quarterly comprehensive reviews of individual portfolio holdings that have a market value less than their respective carrying value. As part of our review for other-than-temporary impairment, we track the respective carrying values and market values for all individual securities with an unrealized loss. We, with the assistance of our external professional money managers, apply both quantitative and qualitative criteria in our evaluation, including facts specific to each individual investment such as, but not limited to, the length of time the fair value has been below the carrying value, the extent of the decline, our intent to sell or hold the security, the expectation for each individual security’s performance, the credit worthiness and related liquidity of the issuer and the issuer’s business sector.

The evaluation for other-than-temporary impairment requires a significant amount of judgment. As such, there are a number of risks and uncertainties inherent in the process of monitoring for potential impairments and determining if a decline is other-than-temporary. These risks and uncertainties include the risks that:

1. The economic outlook is worse than anticipated and has a greater adverse impact on a particular issuer than anticipated.

2. Our assessment of a particular issuer’s ability to meet all of its contractual obligations changes based on changes in the facts and circumstances related to the issuer.

3. New information is obtained or facts and circumstances change that cause a change in our ability or intent to hold a security to maturity or until it recovers in value.

When a security is considered other-than-temporarily impaired, we monitor trends or circumstances that may impact other material investments in our portfolio. For example, we review any other securities that are held in the portfolio from the same issuer and also consider any circumstances that may impact other securities of issuers in the same industry. At December 31, 2006, we had no significant concentration of unrealized losses in any one issuer, industry or sector.

For fixed income and equity securities, we consider the following factors, among others, to determine if a security is other-than-temporarily impaired:

•

the extent and duration to which market value is less than cost

•

historical operating performance of the security

•

issuer news releases, including those disclosing that the issuer has committed an event of default (missed payment beyond grace period, bankruptcy filing, loss of principle customer or supplier, debt downgrade, disposal of segment, etc.)

•

near term prospects for improvement of the issuer and/or its industry to include relevant industry conditions and trends

•

industry research and communications with industry specialists

•

third party research reports

•

credit rating reports

•

financial models and expectations

•

discussions with issuer’s management by investment manager

•

our ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery

•

time to conversion with respect to a mandatory convertible security

For fixed income securities, we also consider the following factors:

•

the recoverability of principal and interest

•

the issuer’s ability to continue to make obligated payments to security holders

•

the current interest rate environment

The investment portfolio is comprised of various asset classes which are independently managed by external professional portfolio managers under the oversight and guidelines established by our investment committee. We evaluate the performance of the portfolio managers relative to benchmarks we believe appropriate given the asset class. Investment managers will manage the portfolio under these guidelines to maximize the return on their investment class. As part of their investment strategy, the investment managers will buy and sell securities based on changes in the availability of, and the yield on, alternative investments. Investment managers may also buy and sell investments to diversify risk, attain a specific characteristic such as duration or credit quality, rebalance or reposition the portfolio or for a variety of other reasons.

It is our intent, and thus the intent of our investment managers, to hold securities that have an unrealized gain or loss. For the securities with an unrealized loss, which in our judgment we believe to be temporary, it is our intent to hold the security for a period of time that will allow

the security to recover in value. While the Company has the ultimate authority regarding sales of securities, investment managers may sell certain securities and reinvest the proceeds if they believe returns would be enhanced by doing so, in which case the unrealized gain or loss will be recognized as a realized gain or loss. As part of our comprehensive quarterly review for other than temporary impairment, the Company asks investment managers to identify any securities in which they have the intent to sell in the near term. In the case where investment managers have indicated their intent to sell a security in the near term and there is an unrealized loss, we record an other-than-temporary impairment at the balance sheet date, if such date is prior to the sale of the security. At December 31, 2006, we had no securities with an unrealized loss for which a decision was made to sell in the near term.

For the years ended December 31, 2006, 2005 and 2004, we incurred no losses related to other-than-temporary impairments. Impairment charges, if incurred, would be included in the consolidated financial statements in “net realized investment gains (losses).”

Defined Benefit Pension Plans

Midland maintains defined benefit pension plans for a limited number of active participants. The defined benefit pension plans are not open to employees hired after March 31, 2000. The pension expense is calculated based upon a number of actuarial assumptions, including an expected long-term rate of return and a discount rate. In determining our expected long-term rate of return and our discount rate, we evaluate input from our actuaries, asset allocations, long-term bond yields and historical performance of the invested pension assets over a ten-year period. If other assumptions were used, the amount recorded as pension expense would be different from our current estimate.

New Accounting Standards

In October 2005, the American Institute of Certified Public Accountants issued Statement of Position (“SOP”) 05-1. SOP 05-1 provides accounting guidance for deferred policy acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in Statement of Financial Accounting Standards (“SFAS”) No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments.” SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement or rider to a contract, or by the election of a feature or coverage within a contract. The provisions of SOP 05-1 are effective for internal replacements occurring in fiscal years beginning after December 15, 2006. The SOP is not expected to have a material impact on the Company’s Consolidated Financial Position or Results of Operations.

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140,” which resolves issues addressed in Statement 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” SFAS No. 155, among other things, permits the fair value remeasurement of any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement 133; and establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation. SFAS No. 155 is effective for all financial instruments acquired or issued in a fiscal year beginning after September 15, 2006. The Company is currently assessing the impact of SFAS No. 155 on its consolidated financial position and results of operations.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes.” The interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes.” Specifically, the pronouncement prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on the related de-recognition, classification, interest and penalties, accounting for interim periods, disclosure and transition of uncertain tax positions. The interpretation is effective for fiscal years beginning after December 15, 2006. The Company does not expect the adoption of this new pronouncement to have a material effect on its financial position or results of operations.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”). This Standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those years. The Company is assessing the impact that SFAS 157 will have on its consolidated financial statements.

Also in September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statement No. 87, 88, 106 and 132(R)” (“SFAS 158”). This Standard requires recognition of the funded status of a benefit plan in the statement of financial position. The Standard also requires recognition in other comprehensive income certain gains and losses that arise during the period but are deferred under pension accounting rules, as well as modifies the timing of reporting and adds certain disclosures. The recognition and disclosure elements of SFAS 158 are effective for fiscal years ending after December 15, 2006. The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. The adoption of SFAS 158 resulted in a reduction of shareholders’ equity of $3.6 million, net of tax, at December 31, 2006.

Impact of Inflation

We do not consider the impact of the change in prices due to inflation to be material in the analysis of our overall operations.

ITEM 7A.

Quantitative and Qualitative Disclosures about Market Risk

Market risk is the risk that we will incur investment losses due to adverse changes in market rates and prices. Our market risk exposures are substantially related to the Company’s investment portfolio and changes in interest rates and equity prices. Each risk is defined in more detail as follows.

Interest rate risk is the risk that the Company will incur economic losses due to adverse changes in interest rates. The risk arises from many of the Company’s investment activities, as the Company invests substantial funds in interest-sensitive assets. The Company manages the interest rate risk inherent in its investment assets relative to the interest rate risk inherent in its liabilities. One of the measures the Company uses to quantify this exposure is duration. By definition, duration is a measure of the sensitivity of the fair value of a fixed income portfolio to changes in interest rates. Based upon the 5.0 year duration of the Company’s fixed income portfolio as of December 31, 2006, management estimates that a 100 basis point increase in interest rates would decrease the market value of its $801.7 million debt security portfolio by 5.0%, or $40.1 million.

Equity price risk is the risk that the Company will incur economic losses due to adverse changes in a particular stock or stock index. The Company’s equity exposure consists primarily of declines in the value of its equity security holdings. As of December 31, 2006, the Company had $229.7 million in equity holdings, including $88.8 million of U.S. Bancorp common stock. A 10% decrease in the market value of U.S. Bancorp’s common stock would decrease the fair value of its equity portfolio by approximately $8.9 million. As of December 31, 2006, the remainder of the Company’s portfolio of equity securities had a beta coefficient (a measure of stock price volatility) of 0.95. This means that, in general, if the S&P 500 Index decreases by 10%, management estimates that the fair value of the remaining equity portfolio will decrease by 9.5%.

The active management of market risk is integral to the Company’s operations. The Company has investment guidelines that define the overall framework for managing market and other investment risks, including the accountabilities and controls over these activities.

ITEM 8.

FINANCI AL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and Board of Directors of

The Midland Company:

We have audited the accompanying consolidated balance sheets of The Midland Company and subsidiaries (the “Company”) as of December 31, 2006 and 2005, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006. Our audits also included the financial statement schedules listed in the index at 15(a)(2). These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of The Midland Company and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

As discussed in Note 1, the Company adopted the recognition and related disclosure provisions of Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Benefit Plans – an amendment of FASB Statements No. 87, 88, 106, and 132(R), on December 31, 2006 and Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-Based Payment, on January 1, 2005.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 7, 2007, expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ Deloitte & Touche LLP

Cincinnati, Ohio

March 7, 2007

THE MIDLAND COMPANY

AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2006 AND 2005

Amounts in 000’s


	December 31, 2006		December 31, 2005
ASSETS
MARKETABLE SECURITIES:
Fixed income (amortized cost, $792,998 at December 31, 2006 and $743,354 at December 31, 2005)	$	801,682	$	751,651
Equity (cost, $117,659 at December 31, 2006 and $109,020 at December 31, 2005)		229,695		195,445

Total		1,031,377		947,096
CASH		5,059		3,368
ACCOUNTS RECEIVABLE - NET		148,204		137,125
REINSURANCE RECOVERABLES AND PREPAID REINSURANCE PREMIUMS		128,506		132,737
PROPERTY, PLANT AND EQUIPMENT - NET		118,879		89,888
DEFERRED INSURANCE POLICY ACQUISITION COSTS		99,277		88,374
OTHER ASSETS		38,226		29,525

TOTAL ASSETS	$	1,569,528	$	1,428,113

See notes to consolidated financial statements.

THE MIDLAND COMPANY

AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2006 AND 2005

Amounts in 000’s


	December 31, 2006			December 31, 2005
LIABILITIES & SHAREHOLDERS’ EQUITY
UNEARNED INSURANCE PREMIUMS	$	445,324		$	395,007
INSURANCE LOSS RESERVES		221,639			254,660
INSURANCE COMMISSIONS PAYABLE		46,593			41,900
FUNDS HELD UNDER REINSURANCE AGREEMENTS
AND REINSURANCE PAYABLES		15,139			11,655
LONG-TERM DEBT		66,508			67,766
NOTES PAYABLE		17,937			20,005
DEFERRED FEDERAL INCOME TAX		47,197			38,350
OTHER PAYABLES AND ACCRUALS		110,445			90,393
JUNIOR SUBORDINATED DEBENTURES		24,000			24,000

TOTAL LIABILITIES		994,782			943,736

COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS’ EQUITY:
Common stock (issued and outstanding: 19,224 shares at December 31, 2006 and 18,964 shares at December 31, 2005 after deducting treasury stock of 3,782 shares and 4,042 shares, respectively)		959			959
Additional paid-in capital		65,669			57,061
Retained earnings		477,145			411,210
Accumulated other comprehensive income		72,346			57,863
Treasury stock - at cost		(41,373	)		(42,716	)

TOTAL SHAREHOLDERS’ EQUITY		574,746			484,377
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	1,569,528		$	1,428,113

See notes to consolidated financial statements.

THE MIDLAND COMPANY

AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004

Amounts in 000’s (except per share information)


	Years Ended December 31,
	2006		2005		2004
REVENUES:
Premiums earned	$	675,864	$	631,864	$	677,584
Other insurance income		12,929		12,600		13,780
Net investment income		42,223		40,519		37,165
Net realized investment gains		8,445		6,262		9,933
Transportation		49,807		42,185		45,379

Total		789,268		733,430		783,841

COSTS AND EXPENSES:
Losses and loss adjustment expenses		307,503		286,662		348,611
Commissions and other policy acquisition costs		209,719		198,585		201,155
Operating and administrative expenses		127,236		112,329		108,536
Transportation operating expenses		41,792		36,986		43,266
Interest expense		5,164		5,967		5,169

Total		691,414		640,529		706,737

INCOME BEFORE FEDERAL INCOME TAX		97,854		92,901		77,104
PROVISION FOR FEDERAL INCOME TAX		27,159		27,575		22,866

NET INCOME	$	70,695	$	65,326	$	54,238

BASIC EARNINGS PER SHARE OF COMMON STOCK:	$	3.70	$	3.46	$	2.91

DILUTED EARNINGS PER SHARE OF COMMON STOCK:	$	3.60	$	3.37	$	2.83

See notes to consolidated financial statements.

THE MIDLAND COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMEN TS OF CHANGES IN SHAREHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004

Amounts in 000’s


	Common Stock		Additional Paid-In Capital		Retained Earnings			Accumulated Other Com- prehensive Income			Treasury Stock			Unvested Restricted Stock Awards			Total			Compre- hensive Income
BALANCE, DECEMBER 31, 2003	$	911	$	23,406	$	299,752		$	73,455		$	(41,442	)	$	(24	)	$	356,058
Comprehensive income:
Net income						54,238												54,238		$	54,238
Increase in unrealized gain on marketable securities, net of federal income tax of $518									966									966			966
Other, net of federal income tax of $(750)									(1,394	)								(1,394	)		(1,394	)

Total comprehensive income																				$	53,810

Common stock issuance		48		25,022														25,070
Purchase of treasury stock												(2,918	)					(2,918	)
Issuance of treasury stock for options exercised and employee savings plan				1,642								1,325						2,967
Cash dividends declared						(3,849	)											(3,849	)
Federal income tax benefit related to the exercise or granting of stock awards				1,114														1,114
Amortization and cancellation of unvested restricted stock awards															24			24

BALANCE, DECEMBER 31, 2004	$	959	$	51,184	$	350,141		$	73,027		$	(43,035	)	$	—		$	432,276
Comprehensive income:
Net income						65,326												65,326		$	65,326
Decrease in unrealized gain on marketable securities, net of federal income tax of $(7,473)									(13,877	)								(13,877	)		(13,877	)
Other, net of federal income tax of $(692)									(1,287	)								(1,287	)		(1,287	)

Total comprehensive income																				$	50,162

Purchase of treasury stock												(1,839	)					(1,839	)
Issuance of treasury stock for options exercised and employee savings plan				3,520								2,158						5,678
Cash dividends declared						(4,257	)											(4,257	)
Federal income tax benefit related to the exercise or granting of stock awards				455														455
Stock option expense				1,902														1,902

BALANCE, DECEMBER 31, 2005	$	959	$	57,061	$	411,210		$	57,863		$	(42,716	)	$	—		$	484,377
Comprehensive income:
Net income						70,695												70,695		$	70,695
Increase in unrealized gain on marketable securities, net of federal income tax of $9,099									16,899									16,899			16,899
Other, net of federal income tax of $655									1,216									1,216			1,216

Total comprehensive income																				$	88,810

SFAS 158 pension adjustment, net of federal income tax of $(1,956)									(3,632	)								(3,632	)
Purchase of treasury stock												(2,082	)					(2,082	)
Issuance of treasury stock for options exercised and employee savings plan				4,656								3,425						8,081
Cash dividends declared						(4,760	)											(4,760	)
Federal income tax benefit related to the exercise or granting of stock awards				1,420														1,420
Stock option expense				2,532														2,532

BALANCE, DECEMBER 31, 2006	$	959	$	65,669	$	477,145		$	72,346		$	(41,373	)	$	—		$	574,746

See notes to consolidated financial statements.

THE MIDLAND COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004

Amounts in 000’s


	2006			2005			2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	70,695		$	65,326		$	54,238
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		9,412			10,521			10,867
Stock-based compensation		5,616			3,943			1,852
Net realized investment gains		(7,175	)		(5,870	)		(9,169	)
Changes in:
Reinsurance recoverables and prepaid reinsurance premiums		13,056			(45,011	)		(16,736	)
Net accounts receivable		(10,582	)		(23,146	)		(19,971	)
Insurance loss reserves		(35,739	)		21,745			28,082
Unearned insurance premiums		28,576			4,560			6,578
Other assets		(4,320	)		(3,878	)		(4,315	)
Insurance commissions payable		4,683			(1,167	)		12,545
Deferred insurance policy acquisition costs		(4,822	)		2,049			(2,550	)
Funds held under reinsurance agreements and reinsurance payables		3,334			(2,117	)		6,794
Other accounts payable and accruals		13,943			(781	)		18,680
Provision (benefit) for deferred federal income tax		(408	)		(1,088	)		407
Other-net		783			2,044			1,604

Net cash provided by operating activities		87,052			27,130			88,906

CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions, net of cash acquired		(15,174	)		—			—
Purchase of marketable securities		(331,244	)		(504,809	)		(617,105	)
Sale of marketable securities		248,355			457,815			407,729
Maturity of marketable securities		27,367			86,083			76,946
Decrease (increase) in cash equivalent marketable securities		25,800			(32,558	)		15,992
Acquisition of property, plant and equipment		(50,832	)		(32,435	)		(11,699	)
Proceeds from sale of property, plant and equipment		13,157			890			2,243

Net cash used in investing activities		(82,571	)		(25,014	)		(125,894	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable		(2,068	)		(13,172	)		(448	)
Repayment of long-term debt		(1,258	)		(1,903	)		(3,488	)
Issuance of long-term debt		—			10,940			—
Dividends paid		(4,651	)		(4,155	)		(3,723	)
Issuance of treasury stock		6,103			4,523			2,967
Purchase of treasury stock		(2,082	)		(1,839	)		(2,918	)
Excess tax benefits from exercise of stock options		1,166			—			—
Proceeds from common stock issuance		—			—			25,070
Issuance of junior subordinated debentures		—			—			24,000

Net cash provided by (used in) financing activities		(2,790	)		(5,606	)		41,460

NET INCREASE (DECREASE) IN CASH		1,691			(3,490	)		4,472
CASH AT BEGINNING OF PERIOD		3,368			6,858			2,386

CASH AT END OF PERIOD	$	5,059		$	3,368		$	6,858

INTEREST PAID	$	5,029		$	5,753		$	4,470
INCOME TAXES PAID	$	29,625		$	24,600		$	22,869

Treasury stock issued under the Company’s performance stock award plan amounted to $1,978 and $1,155 for 2006 and 2005, respectively.

See notes to consolidated financial statements.

Notes to Consolidated Financial Statements

Years Ended December 31, 2006, 2005 and 2004

1. General Information and Summary of Significant Accounting Policies

The Midland Company (the “Company” or “Midland”) operates in two industries—insurance and transportation with the most significant business activities being in insurance. Midland’s insurance operations are conducted through its wholly-owned subsidiary, American Modern Insurance Group, Inc. (“American Modern”). M/G Transport Services, Inc. and MGT Services, Inc. (collectively “M/G Transport”) operates a fleet of dry cargo barges for the movement of dry bulk commodities such as petroleum coke, ores, barite, sugar and other cargos primarily on the lower Mississippi River and its tributaries.

The accounting policies of the Company and its subsidiaries conform to accounting principles generally accepted in the United States of America. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make numerous estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The accompanying consolidated financial statements include estimates for items such as insurance loss reserves, income taxes, various other liability accounts and deferred insurance policy acquisition costs. Actual results could differ from those estimates. Policies that affect the more significant elements of the consolidated financial statements are summarized below.

Principles of Consolidation — The consolidated financial statements include the accounts of the Company and all subsidiary companies. Material intercompany balances and transactions have been eliminated.

Marketable Securities — Marketable securities are categorized as fixed income securities (cash equivalents, debt instruments and preferred stocks having scheduled redemption provisions) and equity securities (common, convertible and preferred stocks which do not have redemption provisions). The Company classifies all fixed income and equity securities as available-for-sale and carries such investments at market value. Unrealized gains or losses on investments, net of related income taxes, are included in shareholders’ equity as an item of accumulated other comprehensive income. Realized gains and losses on sales of investments are recognized in income on a specific identification basis. Embedded derivatives are valued separately and the change in market value of the derivatives is included in Net Realized Investment Gains on the Consolidated Statements of Income.

Available-for-sale securities are reviewed quarterly for possible other-than-temporary impairment. The review includes an analysis of the facts and circumstances of each individual investment such as the length of time the fair value has been below cost, the expectation for that security’s performance, the credit worthiness of the issuer and the Company’s intent to sell or its ability to hold the security to maturity. A decline in value that is considered to be other-than-temporary is recorded as a loss within Net Realized Investment Gains in the Consolidated Statements of Income.

Property and Depreciation — Property, plant and equipment are recorded at cost. The Company periodically measures fixed assets for impairment. Depreciation and amortization are generally calculated over the estimated useful lives of the respective properties (buildings and equipment – 15 to 35 years, furniture and equipment – 3 to 7 years, and barges – 23 years).

During 2006, the Company performed an extensive review of its useful life and salvage value estimates as they relate to M/G Transport’s barges. As a result of this review, the Company determined that the useful lives of the barges should be extended from 20 years to 23 years. In addition, the Company determined that the salvage values of each barge should be increased from $10,000 to $30,000. Both of these changes were implemented prospectively and were effective on October 1, 2006. The effect of this change in accounting estimate on the Company’s net income was $146,000 for the fourth quarter of 2006.

The Company has implemented several modules and is continuing the process of developing an information technology system for its insurance operations. The system is known as modernLINK® and its development began in 2000 and will continue over the next several years. Certain costs that are directly related to this system are capitalized. As components of the system are implemented and placed into service, depreciation commences using the straight-line method over periods ranging from four to eight years.

Goodwill and Other Intangibles — In July 2006, the Company acquired all of the outstanding stock of Southern Pioneer Life Insurance Company, a privately held insurance company located in Trumann, Arkansas. Operating results emanating from this purchase since July 2006 are reported in the “All other insurance” segment.

As a result of this acquisition, the Company recorded $3.2 million in goodwill and $1.7 million in other intangible assets. The other intangible assets will be amortized over periods ranging from five to fifteen years. Future amortization expense will equal (amounts in 000’s): $127 – 2007; $127 – 2008; $127 – 2009; $127 – 2010; $117 in 2011 and $1,056 – thereafter.

In addition to the $3.2 million of goodwill mentioned above, the Company also has $2.1 million of goodwill related to past business combinations. The goodwill balances are recorded in Other Assets on the Company’s Consolidated Balance Sheets. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, the Company accounts for goodwill under the impairment approach. Based on the Company’s impairment review, no impairment charges were necessary for 2006, 2005 or 2004.

Federal Income Tax — Deferred federal income taxes are recognized to reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for federal income tax purposes. The Company continually reviews deferred tax assets to determine the necessity of a valuation allowance.

The Company files a consolidated federal income tax return which includes all subsidiaries.

Insurance Income — Premiums for physical damage and other property and casualty related coverages, net of premiums ceded to reinsurers, are recognized as income on a pro-rata basis over the lives of the policies. Credit accident and health and credit life premiums are recognized as income over the lives of the policies in proportion to the amount of insurance protection provided. The Company does not consider anticipated investment income in determining premium deficiencies (if any) on short-term contracts. Policy acquisition costs, primarily pre-paid commission expenses and premium taxes, are capitalized and expensed over the terms of the related policies on the same basis as the related premiums are earned. Selling and administrative expenses that are not primarily related to premiums written are expensed as incurred.

Insurance Loss Reserves — Unpaid insurance losses and loss adjustment expenses include an amount determined from reports on individual cases and an amount, based on past experience and other assumptions, for losses incurred but not reported. Such liabilities are necessarily based on estimates and, while management believes that the amounts are fairly stated, the ultimate liability may be in excess of or less than the amounts provided. The methods of making such estimates and for establishing the resulting liabilities are continually reviewed and any adjustments resulting therefrom are included in earnings currently. Insurance loss reserves also include an amount for claim drafts issued but not yet paid. In addition, insurance loss reserves are presented net of amounts recoverable from salvage and subrogation and include amounts recoverable from reinsurance for which receivables are recognized.

Allowance for Losses — Provisions for losses on receivables are made in amounts deemed necessary to maintain adequate reserves to cover probable future losses.

Reinsurance — In order to limit its exposure to certain levels of risks, the Company cedes varying portions of its written premiums to other insurance companies. As such, the Company limits its loss exposure to that portion of the insurable risk it retains. In addition, the Company pays a percentage of earned premiums to reinsurers in return for coverage against catastrophic losses. However, if a reinsurer fails to honor its obligations, American Modern could suffer additional losses as the reinsurance contracts do not relieve American Modern of its obligations to policyholders.

American Modern and its independent reinsurance brokers regularly conduct “market security” evaluations of both its current and prospective reinsurers. Such evaluations include a complete review of each reinsurer’s financial condition along with an assessment of credit risk concentrations arising from similar geographic regions, activities or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The specific evaluation procedures include, but are not limited to, reviewing the periodic financial statements and ratings assigned to each reinsurer from rating agencies such as S&P, Moody’s and A.M. Best. During 2006, approximately 85% of the Company’s catastrophe reinsurers had an A.M. Best or S&P rating of “A” or higher.

The Company also assumes a limited amount of business on certain reinsurance contracts. Related premiums and loss reserves are recorded based on records supplied by the ceding companies.

Transportation Revenues — Revenues for river transportation activities are recognized when earned. If freight services are in process at the end of a reporting period, an allocation of revenue between reporting periods is made based on relative transit time in each reporting period with expenses recognized as incurred.

Statements of Cash Flows — For purposes of the consolidated statements of cash flows, the Company defines cash as cash held in operating accounts at financial institutions. The amounts reported in the consolidated statements of cash flows for the purchase, sale or maturity of marketable securities do not include cash equivalents.

Fair Value of Financial Instruments — The carrying values of cash, receivables, short-term notes payable, trade accounts payable and any financial instruments included in other assets and accrued liabilities approximate their fair values principally because of the short-term maturities of these instruments. Generally, the fair value of investments, including derivatives, is considered to be the market value which is based on quoted market prices. The fair value of long-term debt is estimated using interest rates that are currently available to the Company for issuance of debt with similar terms and maturities.

Derivative Instruments — The Company accounts for its derivatives under Statement of Financial Accounting Standards (“SFAS”) 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended. The standard requires recognition of all derivatives as either assets or liabilities in the balance sheet and requires measurement of those instruments at fair value through adjustments to either accumulated other comprehensive income or current earnings or both, as appropriate. During 2002, the Company entered into a series of interest rate swaps to convert $30 million of floating rate debt to a fixed rate. The interest rate swaps were

designated as a cash flow hedge and were deemed to be 100% effective. Thus, the changes in the fair value of the swap agreements are recorded as a separate component of shareholders’ equity and have no impact on the Consolidated Statements of Income. The interest rate swap agreements ended during 2005 and, therefore, no balances were outstanding related to these derivatives at December 31, 2006 or 2005. At December 31, 2004, $0.3 million in deferred losses, net of tax, related to this hedge were recorded in accumulated other comprehensive income.

Stock Option and Award Plans — Midland has various plans which provide for granting options and common stock to certain employees and independent directors of the Company and its subsidiaries. During the fourth quarter of 2005, the Company elected to early adopt SFAS 123 (Revised 2004), “Share-Based Payment” (“SFAS 123(R)”) under the modified retrospective approach, restating only prior interim periods in fiscal 2005. As a result, the Company has applied SFAS 123(R) to new awards and to awards modified, repurchased or cancelled after January 1, 2005. Additionally, compensation cost for the portion of awards for which the requisite service had not been rendered, that were outstanding as of January 1, 2005, are being recognized as the requisite service is rendered on or after January 1, 2005 (generally over the remaining option vesting period). The compensation cost for that portion of awards has been based on the grant-date fair value of those awards as calculated previously for pro forma disclosures. Prior to the fourth quarter of 2005, the Company accounted for compensation expense related to such transactions using the “intrinsic value” based method under the provisions of Accounting Principles Board (“APB”) Opinion No. 25 and its related interpretations. Midland’s equity compensation plans are described more fully in Note 13.

The fair values of the 2006, 2005 and 2004 option grants were estimated on the date of the grant using the Black Scholes option-pricing model with the following (weighted average) assumptions:


	2006			2005			2004
Fair value of options granted	$	11.72		$	12.31		$	8.77
Dividend yield		0.9	%		1.0	%		1.0	%
Expected volatility		28.9	%		30.5	%		31.6	%
Risk free interest rate		4.5	%		4.0	%		3.6	%
Expected life (in years)		7.0			7.5			7.0

Prior to 2005, Midland accounted for stock options using the “intrinsic value” method. Therefore, no compensation cost had been recognized for the stock option plans. Had the Company accounted for all stock based employee compensation under the fair value method (SFAS 123), the Company’s 2004 net income and earnings per share would have been reduced to the pro forma amounts indicated below (amounts in 000’s, except per share data):


	Pro forma 2004
Net income as reported	$	54,238
Deduct: Total stock option employee compensation determined under fair value based method for all awards, net of related tax effects		1,053

Pro forma net income	$	53,185

*Average shares outstanding*
Basic		18,618
Diluted		19,190
*Earnings per share*
Basic—as reported	$	2.91
Basic—pro forma		2.86
Diluted—as reported	$	2.83
Diluted—pro forma		2.77

New Accounting Standards — In October 2005, the American Institute of Certified Public Accountants issued Statement of Position (“SOP”) 05-1. SOP 05-1 provides accounting guidance for deferred policy acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in Statement of Financial Accounting Standards (“SFAS”) No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments.” SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement or rider to a contract, or by the election of a feature or coverage within a contract. The provisions of SOP 05-1 are effective for internal replacements occurring in fiscal years beginning after December 15, 2006. The SOP is not expected to have a material impact on the Company’s Consolidated Financial Position or Results of Operations.

2. Marketable Securities


	Thousands of Dollars
	Cost or Amortized Cost
			Gross Unrealized				Fair Value
2006			Gains		Losses		Fair Value
Debt Securities:
Governments	$	39,409	$	683	$	240	$	39,852
Mortgage Backed		118,379		751		897		118,233
Municipals		405,694		5,538		907		410,325
Corporates		164,921		5,182		1,426		168,677
Cash Equivalents		53,586		—		—		53,586
Other—Notes Receivable		1,048		—		—		1,048
Accrued Interest		9,961		—		—		9,961

Total		792,998		12,154		3,470		801,682

Equity Securities		112,609		112,690		654		224,645
Derivatives		3,884		—		—		3,884
Accrued Dividends		1,166		—		—		1,166

Total		117,659		112,690		654		229,695

Total Marketable
Securities	$	910,657	$	124,844	$	4,124	$	1,031,377


	Thousands of Dollars
	Cost or Amortized Cost
			Gross Unrealized				Fair Value
2005			Gains		Losses		Fair Value
Debt Securities:
Governments	$	50,647	$	998	$	366	$	51,279
Mortgage Backed		112,105		601		1,446		111,260
Municipals		347,086		5,054		1,581		350,559
Corporates		155,363		6,445		1,408		160,400
Cash Equivalents		68,242		—		—		68,242
Other—Notes Receivable		1,137		—		—		1,137
Accrued Interest		8,774		—		—		8,774

Total		743,354		13,098		4,801		751,651

Equity Securities		105,182		87,770		1,345		191,607
Derivatives		2,843		—		—		2,843
Accrued Dividends		995		—		—		995

Total		109,020		87,770		1,345		195,445

Total Marketable
Securities	$	852,374	$	100,868	$	6,146	$	947,096

At December 31, 2006 and 2005, the fair value of the Company’s investment in the common stock of US Bancorp, which exceeded 10% of the Company’s shareholders’ equity, was $88.8 million and $73.5 million, respectively. Also, at December 31, 2006 and 2005, the market value of the Company’s investment portfolio includes approximately $24.2 million and $35.1 million, respectively, of convertible securities, some of which contain derivatives features.

The following is investment information summarized by investment category (amounts in 000’s):


	2006			2005			2004
Investment Income:
Interest on Fixed Income Securities	$	37,435		$	35,942		$	32,523
Dividends on Equity Securities		6,983			6,688			6,547
Investment Expense		(2,195	)		(2,111	)		(1,905	)

Net Investment Income	$	42,223		$	40,519		$	37,165

Net Realized Investment Gains (Losses):
Fixed Income:
Gross Realized Gains	$	2,832		$	3,822		$	5,121

Gross Realized Losses		(2,884	)		(4,067	)		(2,109	)

Equity Securities:
Gross Realized Gains		9,363			8,804			10,962

Gross Realized Losses		(866	)		(2,297	)		(4,041	)

Net Realized Investment Gains	$	8,445		$	6,262		$	9,933

Change in Unrealized Investment Gains (Losses):
Fixed Income	$	387		$	(16,828	)	$	(2,594	)
Equity Securities		25,611			(4,523	)		4,078

Change in Unrealized Investment Gains (Losses)	$	25,998		$	(21,351	)	$	1,484

Included in Net Realized Investment Gains (Losses) for 2006, 2005 and 2004 is the change in the fair value of derivative features of (amounts in 000’s) $1,041, $392 and $764 respectively.

The cost or amortized cost and approximate fair value of debt securities held at December 31, 2006, summarized by contractual maturities, are shown below. Actual maturities may differ from contractual maturities when there exists a right to call or prepay obligations with or without call or prepayment penalties (amounts in 000’s).


	Cost or Amortized Cost		Fair Value
One year or less	$	75,564	$	75,609
After one year through five years		138,075		140,185
After five years through ten years		277,920		280,440
After ten years		301,439		305,448

Total	$	792,998	$	801,682

The Company’s fixed income portfolio primarily consists of high quality investment grade securities and has an “AA” Standard & Poor’s average quality rating at December 31, 2006. The Company performs quarterly comprehensive reviews of individual fixed income and equity portfolio holdings that have a market value less than their respective carrying value. The Company, with the assistance of its external professional money managers, applies both quantitative and qualitative criteria in its evaluation of possible other-than-temporary impairment, including facts specific to each individual investment, including, but not limited to, the length of time the fair value has been below carrying value, the extent of the decline, the Company’s intent to hold or sell the security, the expectation for each security’s performance as well as prospects for recovery, the credit worthiness and related liquidity of the issuer and the issuer’s business sector.

The following table shows the Company’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2006 and 2005 (amounts in 000’s):


2006	Less Than 12 Months
	Fair Value		Unrealized Losses		Number Securities
Governments	$	4,204	$	15	5
Mortgage backed		25,243		98	42
Municipals		51,010		220	65
Corporates		48,912		607	72

Total Debt Securities		129,369		940	184

Equity Securities		8,420		481	18

Total	$	137,789	$	1,421	202


	12 Months or More
	Fair Value		Unrealized Losses		Number Securities
Governments	$	9,071	$	225	17
Mortgage backed		36,083		800	42
Municipals		68,008		687	77
Corporates		18,969		818	35

Total Debt Securities		132,131		2,530	171

Equity Securities		2,834		173	5

Total	$	134,965	$	2,703	176


	Total
	Fair Value		Unrealized Losses		Number Securities
Governments	$	13,275	$	240	22
Mortgage backed		61,326		898	84
Municipals		119,018		907	142
Corporates		67,881		1,425	107

Total Debt Securities		261,500		3,470	355

Equity Securities		11,254		654	23

Total	$	272,754	$	4,124	378


2005	Less Than 12 Months
	Fair Value		Unrealized Losses		Number Securities
Governments	$	16,448	$	169	13
Mortgage backed		50,014		791	52
Municipals		136,681		1,293	99
Corporates		44,720		1,350	78

Total Debt Securities		247,863		3,603	242

Equity Securities		16,399		1,237	25

Total	$	264,262	$	4,840	267


	12 Months or More
	Fair Value		Unrealized Losses		Number Securities
Governments	$	6,243	$	197	13
Mortgage backed		20,500		655	23
Municipals		10,207		288	19
Corporates		2,128		58	4

Total Debt Securities		39,078		1,198	59

Equity Securities		1,329		108	4

Total	$	40,407	$	1,306	63


	Total
	Fair Value		Unrealized Losses		Number Securities
Governments	$	22,691	$	366	26
Mortgage backed		70,514		1,446	75
Municipals		146,888		1,581	118
Corporates		46,848		1,408	82

Total Debt Securities		286,941		4,801	301

Equity Securities		17,728		1,345	29

Total	$	304,669	$	6,146	330

3. Accounts Receivable—Net

Accounts receivable at December 31, 2006 and 2005 are generally due within one year and consist of the following (amounts in 000’s):


	2006		2005
Insurance	$	138,227	$	119,250
Transportation		7,246		12,059
Other		3,513		6,591

Total		148,986		137,900
Less Allowance for Losses		782		775

Accounts Receivable—Net	$	148,204	$	137,125

At December 31, 2006 and 2005, the Company had outstanding receivables, all of which were current, from one of its customers of $20.0 million and $12.6 million, respectively.

4. Property, Plant and Equipment—Net

At December 31, 2006 and 2005, property, plant and equipment stated at original cost consist of the following (amounts in 000’s):


	2006		2005
Land	$	1,491	$	1,491
Buildings, Improvements, Fixtures, etc.		91,034		70,128
Transportation Equipment		57,358		53,108
Software Development		40,255		31,267

Total		190,138		155,994
Less Accumulated Depreciation and Amortization		71,259		66,106

Property, Plant and Equipment—Net	$	118,879	$	89,888

Included in Buildings, Improvements, Fixtures, etc. in the above table is $17.4 million and $0.8 million of construction in progress for 2006 and 2005, respectively, related to the expansion of the Company’s headquarters which is scheduled for completion in September 2007. The construction in progress amount includes $0.3 million of capitalized interest for 2006. There was no capitalized interest at the end of 2005.

Included in Software Development in the above table is $25.6 million and $17.5 million of construction in progress for 2006 and 2005, respectively, related to the development of modernLINK, the Company’s proprietary information systems and web enablement initiative. The construction in progress amount includes $1.9 million and $0.5 million of capitalized interest for 2006 and 2005, respectively.

Total rent expense related to the rental of equipment included in the accompanying Consolidated Statements of Income is (amounts in 000’s) $9,643 in 2006, $3,808 in 2005 and $3,756 in 2004. Future rentals under non-cancelable operating leases are approximately (amounts in 000’s): $2,886 – 2007; $2,516 – 2008; $2,466 – 2009; $2,534 – 2010; $2,534 in 2011 and $20,347 – thereafter.

Depreciation expense recorded in 2006, 2005 and 2004 was (amounts in 000’s): $8,978, $10,250 and $10,043, respectively.

As of December 31, 2006 and 2005, the unamortized balance of modernLINK’s software development costs was $28.3 million and $20.1 million, respectively.

5. Deferred Insurance Policy Acquisition Costs

Acquisition costs capitalized during 2006, 2005 and 2004 amounted to $178.2 million, $164.0 million and $176.3 million, respectively. Amortization of deferred acquisition costs was $167.3 million, $166.1 million and $173.8 million for 2006, 2005 and 2004, respectively.

6. Notes Payable

The Company had conventional lines of credit with commercial banks of $83 million at both December 31, 2006 and 2005 with $10 million and $14 million in use under these agreements at December 31, 2006 and 2005, respectively. Borrowings under these lines of credit constitute senior debt. Total commercial paper debt outstanding at December 31, 2006 and 2005 was $7.9 million and $6.0 million, respectively.

The aforementioned notes payable, together with outstanding commercial paper, had weighted average interest rates of 5.67% and 4.90% at December 31, 2006 and 2005, respectively.

7. Long-Term Debt

Long-term debt at December 31, 2006 and 2005 is summarized as follows (amounts in 000’s):


	2006		2005
Equipment Obligations, Due Through—
4.89% August 13, 2008	$	5,441	$	6,108
5.12% December 11, 2008		974		1,088
5.51% May 20, 2012		10,235		10,712
Mortgage Notes, Due Through—
6.31% December 20, 2007		13,858		13,858
Unsecured Notes Under a $72 million Credit Facility—
6.37% December 1, 2010		36,000		36,000

Total Obligations		66,508		67,766
Current Maturities		15,183		1,258

Non Current Portion	$	51,325	$	66,508

Equipment and real estate obligations are collateralized by transportation equipment and real estate with a net book value of $39.6 million at December 31, 2006.

The aggregate amount of repayment requirements on long-term debt for the five years subsequent to 2006 are (amounts in 000’s): 2007 – $15,183; 2008 – $6,125; 2009 – $562; 2010 – $36,593; 2011 – $627; thereafter – $7,418.

At December 31, 2006 and 2005, the carrying value of the Company’s long-term debt approximated its fair value.

8. Junior Subordinated Debentures

Wholly-owned subsidiary trusts of Midland have issued preferred trust securities and, in turn, purchased a like amount of subordinated debt which provides interest and principal payments to fund the trusts’ obligations. The preferred trust securities are mandatorily redeemable upon maturity or redemption of the subordinated debt and are an obligation of Midland. The interest rate related to these securities is based on the 90 day LIBOR rate plus 3.5%, not to exceed 12.5% through the optional redemption dates in April and May 2009, respectively. The interest rates were 8.9% and 7.9% at December 31, 2006 and 2005, respectively. The junior subordinated debentures are due in 2034. They consist of $12 million issued in April 2004 and $12 million issued in May 2004 that are redeemable at the Company’s option any time after April and May 2009, respectively.

9. Federal Income Tax

The provision for federal income tax is summarized as follows (amounts in 000’s):


	2006			2005			2004
Current provision	$	27,567		$	28,663		$	22,459
Deferred provision (benefit)		(408	)		(1,088	)		407

Total	$	27,159		$	27,575		$	22,866

The federal income tax provision for the years ended December 31, 2006, 2005 and 2004 is different from amounts derived by applying the statutory tax rates to income before federal income tax as follows (amounts in 000’s):


	2006			2005			2004
Federal income tax at statutory rate	$	34,249		$	32,515		$	26,986
Tax effect of:
Tax exempt interest and excludable dividend income		(7,081	)		(5,447	)		(4,401	)
Other—net		(9	)		507			281

Provision for federal income tax	$	27,159		$	27,575		$	22,866

Significant components of the Company’s net deferred federal income tax liability are summarized as follows (amounts in 000’s):


	2006		2005
Deferred tax liabilities:
Deferred insurance policy acquisition costs	$	29,929	$	28,447
Unrealized gain on marketable securities		42,241		33,142
Accelerated depreciation		10,787		10,465
Other		6,101		3,759

Sub–total		89,058		75,813

Deferred tax assets:
Unearned insurance premiums		24,711		23,368
Pension expense		1,499		1,019
Insurance loss reserves		4,489		5,135
Other		11,162		7,941

Sub–total		41,861		37,463

Deferred federal income tax	$	47,197	$	38,350

For 2006, 2005 and 2004, $1,420, $455 and $1,114, respectively, of income tax benefits applicable to deductible compensation related to stock options exercised and restricted stock issued were credited to shareholders’ equity.

10. Reinsurance

Premium income in the accompanying consolidated statements of income include (amounts in 000’s) $63,580, $53,343 and $54,088 of earned premiums on assumed business and is net of $127,368, $112,777, and $69,444 of earned premiums on ceded business for 2006, 2005, and 2004, respectively. Written premiums consist of the following (amounts in 000’s):


	2006			2005			2004
Direct	$	764,012		$	676,517		$	680,061
Assumed		64,987			57,963			74,420
Ceded		(134,739	)		(107,110	)		(69,576	)

Net	$	694,260		$	627,370		$	684,905

The net earned premium for the property and casualty group for 2006, 2005 and 2004 was $659,379, $621,235 and $661,579, respectively.

The amounts of recoveries pertaining to property and casualty reinsurance contracts that were deducted from losses incurred during 2006, 2005 and 2004 were (amounts in 000’s): $30,722, $189,407 and $38,295, respectively.

11. Insurance Loss Reserves

Activity in the liability for unpaid insurance losses and loss adjustment expenses (excluding claim checks issued but not yet paid) for the property and casualty companies is summarized as follows (amounts in 000’s):


	2006			2005			2004
Balance at January 1	$	201,910		$	197,666		$	169,931
Less reinsurance recoverables		53,844			31,364			20,453

Net balance at January 1		148,066			166,302			149,478

Incurred related to:
Current year		310,065			317,978			359,504
Prior years		(10,010	)		(36,375	)		(17,551	)

Total incurred		300,055			281,603			341,953

Paid related to:
Current year		232,682			225,713			257,061
Prior years		76,453			74,126			68,068

Total paid		309,135			299,839			325,129

Net balance at December 31		138,986			148,066			166,302
Plus reinsurance recoverables		42,802			53,844			31,364

Balance at December 31	$	181,788		$	201,910		$	197,666

With the benefit of hindsight, including one year of actual development patterns observed during 2006, the Company’s 2005 loss reserves were subsequently re-estimated to be $138.1 million. This produced a net cumulative redundancy, after one year of development, of $10.0 million which benefited incurred losses in 2006. Although the 2005 loss reserves developed favorably in 2006, the redundancy was lower than what was experienced over the last few years. The lower redundancy related to the 2005 loss reserves was due primarily to adverse development in 2006 related to assessments associated with hurricane Katrina combined with the Company’s personal liability lines and excess and surplus lines of business. The Company continued to see favorable development related to its motorcycle product.

In 2005 and 2004 incurred losses related to prior years benefited from claims settling in 2005 and in 2004 for less than the case base reserve amounts that were estimated at the end of the previous respective years.


	2006		2005		2004
Property and Casualty Gross Loss Reserves	$	181,788	$	201,910	$	197,666
Life and Other Gross Loss Reserves		19,115		14,378		13,434
Outstanding Checks and Drafts		20,736		38,372		21,815

Consolidated Gross Loss Reserves	$	221,639	$	254,660	$	232,915

Loss reserves, net of reinsurance, for Life and Other totaled $7.4 million, $6.0 million and $6.9 million at December 31, 2006, 2005 and 2004 respectively.

12. Benefit Plans

The Company has a qualified defined benefit pension plan which provides for the payment of annual benefits to participants upon retirement. Such benefits are based on years of service and the participant’s highest compensation during five consecutive years of employment. The Company’s funding policy is to contribute annually an amount sufficient to satisfy ERISA funding requirements. Contributions are intended to provide not only for benefits attributed to service to date but also for benefits expected to be earned in the future. During 2000, the participants of the qualified pension plan were given a one-time election to opt out of the qualified pension plan and enroll in a qualified self-directed defined contribution retirement plan. All employees hired subsequent to that election are automatically enrolled in the qualified self-directed defined contribution retirement plan. The Company contributed $2.8 million, $2.3 million and $1.9 million to the qualified self-directed retirement plan for the years 2006, 2005 and 2004, respectively.

The Company has a qualified 401(k) savings plan, a funded non-qualified savings plan and a funded non-qualified self-directed retirement plan. The Company contributed (amounts in 000’s) $1,412, $1,256 and $1,118 to the qualified 401(k) savings plan and $202, $250 and $228 to the non-qualified savings plan for the years 2006, 2005 and 2004, respectively. The Company also has an unfunded non-qualified defined benefit pension plan.

The Company uses a measurement date of December 31 for its pension plans. The following tables include amounts related to both the qualified and non-qualified defined benefit pension plans (amounts in 000’s except for percentages):


	2006			2005
Change in benefit obligation:
Benefit obligation at beginning of year	$	30,953		$	27,690
Service cost		909			837
Interest cost		1,725			1,648
Actuarial (gain)/loss		(141	)		1,772
Benefits paid		(1,034	)		(994	)

Benefit obligation at end of year (accumulated benefit obligation of $27,097 and $26,483, respectively)	$	32,412		$	30,953

Change in plan assets:
Fair value of plan assets at beginning of year	$	19,741		$	18,793
Actual return on plan assets		2,048			731
Employer contributions		1,016			1,211
Benefits paid		(1,034	)		(994	)

Fair value of plan assets at end of year	$	21,771		$	19,741

Funded status:
Funded status at end of year	$	(10,641	)	$	(11,211	)
Unrecognized net actuarial loss		—			10,170
Unrecognized prior service cost		—			302

Accrued benefit cost	$	(10,641	)	$	(739	)

Amounts recognized in the Consolidated Balance Sheets consist of:
Prepaid benefit cost	$	—		$	—
Accrued benefit cost		(10,641	)		(739	)
Additional minimum liability		—			(6,018	)
Intangible asset		—			302
Accumulated other comprehensive income		—			5,716

Net amount recognized at end of year	$	(10,641	)	$	(739	)


	2006			2005			2004
Components of net periodic benefit cost:
Service cost	$	909		$	837		$	804
Interest cost		1,725			1,648			1,500
Expected return on assets		(1,655	)		(1,580	)		(1,629	)
Amortization of:
Transition asset		—			—			(72	)
Prior service cost		30			30			31
Actuarial loss		477			348			86

Net periodic benefit cost	$	1,486		$	1,283		$	720

At December 31, 2006, the actuarial loss and prior service cost recognized in accumulated other comprehensive income and not yet recognized as a component of net periodic benefit cost consist of (in 000’s) $7,776 and $262, respectively.

The estimated actuarial loss and prior service cost that will be amortized from accumulated other comprehensive income into net periodic benefit cost in 2007 are (in 000’s) $479 and $30, respectively.

The assumptions used relative to the plans are evaluated annually and updated as necessary. The discount rate assumption is based on average bond yields for high quality corporate bonds. The expected long-term rate of return assumption was based on actuarial recommendations, economic conditions and the historical performance of the plan’s investment portfolio over the past ten years.


	2006		2005		2004
Assumptions:
Weighted average assumptions:
For disclosure:
Discount rate	5.90	%	5.50	%	5.75	%
Rate of compensation increase	4.00	%	4.00	%	4.00	%
For measuring net periodic pension benefit cost:
Discount rate	5.50	%	5.75	%	6.00	%
Rate of compensation increase	4.00	%	4.00	%	4.00	%
Expected return on plan assets	8.00	%	8.00	%	8.00	%

Plan assets consist primarily of equity and fixed income securities managed by non-affiliated professional investment managers. No plan assets are invested in either real estate or the Company’s stock. The following table reflects the asset allocations at fair value related to plan assets in 2006 and 2005:


	Weighted average asset allocation
	2006		2005
Total equity securities	60	%	60	%
Total fixed income securities	38	%	37	%
Cash and cash equivalents	2	%	3	%

Total	100	%	100	%

The primary objective for the investment of plan assets is the preservation of capital with an emphasis on long-term growth without undue exposure to risk. Targeted allocations are 50% to 80% for equities and 20% to 50% for fixed income securities.

The Company’s qualified defined benefit pension plan had projected benefit obligations, accumulated benefit obligations and fair value of plan assets amounting to (in 000’s) $30,726, $25,334 and $21,771 in 2006 and $29,213, $24,869 and $19,741 in 2005, respectively. The Company’s non-qualified defined benefit plan had projected benefit obligations, accumulated benefit obligations and fair value of plan assets amounting to (in 000’s) $1,686, $1,763 and $0 in 2006 and $1,740, $1,614 and $0 in 2005, respectively.

The Company made a cash contribution of $1.0 million in 2006 which exceeded its required cash contribution of $0.6 million. The Company’s expected pension benefit payments, which reflect expected future service, for the next ten years are as follows (amounts in 000’s): 2007 — $1,264; 2008 — $1,311; 2009 — $1,364; 2010 — $1,463; 2011 — $1,567; 2012 through 2016 — $10,459.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statement No. 87, 88, 106 and 132(R)” (“SFAS 158”). This Standard requires recognition of the funded status of a benefit plan in the statement of financial position. The following table illustrates the incremental effect of applying SFAS 158 on individual line items on the Consolidated Balance Sheet at December 31, 2006 (amounts in 000’s):


	Before Application of Statement 158		Adjustments			After Application of Statement 158
Other Assets	$	38,498	$	(272	)	$	38,226
Total Assets		1,569,800		(272	)		1,569,528
Liability for pension benefits		5,326		5,315			10,641
Deferred federal income tax		49,152		(1,955	)		47,197
Total liabilities		991,422		3,360			994,782
Accumulated other comprehensive income		75,978		(3,632	)		72,346
Total shareholders’ equity		578,378		(3,632	)		574,746

At December 31, 2006 (prior to adoption of SFAS 158) and 2005, the Company’s additional minimum pension liabilities were $4.1 million and $6.0 million, respectively. Related to these actuarily determined minimum pension liabilities, comprehensive income was increased by $1.2 million at December 31, 2006, net of deferred federal income taxes and prior to adoption of SFAS 158, and reduced by $1.6 million, net of deferred federal income taxes, at December 31, 2005.

13. Stock Options and Award Plans

Midland’s equity compensation plans include plans for restricted stock, performance shares and non-qualified stock options.

The Company implemented a restricted stock award program during 1993. Under this program, restricted grants of the Company’s common stock will vest after a five-year incentive period, conditioned upon the recipient’s employment throughout the period. During the vesting period, shares issued are nontransferable, but the shares are entitled to all of the other rights of outstanding shares. In 2004, 202,000 shares were distributed relating to the 1999 grant. At December 31, 2006 and 2005, no restricted stock awards were outstanding.

In 2000, the Company established a performance stock award program. Under this program, shares vest after a three-year performance measurement period and will only be awarded if pre-established performance levels have been achieved. Shares are awarded at no cost and the recipient must have been employed throughout the entire three-year performance period. In 2006, 61,000 shares were issued under this program, 57,000 shares have been earned and are scheduled for distribution in 2007, and a maximum of 60,000 and 82,000 shares could potentially be issued in 2008 and 2009, respectively, related to this program. The expected fair value of these awards is charged to compensation expense over the performance period. Compensation expense for 2006, 2005 and 2004 amounted to (amounts in 000’s) $3,085, $2,215 and $1,852, respectively.

Under the Company’s stock option plans, all of the outstanding stock options at December 31, 2006 were non-qualified options and had an exercise price of not less than 100% of the fair market value of the common stock on the date of grant. Of these stock options, 990,000 were exercisable at December 31, 2006, and 225,000, 171,000, 121,000 and 75,000 options become exercisable in 2007, 2008, 2009 and 2010, respectively. A summary of stock option transactions follows:


	2006				2005				2004
	(000’s) Shares		Wtd. Avg. Option Price		(000’s) Shares		Wtd. Avg. Option Price		(000’s) Shares		Wtd. Avg. Option Price
Outstanding, beginning of year	1,426		$	19.98	1,272		$	17.38	1,091		$	15.73
Exercised	(163	)		14.86	(61	)		12.97	(43	)		14.64
Forfeited	(32	)		29.08	(3	)		24.74	(17	)		17.72
Granted	351			32.10	218			33.21	241			24.40

Outstanding, end of year	1,582		$	23.00	1,426		$	19.98	1,272		$	17.38

Exercisable, end of year	990		$	19.00	916		$	16.70	753		$	15.12

Information regarding such outstanding options at December 31, 2006 follows:


Remaining Life	Outstanding Options (000’s)	Price
Less than one year	15	$	6.32
Two years	38		13.05
Three years	167		11.38
Four years	166		16.59
Five years	171		20.78
Six years	256		17.23
Seven years	226		24.40
Eight years	208		33.21
Nine years	335		32.10

Total outstanding	1,582

Weighted average price		$	23.00

At December 31, 2006, options exercisable have exercise prices between $6.32 and $33.21 and an average contractual life of approximately 5.1 years.

At December 31, 2006, 978,000 common shares are authorized for future option award or stock grants.

During the fourth quarter of 2005, the Company elected to early adopt SFAS 123 (Revised 2004), “Share-Based Payment” (“SFAS 123(R)”) under the modified retrospective approach, restating only prior interim periods in fiscal 2005. The Company recognized $2.5 million and $1.9 million of expense in 2006 and 2005, respectively, related to its stock option program.

14. Earnings Per Share

The following table is a reconciliation of the number of shares used to compute Basic and Diluted earnings per share. No adjustments are necessary to the income used in the Basic or Diluted calculations for the years ended December 31, 2006, 2005 or 2004.


	Shares in 000’s
	2006	2005	2004
Shares used in basic EPS calculation (average shares outstanding)	19,081	18,894	18,618
Effect of dilutive stock options	424	385	455
Effect of dilutive performance stock awards	153	128	117

Shares used in diluted EPS calculation	19,658	19,407	19,190

15. Commitments and Contingencies

Various litigation and claims against the Company and its subsidiaries are in process and pending. Based upon a review of open matters with legal counsel, Management believes that the outcome of such matters will not have a material effect upon the Company’s consolidated financial position, results of operations or cash flows. The Company also has credit exposure with customers, generally in the form of premiums receivable. Management monitors these exposures on a regular basis. However, as collectibility of such receivables is dependent upon the financial stability of the customers, the Company cannot assure collections in full. Where appropriate, the Company has provided a reserve for such exposures.

16. Shareholders’ Equity

The Company has 40,000,000 shares of common stock authorized for issuance without par value (stated value of $.042 a share). The Company also has 1,000,000 shares of preferred stock authorized, without par value, none of which have been issued.

On February 5, 2004, the Company sold 1,150,000 shares of its common stock pursuant to an approved universal shelf registration statement previously filed with the Securities and Exchange Commission on October 21, 2003. The net proceeds derived from the sale of $25.1 million were used to increase the capital and paid-in surplus of the Company’s insurance subsidiaries to fund future growth and for other general corporate purposes.

In January 2001, the Company’s Board of Directors authorized the repurchase of up to 1,000,000 shares of the Company’s common stock and 414,000 of these shares have been repurchased as of December 31, 2006. No shares were repurchased under this program in 2006 or 2005.

The change in accumulated other comprehensive income is due to changes related to the unrealized gains and losses on investments, the fair value of interest rate swap, additional minimum pension liability and the adoption of SFAS 158 as follows (amounts in 000’s):


	2006			2005			2004
Unrealized holding gains (losses) on securities arising during the period	$	22,468		$	(9,807	)	$	7,421
Impact of net realized gain		(8,445	)		(6,262	)		(9,933	)
Income taxes on above		2,876			2,192			3,478

Change in unrealized gains (losses) on securities, net		16,899			(13,877	)		966

Fair value of interest rate swaps		—			432			1,002
Income taxes on above		—			(151	)		(351	)

Change in interest rate swaps, net		—			281			651

Additional Pension Liability		1,871			(2,411	)		(3,146	)
Income Taxes on above		(655	)		843			1,101

Change in additional pension liability, net		1,216			(1,568	)		(2,045	)

SFAS 158 Pension Adjustment		(5,587	)		—			—
Income taxes on above		1,955			—			—

Change in funded status, net		(3,632	)		—			—

Net increase (decrease) in accumulated other comprehensive income	$	14,483		$	(15,164	)	$	(428	)

The insurance subsidiaries are subject to state regulations which limit by reference to statutory net income and policyholders’ surplus the dividends that can be paid to their parent company without prior regulatory approval. Dividend restrictions vary between the companies as determined by the laws of the domiciliary states. Under these restrictions, the maximum dividends that may be paid by the insurance subsidiaries in 2007 without regulatory approval total (amounts in 000’s): $65,533; such subsidiaries paid cash dividends of $13,835 in 2006, $23,030 in 2005 and $2,600 in 2004.

Net income as reported by the Company’s insurance subsidiaries, determined in accordance with statutory accounting practices, which differ in certain respects from accounting principles generally accepted in the United States of America, for the Company’s insurance subsidiaries was (amounts in 000’s): $64,053, $68,634 and $57,677 for 2006, 2005 and 2004, respectively. Statutory surplus as reported by the Company’s insurance subsidiaries, was (amounts in 000’s): $450,729 and $394,314 at December 31, 2006 and 2005, respectively.

17. Related Party Transactions

The Company has a commercial paper program under which qualified purchasers may invest in the short-term unsecured notes of Midland. Many of the investors in this program are executive officers and directors of the Company. Total commercial paper debt outstanding at December 31, 2006 and 2005 was $7.9 million and $6.0 million, respectively, of which $6.6 million and $5.1 million at those respective dates represented notes held either directly or indirectly by the executive officers and directors of the Company. The effective annual yield paid to all participants in this program was 5.4% as of December 31, 2006, a rate that is considered to be competitive with the market rate for similar instruments.

18. Industry Segments

The Company operates in several industries and Company management reviews operating results by several different classifications (e.g., product line, legal entity, distribution channel). Reportable segments are determined based upon revenues and/or operating profits and are based on significant product groups, which include residential property, recreational casualty, financial institutions, all other insurance and transportation.

The residential property segment includes primarily manufactured housing and site-built dwelling insurance products. Approximately 41% of American Modern’s property and casualty and credit life gross written premium relates to physical damage insurance and related coverages on manufactured homes, generally written for a term of 12 months with many coverages similar to homeowner’s insurance policies. The recreational casualty segment includes specialty insurance products such as motorcycle, watercraft, recreational vehicle, collector car and snowmobile. The financial institutions segment includes specialty insurance products such as mortgage fire, collateral protection and debt cancellation, which are sold to financial institutions or their customers. The all other insurance segment includes products such as credit life, long-haul truck physical damage, commercial, excess and surplus lines and also includes the results of our fee producing subsidiaries.

The Company writes insurance throughout the United States with larger concentrations in the southern and southeastern states. Transportation includes barge chartering and freight brokerage operations primarily on the lower Mississippi River and its tributaries.

Listed below is financial information required to be reported for each industry segment. The accounting policies used for segment reporting are the same as the accounting policies for the consolidated financial statements. Certain amounts are allocated and certain amounts are not allocated (e.g., assets and investment gains) to each segment for management review. Operating segment information based upon how it is reviewed by the chief operating decision maker, the Company’s President and Chief Executive Officer, is as follows for the years ended December 31, 2006, 2005 and 2004 (amounts in 000’s):


	Insurance Group
	Residential Property		Recreational Casualty		Financial Institutions		All Other Insurance		Unallocated Insurance Amounts		Transportation		Corporate and All Other			Intersegment Elimination			Total
2006
Revenues—External customers	$	398,886	$	97,271	$	103,831	$	88,681			$	49,807	$	124					$	738,600
Net investment income		21,376		5,614		5,106		8,310	$	342				2,899		$	(1,424	)		42,223
Net realized investment gains										8,445										8,445
Interest expense										1,130		945		5,055			(1,966	)		5,164
Depreciation and amortization		3,419		1,357		378		960				2,429		850						9,393
Income before taxes		42,554		10,186		12,507		26,751		7,715		7,842		(9,701	)					97,854
Income tax expense										28,684		2,734		(4,259	)					27,159
Acquisition of fixed assets										16,802		17,374		16,656						50,832
Identifiable assets										1,419,716		51,435		111,732			(13,355	)		1,569,528
2005
Revenues—External customers	$	384,053	$	105,607	$	78,424	$	76,414			$	42,185	$	(34	)				$	686,649
Net investment income		20,682		6,000		4,194		7,627	$	216				2,544		$	(744	)		40,519
Net realized investment gains										6,262										6,262
Interest expense										1,737		761		4,375			(906	)		5,967
Depreciation and amortization		3,903		1,501		419		939				2,923		836						10,521
Income before taxes		45,755		12,693		9,471		19,903		5,877		4,886		(5,684	)					92,901
Income tax expense										28,159		1,720		(2,304	)					27,575
Acquisition of fixed assets										18,085		13,172		1,178						32,435
Identifiable assets										1,295,938		50,400		102,859			(21,084	)		1,428,113
2004
Revenues—External customers	$	406,544	$	121,432	$	86,803	$	76,405			$	45,379	$	180					$	736,743
Net investment income		19,120		6,107		3,615		6,902	$	172				1,546		$	(297	)		37,165
Net realized investment gains										19,623				43			(9,733	)		9,933
Interest expense										2,038		856		2,730			(455	)		5,169
Depreciation and amortization		4,238		1,836		275		570				2,296		1,652						10,867
Income before taxes		47,418		4,987		6,991		12,396		17,816		1,689		(4,460	)		(9,733	)		77,104
Income tax expense										27,662		599		(1,989	)		(3,406	)		22,866
Acquisition of fixed assets										9,392		2,160		147						11,699
Identifiable assets										1,248,521		38,869		113,716			(36,422	)		1,364,684

No single customer contributed in excess of 10% of consolidated revenues in 2006, 2005 or 2004.

Quarterly Data (Unaudited)

The Midland Company and Subsidiaries


	2006								2005
*(Amounts in thousands,* *except per share data)*	First Quarter		Second Quarter		Third Quarter		Fourth Quarter		First Quarter		Second Quarter		Third Quarter		Fourth Quarter
Revenues	$	186,932	$	190,173	$	204,813	$	207,350	$	190,366	$	186,338	$	173,243	$	183,483

Net income	$	22,435	$	9,805	$	17,345	$	21,110	$	21,144	$	20,450	$	3,732	$	20,000

Basic earnings per common share(a)	$	1.18	$	0.51	$	0.91	$	1.10	$	1.12	$	1.08	$	0.20	$	1.06

Diluted earnings per common share(a)	$	1.15	$	0.50	$	0.88	$	1.07	$	1.08	$	1.05	$	0.19	$	1.03

Dividends per common share	$	0.06125	$	0.06125	$	0.06125	$	0.06125	$	0.05625	$	0.05625	$	0.05625	$	0.05625

Price range of common stock (Nasdaq):
High	$	37.75	$	44.10	$	43.75	$	47.50	$	34.63	$	35.32	$	40.42	$	39.45

Low	$	31.91	$	32.50	$	34.86	$	39.84	$	29.55	$	30.60	$	31.38	$	31.13

(a)	The sum of quarterly earnings per common share may not equal the year end earnings per common share due to rounding.

ITEM 9.

Changes In and Disagreements with Accountants on Accounting and Financial Disclosure

None.

ITEM 9A.

Controls and Procedures

At the end of the period covered by this report (the “Evaluation Date”), we carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Executive Officer and our Executive Vice President and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon this evaluation, our President and Chief Executive Officer and our Executive Vice President and Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective.

The company maintains a system of internal control over financial reporting. There have been no changes in the company’s internal control over financial reporting that occurred during the company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the company’s internal control over financial reporting.

MANAGEMENT’S ASSESSMENT AS TO THE EFFECTIVENESS OF INTERNAL

CONTROL OVER FINANCIAL REPORTING

The Management of The Midland Company is responsible for establishing and maintaining adequate internal control, 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. The Company’s internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (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 of the Company are being made only in accordance with authorizations of management and 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 the financial statements.

All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention of overriding controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time.

The Company’s Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006 as required by Section 404 of the Sarbanes Oxley Act of 2002. Management’s assessment is based on the criteria established in the Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and was designed to provide reasonable assurance that the Company maintained effective internal control over financial reporting as of December 31, 2006. Based on our assessment, we believe that the Company maintained effective internal control over financial reporting as of December 31, 2006.

The Company’s independent registered public accounting firm has issued an attestation report on our internal control over financial reporting as of December 31, 2006 and the Company’s management assessment of the internal control over financial reporting. This report appears on page 83.

March 7, 2007



/s/ John W. Hayden				/s/ W. Todd Gray
John W. Hayden				W. Todd Gray
President and Chief Executive Officer				Executive Vice President and Chief Financial Officer

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and Board of Directors of

The Midland Company:

We have audited management’s assessment, included in the accompanying Management’s Assessment as to the Effectiveness of Internal Control Over Financial Reporting, that The Midland Company and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s 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. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (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 of the company are being made only in accordance with authorizations of management and 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 the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedules as of and for the year ended December 31, 2006 of the Company and our report dated March 7, 2007 (which includes an explanatory paragraph related to Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Benefit Plans – an amendment of FASB Statements No. 87, 88, 106, and 132(R), on December 31, 2006 and Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-Based Payment, on January 1, 2005) expressed an unqualified opinion on those financial statements and financial statement schedules.

/s/ Deloitte & Touche LLP

Cincinnati, Ohio

March 7, 2007

ITEM 9B.

Other Information

None.

PART III

ITEM 10.

Directors, Executive Officers and Corporate Governance of the Registrant.

Incorporated herein by reference from Midland’s Proxy Statement to be filed on or around March 26, 2007.

ITEM 11.

Executive Compensation.

Incorporated herein by reference from Midland’s Proxy Statement to be filed on or around March 26, 2007.

ITEM 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Incorporated herein by reference from Midland’s Proxy Statement to be filed on or around March 26, 2007.

EQUITY COMPENSATION PLAN INFORMATION

The following table summarizes the number of outstanding options granted to employees and directors, as well as the number of securities remaining available for future issuance, under our compensation plans as of December 31, 2006:


Plan Category	Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights		Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights		Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in the First Column)
Equity compensation plans approved by security holders	1,582,000	(1)	$	23.00	978,000
Equity compensation plans not approved by security holders	—			—	—

Total	1,582,000		$	23.00	978,000

(1)	In addition to 1,582,000 outstanding options, performance shares have been granted to certain senior-level officers. The ultimate number of shares that may be issued will range between 0 and 211,260 depending on the achievement of certain corporate financial objectives.

ITEM 13.

Certain Relationships and Related Transactions and Director Independence.

Incorporated herein by reference from Midland’s Proxy Statement to be filed on or around March 26, 2007.

ITEM 14.

Principal Accounting Fees and Services.

Incorporated herein by reference from Midland’s Proxy Statement to be filed on or around March 26, 2007.

PART IV

ITEM 15.

Exhibits and Financial Statement Schedules.

(a)

1. Financial Statements.


Incorporated by reference in Part II of this report:
Reports of Independent Registered Public Accounting Firm.		53
Management’s Assessment as to the Effectiveness of Internal Control over Financial Reporting		82
Consolidated Balance Sheets, December 31, 2006 and 2005.		54
Consolidated Statements of Income for the Years Ended December 31, 2006, 2005 and 2004.		56
Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2006, 2005 and 2004.		57
Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004.		58
Notes to Consolidated Financial Statements.		59

(a) 2.

Financial Statement Schedules.

Included in Part IV of this report:


		Page
Schedule I - Summary of Investments - Other than Investments in Related Parties—December 31, 2006		89
Schedule II - Condensed Financial Information of Registrant		90-94
Schedule III - Supplementary Insurance Information for the Years Ended December 31, 2006, 2005 and 2004		95
Schedule IV - Reinsurance for the Years Ended December 31, 2006, 2005 and 2004		96
Schedule V - Valuation and Qualifying Accounts for the Years Ended December 31, 2006, 2005 and 2004		97
Schedule VI - Supplemental Information Concerning Property - Casualty Insurance Operations for the Years Ended December 31, 2006, 2005 and 2004		98

(b)

Exhibits.



3.1		Articles of Incorporation - Filed as Exhibit 3(i) to the Registrant’s Form 10-Q for the quarter ended June 30, 1998 and incorporated herein by reference.

3.2		Code of Regulations (Amended and Restated) - Filed as Exhibit 3(ii) to the Registrant’s Form 10-Q for the quarter ended June 30, 2000 and incorporated herein by reference.

10.1		The Midland Company 2002 Employee Incentive Stock Plan (Amended and Restated)* – Incorporated by Reference to Registrant’s Proxy Statement dated March 12, 2002; amended to include amendments set forth in Registrant’s Proxy Statement dated March 10, 2004, which is incorporated herein by reference.

10.2		The Midland Company 2002 Restricted Stock and Stock Option Plan for Non-Employee Directors* – Incorporated by Reference to the Registrant’s Proxy Statement dated March 12, 2002.

10.3		The Midland Company 1992 Employee Incentive Stock Plan (Amended and Restated)* - Filed as Exhibit 10.1 to the Registrant’s Form 10-K for the year ended December 31, 2000 and incorporated herein by reference.

10.4		Annual Incentive Plan* - Filed as Exhibit 10.4 to the Registrant’s Form 10-K for the year ended December 31, 2003 and incorporated herein by reference.

10.5		Executive Annual Incentive Plan* - Set forth in Registrant’s Proxy Statement dated March 10, 2004, which is incorporated herein by reference.

10.6		Employee Stock Service Award Plan* – Set forth in Registrant’s Proxy Statement dated March 20, 2006, which is incorporated herein by reference.

10.7		Employee Retention Agreements with Joseph P. Hayden III, John W. Hayden, John I. Von Lehman and Paul T. Brizzolara - Filed as Exhibits 10.5(a), 10.5(b), 10.5(c)* and 10.5(d)* to the Registrant’s Form 10-K for the year ended December 31, 2000 and incorporated herein by reference.



10.8		The Midland Guardian Co. Salaried Employees 401(k) Savings Plan, The Midland Company 2000 Associate Discount Stock Purchase Plan and The Midland Company Stock Option Plan for Non-Employee Directors* - Incorporated by Reference to Registrant’s Registration Statement No. 333-40560 on Form S-8.

10.9		The Midland Company Dividend Reinvestment Plan - Incorporated by Reference to Registrant’s Registration Statement No. 033-64821 on Form S-3.

10.10		The Midland Company Non-Employee Director Deferred Compensation Plan, The Midland Company Supplemental Retirement Plan, Midland-Guardian Co. Salaried Employees’ Non-Qualified Savings Plan, Midland-Guardian Co. Non-Qualified Self-Directed Retirement Plan, The Midland Company Stock Option Plan for Non-Employee Directors as Amended January 2000* filed as Exhibits 10.1, 10.2, 10.3, 10.4 and 10.5 to the Registrant’s Form 10-Q for the quarter ended June 30, 2001 and incorporated herein by reference.

10.11		Vessel Construction Contract between M/G Transport Services, Inc. and Trinity Marine Products Inc. dated September 6, 2005, as amended (Filed as Exhibit 10.1 to the Form 8-K dated September 6, 2005 and incorporated herein by reference), as amended (Filed as Exhibit 10.1 to the Form 8-K dated October 26, 2005 and incorporated herein by reference), as amended (Filed as Exhibit 10.1 to the Form 8-K dated April 10, 2006 and incorporated herein by reference).

10.12		Design-Build Agreement dated March 6, 2006 between The Midland Company and Miller-Valentine Construction, LLC (Filed as Exhibit 10.1 to the Form 8-K dated March 6, 2006 and incorporated herein by reference).

10.13		Director Indemnification Agreements with current directors* – Filed as Exhibit 10.1 to the Form 8-K dated October 26, 2006 and incorporated herein by reference.

10.14		Agreement for Services between The Midland Company and J.P. Hayden, Jr.* – Filed as Exhibit 10.1 to the Form 8-K dated December 6, 2006 and incorporated herein by reference.

14.		Code of Ethics (Filed as Exhibit 14 to the Form 8-K dated April 29, 2004 and incorporated herein by reference).

21.		Subsidiaries of the Registrant

23.		Consent of Independent Registered Public Accounting Firm

31.1		Certification of Principal Executive Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

31.2		Certification of Principal Financial Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

32.		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. § 1350.

*	Management Compensatory Plan or Arrangement

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.

THE MIDLAND COMPANY

(Registrant)


Signature	Title	Date

/s/ John W. Hayden (John W. Hayden)	President and Chief Executive Officer	March 7, 2007

/s/ W. Todd Gray (W. Todd Gray)	Executive Vice President and Chief Financial and Accounting Officer	March 7, 2007

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

THE MIDLAND COMPANY


Signature	Title	Date

/S/ James E. Bushman (James E. Bushman)	Director	March 7, 2007

/S/ James H. Carey (James H. Carey)	Director	March 7, 2007

/S/ Michael J. Conaton (Michael J. Conaton)	Director	March 7, 2007

/S/ Jerry A. Grundhofer (Jerry A. Grundhofer)	Director	March 7, 2007

/S/ J. P. Hayden, Jr. (J. P. Hayden, Jr.)	Chairman of the Executive Committee of the Board and Director	March 7, 2007

/S/ J. P. Hayden III (J. P. Hayden III)	Chairman of the Board, Chief Operating Officer and Director	March 7, 2007

/S/ John W. Hayden (John W. Hayden)	President, Chief Executive Officer and Director	March 7, 2007

/S/ William T. Hayden (William T. Hayden)	Director	March 7, 2007

/S/ William J. Keating, Jr. (William J. Keating, Jr.)	Director	March 7, 2007

/S/ John R. LaBar (John R. LaBar)	Director	March 7, 2007

/S/ Richard M. Norman (Richard M. Norman)	Director	March 7, 2007

/S/ David B. O’Maley (David B. O’Maley)	Director	March 7, 2007

/S/ John M. O’Mara (John M. O’Mara)	Director	March 7, 2007

/S/ René J. Robichaud (René J. Robichaud)	Director	March 7, 2007

/S/ Francis Marie Thrailkill, OSU Ed.D. (Francis Marie Thrailkill, OSU Ed.D.)	Director	March 7, 2007

/S/ John I. Von Lehman (John I. Von Lehman)	Executive Vice President, Secretary and Director	March 7, 2007

THE MIDLAND COMPANY AND SUBSIDIARIES

Schedule I - Summary of Investments

Other than Investments in Related Parties

December 31, 2006

(Amounts in 000’s)


Column A	Column B		Column C		Column D
Type of Investment	Cost		Value		Amount at Which Shown in the Balance Sheet
Fixed maturity securities, available-for-sale:
Bonds:
United States Government and government agencies and authorities	$	39,408	$	39,852	$	39,852
States, municipalities and political subdivisions		405,694		410,324		410,324
Mortgage-backed securities		118,380		118,233		118,233
Public utilities		5,908		6,150		6,150
All other corporate bonds		159,951		163,466		163,466

Total		729,341		738,025		738,025

Equity securities, available-for-sale:
Common stocks:
Public utilities		1,073		1,244		1,244
Banks, trusts and insurance companies		10,061		99,371		99,371
Industrial, miscellaneous and all other		86,929		111,349		111,349
Embedded derivatives		3,884		3,884		3,884
Nonredeemable preferred stocks		14,547		12,682		12,682

Total		116,494		228,530		228,530

Accrued interest and dividends		11,127		XXXXXXX		11,127

Mortgage loans on real estate		1,048		XXXXXXX		1,048

Short-term investments		52,647		XXXXXXX		52,647

Total Investments	$	910,657		XXXXXXX	$	1,031,377

THE MIDLAND COMPANY (Parent Only)

Schedule II - Condensed Financial Information of Registrant

Condensed Balance Sheet Information

December 31, 2006 and 2005

(Amounts in 000’s)


	2006		2005
ASSETS
Cash	$	123	$	94

Marketable Securities Available for Sale (at market value):
Fixed Income (cost, $23,463 in 2006 and $21,956 in 2005)		23,609		21,980
Equity (cost, $14,620 in 2006 and $14,595 in 2005)		22,419		18,770

Total		46,028		40,750

Receivables - Net		3,166		5,981

Intercompany Receivables		—		—
Property, Plant and Equipment (at cost):		51,411		34,755
Less Accumulated Depreciation		10,628		9,780

Net		40,783		24,975

Other Assets		11,190		11,279

Investments in Subsidiaries (at equity)		555,447		472,507

Total Assets	$	656,737	$	555,586

THE MIDLAND COMPANY (Parent Only)

Schedule II - Condensed Financial Information of Registrant

Condensed Balance Sheet Information

December 31, 2006 and 2005

(Amounts in 000’s)


	2006			2005
LIABILITIES AND SHAREHOLDERS’ EQUITY
Notes Payable Within One Year:
Banks (including current portion of long-term debt)	$	10,000		$	14,000
Commercial Paper		7,937			6,005

Total		17,937			20,005

Other Payables and Accruals		4,421			6,430

Intercompany Payables		21,775			6,916

Long - Term Debt		13,858			13,858

Junior Subordinated Debt		24,000			24,000

Shareholders’ Equity:
Common Stock - No Par (issued and outstanding: 19,224 shares at December 31, 2006 and 18,964 shares at December 31, 2005 after deducting treasury stock of 3,782 shares and 4,042 shares, respectively)		959			959
Additional Paid - in Capital		65,669			57,061
Retained Earnings		477,145			411,210
Accumulated Other Comprehensive Income		72,346			57,863
Treasury Stock (at cost)		(41,373	)		(42,716	)

Total		574,746			484,377

Total Liabilities and Shareholders’ Equity	$	656,737		$	555,586

THE MIDLAND COMPANY (Parent Only)

Schedule II - Condensed Financial Information of Registrant

Condensed Statements of Income Information

For the Years Ended December 31, 2006, 2005 and 2004

(Amounts in 000’s)


	2006			2005			2004
Revenues:
Net Investment Income	$	2,899		$	2,544		$	1,546
Net Realized Investment Gains		404			10			43
Dividends from Subsidiaries		1,300			750			275
All Other Income, Primarily Charges to Subsidiaries		5,536			5,445			5,416

Total Revenues		10,139			8,749			7,280

Expenses:
Interest Expense		4,980			4,303			2,660
Depreciation and Amortization		848			839			850
All Other Expenses		6,053			6,206			4,894

Total Expenses		11,881			11,348			8,404

Loss Before Federal Income Tax Benefit		(1,742	)		(2,599	)		(1,124	)
Federal Income Tax Benefit		(1,471	)		(1,608	)		(934	)

Income (Loss) Before Change in Undistributed Income of Subsidiaries		(271	)		(991	)		(190	)
Change in Undistributed Income of Subsidiaries		70,966			66,317			54,428

Net Income	$	70,695		$	65,326		$	54,238

THE MIDLAND COMPANY (Parent Only)

Schedule II - Condensed Financial Information of Registrant

Condensed Statements of Cash Flows Information

For the Years Ended December 31, 2006, 2005 and 2004

(Amounts in 000’s)


	2006			2005			2004
Cash Flows from Operating Activities:
Net income	$	70,695		$	65,326		$	54,238
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Increase in undistributed income of subsidiaries		(70,966	)		(66,317	)		(54,428	)
Decrease in receivables		4,236			5,839			847
Increase (decrease) in other payables and accruals		(7,680	)		1,023			(1,223	)
Stock-based compensation expense		5,616			3,943			1,852
Depreciation and amortization		848			839			851
Decrease (increase) in other assets		89			(1	)		(1,445	)
Other - net		(54	)		41			(481	)

Net Cash Provided by Operating Activities		2,784			10,693			211

Cash Flows from Investing Activities:
Purchase of marketable securities		(11,302	)		(13,890	)		(35,636	)
Sale of marketable securities		9,843			12,707			2,139
Acquisition of property, plant and equipment		(16,656	)		(1,178	)		(147	)
Decrease (increase) in cash equivalent marketable securities		(19	)		(965	)		99
Sale of property, plant and equipment - net		—			49			51

Net Cash Used in Investing Activities		(18,134	)		(3,277	)		(33,494	)

Cash Flows from Financing Activities:
Decrease in short - term borrowings		(2,068	)		(13,172	)		(448	)
Net change in intercompany accounts		14,859			8,081			(10,667	)
Issuance of treasury stock		8,080			4,523			2,967
Dividends paid		(4,576	)		(4,154	)		(3,723	)
Purchase of treasury stock		(2,082	)		(1,839	)		(2,918	)
Excess tax benefit from exercise of stock options		1,166			—			—
Decrease in long-term debt		—			(930	)		(865	)
Proceeds from issuance of common stock		—			—			25,070
Issuance of junior subordinated debentures		—			—			24,000

Net Cash Provided by (Used in) Financing Activities		15,379			(7,491	)		33,416

Net Increase (Decrease) in Cash		29			(75	)		133
Cash at Beginning of Year		94			169			36

Cash at End of Year	$	123		$	94		$	169

THE MIDLAND COMPANY (Parent Only)

Schedule II - Condensed Financial Information of Registrant

Notes to Condensed Financial Information

For the Years Ended December 31, 2006 and 2005

(Amounts in 000’s)

The accompanying condensed financial information should be read in conjunction with the consolidated financial statements and notes included in Item 8 of this Form 10-K.

Total debt of the Registrant (parent only) consists of the following:


	DECEMBER 31,
	2006		2005
Short - Term Bank Borrowings	$	10,000	$	14,000
Commercial Paper		7,937		6,005
Mortgage Notes:
6.31%* - Due December 20, 2007		13,858		13,858
Junior Subordinated Debt:
8.87%** - Due April 29, 2034		12,000		12,000
8.87%** - Due May 26, 2034		12,000		12,000

Total Debt	$	55,795	$	57,863

*	Rate in effect at December 31, 2006. Rate is the LIBOR rate plus 1.00% and is adjusted monthly.

**	Rate in effect at December 31, 2006. Rate is the LIBOR rate plus 3.50% and is adjusted every three months.

See Notes 6 and 7 on page 69 for further information on the Company’s outstanding debt at December 31, 2006.

The mortgage note of $13,858 is all due in 2007 and the total junior subordinated debt of $24,000 is not due until 2034.

THE MIDLA ND COMPANY AND SUBSIDARIES

Schedule III - Supplementary Insurance Information

For the Years Ended December 31, 2006, 2005 and 2004

(Amounts in 000’s)


Column A	Column B		Column C		Column D		Column E		Column F		Column G			Column H		Column I		Column J		Column K
	Deferred Policy Acquisition Cost		Future Policy Benefits, Losses, Claims and Loss Expenses		Unearned Premiums		Other Policy Claims and Benefits Payable		Premium Revenue		Net Investment Income (1)			Benefits, Claims, Losses and Settlement Expenses		Amortization of Deferred Policy Acquisition Costs		Other Operating Expenses (1)		Premiums Written
2006
Residential Property	$	60,164	$	43,736	$	247,783			$	392,762	$	21,376		$	197,124	$	110,171	$	70,413	$	402,056
Recreational Casualty		10,090		23,160		44,271				95,520		5,614			42,783		25,121		24,795		92,725
Financial Institutions		14,394		11,004		57,421				103,831		5,106			38,110		48,546		9,774		112,658
All Other Insurance		14,629		71,896		95,849				83,751		8,310			29,486		25,881		22,254		76,351	(2)
Unallocated Amounts				71,843								3,241
Inter-segment Elimination												(1,424	)

Total	$	99,277	$	221,639	$	445,324	$	—	$	675,864	$	42,223		$	307,503	$	209,719	$	127,236	$	683,790

2005
Residential Property	$	60,299	$	57,845	$	235,100			$	378,402	$	20,682		$	184,491	$	108,341	$	66,148	$	381,304
Recreational Casualty		10,967		34,742		47,674				103,234		6,000			48,417		26,965		23,532		98,209
Financial Institutions		8,967		10,289		31,671				78,424		4,194			26,335		39,519		7,293		70,817
All Other Insurance		8,141		58,516		80,562				71,804		7,627			27,419		23,760		15,356		71,597	(2)
Unallocated Amounts				93,268								2,760
Inter-segment Elimination												(744	)

Total	$	88,374	$	254,660	$	395,007	$	—	$	631,864	$	40,519		$	286,662	$	198,585	$	112,329	$	621,927

2004
Residential Property	$	59,856	$	47,052	$	228,935			$	400,929	$	19,120		$	201,414	$	111,910	$	64,922	$	398,525
Recreational Casualty		12,653		33,590		52,845				119,147		6,107			67,180		29,261		26,107		109,565
Financial Institutions		10,661		12,004		36,123				86,803		3,615			42,834		35,218		5,375		99,230
All Other Insurance		7,253		53,669		72,544				70,705		6,902			37,183		24,766		12,132		69,434	(2)
Unallocated Amounts				86,600								1,718
Inter-segment Elimination												(297	)

Total	$	90,423	$	232,915	$	390,447	$	—	$	677,584	$	37,165		$	348,611	$	201,155	$	108,536	$	676,754

Notes to Schedule III:

(1)	Net investment income is allocated to insurance segments based primarily on written premium volume. Other operating expenses include expenses directly related to the segments and expenses allocated to the segments based on historical usage factors.

(2)	Includes other property and casualty insurance and accident and health insurance from the Life insurance subsidiaries ($5,683, $2,659 and $4,770 for 2006, 2005 and 2004, respectively).

THE MIDLAND COMPANY AND SUBSIDIARIES

Schedule IV - Reinsurance

For the Years Ended December 31, 2006, 2005 and 2004

(Amounts in 000’s)


Column A	Column B		Column C		Column D		Column E		Column F
	Gross Amount		Ceded to Other Companies		Assumed from Other Companies		Net Amount		Percentage of Amount Assumed to Net
2006
Life Insurance in Force	$	3,342,643	$	2,218,953	$	59,992	$	1,183,682	5.1	%

Insurance Premiums and Other Considerations:
Life and Accident and Health Insurance	$	52,017	$	36,960	$	1,428	$	16,485	8.7	%
Property & Liability Insurance		687,635		90,408		62,152		659,379	9.4	%

Total Premiums	$	739,652	$	127,368	$	63,580	$	675,864	9.4	%

2005
Life Insurance in Force	$	2,234,858	$	1,768,538	$	69,619	$	535,939	13.0	%

Insurance Premiums and Other Considerations:
Life and Accident and Health Insurance	$	40,849	$	31,861	$	1,646	$	10,634	15.5	%
Property & Liability Insurance		649,407		80,917		52,740		621,230	8.5	%

Total Premiums	$	690,256	$	112,778	$	54,386	$	631,864	8.6	%

2004
Life Insurance in Force	$	849,510	$	453,806	$	52,742	$	448,446	11.8	%

Insurance Premiums and Other Considerations:
Life and Accident and Health Insurance	$	40,121	$	24,759	$	643	$	16,005	4.0	%
Property & Liability Insurance		652,819		44,685		53,445		661,579	8.1	%

Total Premiums	$	692,940	$	69,444	$	54,088	$	677,584	8.0	%

THE MIDLAND COMPANY AND SUBSIDIARIES

Schedule V - Valuation and Qualifying Accounts

For the Years Ended December 31, 2006, 2005 and 2004

(Amounts in 000’s)


DESCRIPTION	BALANCE AT BEGINNING OF PERIOD		ADDITIONS CHARGED (CREDITED) TO COSTS AND EXPENSES		DEDUCTIONS (ADDITIONS)			BALANCE AT END OF PERIOD
YEAR ENDED DECEMBER 31, 2006:
Allowance For Losses	$	776	$	14	$	8	(1)	$	782
YEAR ENDED DECEMBER 31, 2005:
Allowance For Losses	$	826	$	1	$	51	(1)	$	776
YEAR ENDED DECEMBER 31, 2004:
Allowance For Losses	$	826	$	44	$	44	(1)	$	826

NOTES:

(1)	Accounts written off are net of recoveries.

THE MIDLAND COMPANY AND SUBSIDIARIES

Schedule VI - Supplemental Information Concerning Property-Casualty Insurance Operations

For the Years Ended December 31, 2006, 2005 and 2004

(Amounts in 000’s)


Column A	Column B		Column C		Column D		Column E		Column F		Column G		Column H					Column I		Column J		Column K
Affiliation with Registrant	Deferred Policy Acquisition Costs		Reserves for Unpaid Claims and Claim Adjustment Expenses		Discount, if any, Deducted in Column C		Unearned Premiums		Earned Premiums		Net Investment Income		Claims and Claim Adjustment Expenses Incurred Related to					Amortization of Deferred Policy Acquisition Costs		Paid Claims and Claim Adjustment Expenses		Premiums Written
													Current Year		Prior Years
													Current Year		Prior Years
Consolidated Property-Casualty Subsidiaries
2006	$	85,290	$	202,302	$	—	$	394,423	$	659,379	$	36,239	$	310,065	$	(10,010	)	$	205,591	$	309,135	$	678,107

2005	$	81,139	$	239,811	$	—	$	362,546	$	621,235	$	35,039	$	317,978	$	(36,375	)	$	195,461	$	299,839	$	619,267

2004	$	82,361	$	219,370	$	—	$	351,031	$	661,579	$	32,628	$	359,504	$	(17,551	)	$	195,468	$	325,129	$	671,985

Note: Certain amounts above will not agree with Schedule III because other insurance amounts in Schedule III include life and accident and health insurance.