10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

___________________________

FORM 10-Q

þ	Quarterly Report Pursuant to Sections 13 or 15(d) of the Securities Exchange Act of 1934 For the period ended September 30, 2007
	or
¨	Transition Report Pursuant to Sections 13 or 15(d) of the Securities and Exchange Act of 1934 For the transition period from __________ to __________
Commission File Number 001-31434

AMERICAN PHYSICIANS SERVICE GROUP, INC.

(Exact name of registrant as specified in its charter)
Texas	75-1458323
(State or other jurisdiction of incorporation or organization)	(I.R.S. employer Identification No.)
1301 S. Capital of Texas Highway, Suite C-300, Austin, Texas  78746
(Address of principal executive offices)(Zip Code)
(512) 328-0888
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.				Yes þ No ¨
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. (Check one):
Large accelerated filer ¨	Accelerated filer ¨		Non-accelerated filer þ
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.				Yes ¨ No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act				Yes ¨ No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Title of Each Class Common Stock, $.10 par value		Number of Shares Outstanding At November 1, 2007 7,152,711

AMERICAN PHYSICIANS SERVICE GROUP, INC.

Table of Contents to Quarterly Report on Form 10-Q

For the Quarter Ended September 30, 2007

		Page
	Part I Financial Information
Item 1.	Financial Statements
	Unaudited Condensed Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006	3
	Unaudited Condensed Consolidated Statements of Operations for the Three Months and Nine Months Ended September 30, 2007 and 2006	5
	Unaudited Condensed Consolidated Statement of Shareholders' Equity and Comprehensive Income (Loss) for the Nine Months Ended September 30, 2007	7
	Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007 and 2006	8
	Notes to the Unaudited Condensed Consolidated Financial Statements	9
Item 2.	Management's Discussion and Analysis or Plan of Operation	24
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	37
Item 4.	Controls and Procedures	40
	Part II Other Information
Item 1.	Legal Proceedings	41
Item 1A.	Risk Factors	41
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	41
Item 3.	Defaults Upon Senior Securities	42
Item 4.	Submission of Matters to a Vote of Security Holders	42
Item 5.	Other Information	42
Item 6.	Exhibits	42

2

PART 1

FINANCIAL INFORMATION

AMERICAN PHYSICIANS SERVICE GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)	September 30, 2007		December 31, 2006
Assets	(Unaudited)
Investments:
Fixed maturities available for sale, at fair value	$	194,156	$	16,636
Equity securities available for sale, at fair value		10,154		4,403
Other invested assets		1,931		-
Total investments		206,241		21,039
Cash and cash equivalents		14,788		4,242
Cash - restricted		795		1,880
Accrued investment income		1,320		197
Premium and maintenance fees receivable		19,134		-
Reinsurance recoverables on paid and unpaid losses and loss adjustment expenses		22,535		-
Other amounts receivable under reinsurance contracts		3,399		-
Deferred policy acquisition costs		2,691		-
Subrogation recoverables		234		-
Management fees receivable		-		2,736
Deferred tax assets		7,987		1,321
Goodwill		-		1,247
Property and equipment, net		1,049		556
Other assets		2,705		3,058
Total assets	$	282,878	$	36,276

The accompanying notes are an integral part of these condensed consolidated financial statements.

3

 AMERICAN PHYSICIANS SERVICE GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)	September 30, 2007		December 31, 2006
Liabilities	(Unaudited)
Reserve for loss and loss adjustment expense	$	104,858	$	-
Unearned premiums and maintenance fees		39,677		-
Reinsurance premiums payable		364		-
Funds held under reinsurance treaties		5,929		-
Trade accounts payable		1,152		2,228
Accrued expenses and other liabilities		6,464		4,323
Federal income tax payable		269		136
Mandatorily redeemable preferred stock		8,397		-
Total liabilities		167,110		6,687
Minority interest		-		21
Shareholders' Equity
Preferred stock, $1.00 par value, 1,000,000 shares authorized, 9,179 and 0 issued and outstanding at 9/30/07 and 12/31/06
Common stock, $0.10 par value, shares authorized 20,000,000 7,153,711 and 2,817,746 issued and outstanding at 09/30/07 and 12/31/06		715		282
Additional paid-in capital		79,152		7,944
Accumulated other comprehensive income (loss) net of tax		(1,056)		231
Retained earnings		36,957		21,111
Total shareholders' equity		115,768		29,568
Total liabilities & shareholders' equity	$	282,878	$	36,276

The accompanying notes are an integral part of these condensed consolidated financial statements.

4

AMERICAN PHYSICIANS SERVICE GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per share data)	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
REVENUES
Gross premiums and maintenance fees written	$	22,239	$	-	$	37,284	$	-
Premiums ceded		504		-		3,922		-
Change in unearned premiums & maintenance fees		(5,112)		-		(3,129)		-
Net premiums and maintenance fees earned		17,631		-		38,077		-
Investment income, net of investment expense		2,904		249		5,743		668
Realized capital gain (loss), net		(3,195)		90		(3,659)		110
Management service		70		3,726		3,765		10,556
Financial services		5,434		3,048		17,623		11,383
Other revenue		35		12		69		65
Total revenues		22,879		7,125		61,618		22,782
EXPENSES
Losses and loss adjustment expenses		4,624		-		7,786		-
Other underwriting expenses		3,262		-		5,696		-
Change in deferred policy acquisition costs		(444)		-		(287)		-
Management service expenses		-		3,147		3,823		8,548
Financial services expenses		4,907		2,914		15,599		10,359
General and administrative expenses		1,608		423		3,800		1,421
Loss from impairment of goodwill		-		-		1,247		-
Total expenses		13,957		6,484		37,664		20,328
Income from operations		8,922		641		23,954		2,454
Federal income tax expense		3,630		232		8,949		883
Minority interests		-		-		1		2
Net income before extraordinary gain	$	5,292	$	409	$	15,004	$	1,569
Extraordinary gain		-		-		2,264		-
Net income	$	5,292	$	409	$	17,268	$	1,569

The accompanying notes are an integral part of these condensed consolidated financial statements.

5

AMERICAN PHYSICIANS SERVICE GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per share data)	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
Net income per common share
Basic:
Net income before extraordinary gain	$	0.74	$	0.15	$	3.01	$	0.57
Extraordinary gain		-		-		0.46		-
Net Income	$	0.74	$	0.15	$	3.47	$	0.57
Diluted:
Net income before extraordinary gain	$	0.73	$	0.14	$	2.93	$	0.53
Extraordinary gain		-		-		0.44		-
Net Income	$	0.73	$	0.14	$	3.37	$	0.53
Basic weighted average shares outstanding		7,107		2,767		4,977		2,773
Diluted weighted average shares outstanding		7,253		2,892		5,114		2,942

The accompanying notes are an integral part of these condensed consolidated financial statements.

6

AMERICAN PHYSICIANS SERVICE GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS)

(Unaudited)

(In thousands, except per share amounts)	Common Stock		Additional Paid-In Capital		Retained Earnings		Comprehensive  Income (loss)		Accumulated Other Comprehensive  Income (loss)		Treasury Stock		Total Shareholders’ Equity
Balance December 31, 2006	$	282	$	7,944	$	21,111	$	-	$	231	$	-	$	29,568
Comprehensive income:
Net income (loss)		-		-		11,976		11,976		-		-		11,976
Other comprehensive income:
Unrealized loss on securities, net of taxes of ($1,506)		-		-		-		(2,923)		(2,923)		-		(2,923)
Comprehensive income:		-		-		-	$	9,053		-		-		-
Stock options exercised		2		131		-		-		-		-		133
Stock options expensed		-		1,018		-		-		-		-		1,018
Tax benefit from exercise of stock options		-		82		-		-		-		-		82
Treasury stock purchases		-		-		-		-		-		(576)		(576)
Cancelled treasury stock		(3)		(573)		-		-		-		576		-
Stock issued-Public Offering, net of offering costs		200		30,037										30,237
Stock issued-Merger		198		34,670										34,868
Dividend paid (per share - $0.30)						(1,416)								(1, 416)
Stock awarded		3		460		-		-		-		-		463
Balance June 30, 2007	$	682	$	73,769	$	31,671	$	-	$	(2,692)	$	-	$	103,430
Comprehensive income:
Net income (loss)		-		-		5,292		5,292		-		-		5,292
Other comprehensive income:
Unrealized gain on securities, net of taxes of $881		-		-		-		1,636		1,636		-		1,636
Comprehensive income:		-		-		-	$	6,928		-		-		-
Stock options exercised		-		49		-		-		-		-		49
Stock options expensed		-		125		-		-		-		-		125
Tax benefit from exercise of stock options		-		41		-		-		-		-		41
Treasury stock purchases		-		-		-		-		-		(36)		(36)
Cancelled treasury stock		-		(36)		-		-		-		36		-
Stock issued-over-allotment, net of offering costs		31		4,815		-		-		-		-		4,846
Stock issued-Merger		-		93		-		-		-		-		93
Buyback Minority Interest						(6)				-				(6)
Stock Awarded		2		296		-								298
Balance September 30, 2007	$	715	$	79,152	$	36,957	$	-	$	(1,056)	$	-	$	115,768

The accompanying notes are an integral part of these condensed consolidated financial statements.

7

AMERICAN PHYSICIANS SERVICE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
	Nine Months Ended September 30,
	2007		2006
Cash flows from operating activities:
Net Income	$	17,268	$	1,569
Adjustments to reconcile net income to cash provided by (used in) operating activities:
Depreciation, amortization and other		202		589
Common stock awarded		761		102
Extraordinary gain		(2,264)		-
Impairment of assets		5,071		-
Deferred income tax		(2,976)		141
Other non-cash items		(571)		(392)
Changes in operating assets and liabilities:
Premium receivables, net		(4,487)		-
Other amounts receivable under reinsurance contracts		(2,027)		-
Reinsurance recoverables on unpaid and paid loss expenses		7,150		-
Funds held under reinsurance treaties		(3,741)		-
Losses and loss adjustment expenses		(11,370)		-
Unearned premiums and maintenance fees		3,161		-
Other receivables and assets		5,050		1,196
Federal income tax payable		(2,205)		(298)
Deferred compensation		618		22
Stock options expensed		1,143		-
Accrued expenses & other liabilities		(3,740)		(1,804)
Net cash provided by operating activities		7,043		1,125
Cash flows from investing activities:
Capital expenditures		(710)		(131)
Proceeds from the sale of available-for-sale equity and fixed income securities		31,863		7,357
Purchase of available-for-sale equity securities		(69,718)		(8,946)
Funds loaned to others		(275)		(266)
Cash received from API acquisition		9,910		-
Collection of notes receivable and other		91		32
Net cash used in  investing activities		(28,839)		(1,954)
Cash flows from financing activities:
Secondary stock offering and over-allotment		35,083		-
Exercise of stock options		182		791
Excess tax benefits from stock-based compensation		123		456
Repurchases of common stock		(612)		(2,239)
Preferred stock redemption		(1,018)		-
Dividend paid		(1,416)		(820)
Net cash provided by financing activities		32,342		(1,812)
Net change in cash and cash equivalents		10,546		(2,641)
Cash and cash equivalents at beginning of period		4,242		6,231
Cash and cash equivalents at end of period	$	14,788	$	3,590

The accompanying notes are an integral part of these condensed consolidated financial statements.

8

AMERICAN PHYSICIANS SERVICE GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2007

(Unaudited)

1.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. The consolidated unaudited financial statements as of and for the three- and nine-month periods ended September 30, 2007 and 2006 reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented. Such adjustments consist of only items of a normal recurring nature. These consolidated financial statements have not been aud ited by our independent registered public accounting firm. The operating results for the interim periods are not necessarily indicative of results for the full fiscal year.

The notes to consolidated financial statements appearing in our Annual Report on Form 10-K for the year ended December 31, 2006 filed with the SEC should be read in conjunction with this Quarterly Report on Form 10-Q. There have been significant changes in the type of information reported and the presentation format in this Quarterly Report as a result of the acquisition of American Physicians Insurance Company (“API”) effective April 1, 2007 and such changes are disclosed in the notes hereto.

2.

Management’s Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

The most significant estimates that are susceptible to significant change in the near-term relate to the determination of the liability for reserves for losses and loss adjustment expenses, reinsurance, income taxes, and the fair value of investments. Although considerable judgment is inherent in these estimates, management believes that the current estimates are reasonable in all material respects. The estimates are reviewed regularly and adjusted, as necessary. Adjustments related to changes in estimates are reflected in the Company’s results of operations, or other comprehensive income, in the period in which those estimates are changed.

3.

Acquisition

On April 1, 2007, we acquired all of the issued and outstanding stock of API. We considered several factors in determining to acquire API, including the favorable effects tort reform had on the Texas market, our long-term experience managing API’s operations, our credibility in the marketplace, the common goals we shared with API’s board of directors, the ability to increase API’s capital to support future growth after the acquisition and the increased financial strength of the combined entities. The results of operations for API are included in our consolidated results of operations beginning April 1, 2007. The business combination is being accounted for using the purchase method of accounting and, accordingly, the purchase price has been allocated to assets acquired and liabilities assumed based on fair values at the date of acquisition.. The total purchase price was $45,167,000 and consisted of 1,982 ,499 shares of the Company’s common stock, valued at a per share price of $17.635, or $34,961,000 in the aggregate, $35,000 in cash paid in lieu of fractional shares of common stock, 10,197.95 shares of preferred stock valued at $9,179,000, plus costs to complete the acquisition of $992,000. We are required to redeem at least $1 million of the preferred stock each calendar year beginning in 2007, until December 31, 2016, at which time all of the preferred stock must have been redeemed. The preferred stock has a cumulative dividend equal to 3% of the outstanding redemption value per year. In June 2007, we made the first required payment, redeeming 10% of the preferred shares outstanding and paying the dividend.

9

The following table displays the amount of the purchase price assigned to each major asset and liability of API at the acquisition date, April 1, 2007:

(in thousands)
ASSETS
Investments:
Fixed maturities available for sale	$	145,354
Equity securities available for sale		6,851
Other invested assets		1,848
Total investments		154,053
Cash and cash equivalents		9,910
Accrued investment income		793
Premium and maintenance fees receivable		14,647
Other amounts receivable under reinsurance recoverables		1,373
Reinsurance recoverables on paid and unpaid loss adjustment expenses		29,685
Prepaid reinsurance premiums		311
Deferred policy acquisition costs		2,404
Deferred tax assets		4,630
Subrogation recoverables		505
Other assets		358
Total assets	$	218,669
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Reserve for losses and loss adjustment expenses		116,227
Unearned premiums and maintenance fees		36,516
Reinsurance premiums payable		253
Funds held under reinsurance treaties		11,112
Federal income tax payable		2,623
Other liabilities		4,507
Total liabilities	$	171,238
Purchase Price		45,167
Excess of net assets received over cost to acquire (1)		2,264
Total	$	218,669

(1)

The fair value of net assets acquired exceeded the cost of acquisition. After review it was determined that no intangibles were acquired and that no assets should be reduced below their carrying value, which approximates fair value. Consequently, an extraordinary gain of $2,264,000 was recognized in the period of the acquisition in accordance with SFAS No. 141, Accounting for Business Combinations.

The tables below reflect the unaudited pro forma balance sheet as of December 31, 2006, and the results of operations for the three- and nine-month periods ended September 30, 2007 and 2006 of the Company and API as if the acquisition had taken place on January 1 of 2007 and 2006, respectively, including estimated purchase accounting adjustments.

10

AMERICAN PHYSICIANS SERVICE GROUP, INC.

PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands)	December 31, 2006
Assets
Investments:
Fixed maturities available for sale, at fair value	$	148,587
Equity securities available for sale, at fair value		11,111
Other invested assets		1,647
Total investments		161,345
Cash and cash equivalents		8,990
Cash – restricted		1,880
Accrued investment income		706
Premium and maintenance fees receivable		16,493
Reinsurance recoverables on paid and unpaid loss adjustments		28,491
Deferred policy acquisition costs		2,545
Management fees and other receivables		9,488
Subrogation recoverables		509
Deferred tax assets		5,577
Property and equipment, net		556
Other assets		2,625
Total assets	$	239,205

	December 31, 2006
Liabilities
Reserve for losses and loss adjustment expenses	$	110,089
Unearned premiums and maintenance fees		39,786
Reinsurance premiums payable		45
Funds held under reinsurance treaties		4,003
Trade accounts payable		2,228
Accrued expenses and other liabilities		9,457
Federal income tax payable		650
Mandatorily redeemable preferred stock		9,179
Total liabilities		175,437
Minority interest		21
Shareholders’ equity
Common stock		480
Additional paid-in capital		42,707
Accumulated other comprehensive income, net of tax		633
Retained earnings		19,927
Total shareholders’ equity		63,747
Total liabilities and shareholders’ equity	$	239,205

11

AMERICAN PHYSICIANS SERVICE GROUP, INC.

PROFORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per share data)	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
REVENUES
Gross premiums and maintenance fees written	$	22,239	$	24,121	$	52,749	$	61,560
Premiums ceded		504		(3,372)		1,515		(5,627)
Change in unearned premiums & maintenance fees		(5,112)		(5,666)		124		(3,527)
Net premiums and maintenance fees earned		17,631		15,083		54,388		52,406
Investment income, net of investment expense		2,904		2,068		7,570		5,616
Realized capital gains (loss), net		(3,195)		137		(3,452)		280
Management service		70		-		106		-
Financial services		5,434		2,913		17,316		11,032
Other revenue		35		65		84		254
Total revenues		22,879		20,266		76,012		69,588
EXPENSES
Losses and loss adjustment expenses		4,624		10,243		18,750		28,465
Other underwriting expenses		3,262		3,631		9,053		9,536
Change in deferred policy acquisition costs		(444)		(427)		(146)		(356)
Management service expenses		-		-		-		-
Financial services expenses		4,907		2,905		15,674		10,348
General and administrative expenses		1,608		642		3,934		1,750
Loss from impairment of goodwill		-		-		1,247		1,247
Total expenses		13,957		16,994		48,512		50,990
Income from operations		8,922		3,272		27,500		18,598
Federal income tax expense		3,630		1,170		10,141		6,394
Minority interests		-		-		1		2
Net income before extraordinary gain	$	5,292	$	2,102	$	17,358	$	12,202
Extraordinary gain		-		-		2,264		-
Net income	$	5,292	$	2,102	$	19,622	$	12,202

12

4.

Impairment of Goodwill

Goodwill arose with the re-purchase of an interest in one of our subsidiaries, APS Insurance Services, from the minority holder in 2003. Goodwill was determined to exist based on earnings expected to be generated from the management contract with API. With the purchase of API by us and termination of the management agreement, the question of impairment of the goodwill was raised.  Upon review, in accordance with SFAS 142, “Goodwill and Other Intangibles,” we determined that the original circumstances creating the goodwill no longer existed and that the entire $1,247,000 balance was impaired. The goodwill was written down during the three months ended June 30, 2007.

5.

Investments

Available-For-Sale Fixed Maturities. Of the total $194,156,000 portfolio balance in available-for-sale fixed income maturities at September 30, 2007, all but $214,000 is considered investment grade securities. Our investment strategy is reviewed and approved by our board of directors. The primary goal of our investment strategy for our insurance services segment is to ensure that we have sufficient assets to meet our obligations to our policyholders, and our secondary goal is to provide investment income. The investment plan for our insurance services segment provides guidance on diversification, duration of the portfolio, sector allocation and specific restrictions, such as the size of investment in any one issue and limitations on the purchases of securities rated lower than investment grade by Moody’s, Standard and Poor’s or a comparable rating institution.

Our insurance services segment employs an investment strategy that emphasizes asset quality to minimize the credit risk of our investment portfolio and also matches fixed-income maturities to anticipated claim payments and expenditures or other liabilities. The amounts and types of investments that may be made by our insurance services segment are regulated under the Texas Insurance Code. We utilize APS Financial Corporation, our broker/dealer subsidiary, as our fixed-income advisor. Our board of directors reviews our fixed-income advisor’s performance and compliance with our investment guidelines on a quarterly basis.

Our entire fixed-income portfolio consists of investment grade securities rated “A” or higher from any of Standard and Poor’s, Moody’s or Fitch with the exception of one bond with a fair market value of approximately $214,000. The following table reflects the composition of our fixed-income portfolio by security rating category of the issuer, as of September 30, 2007 (dollars in thousands). In cases where the rating agencies had a different rating assigned to a security, the classification in the table used the lower rating.

Rating Category	Fair Value		Percentage
AAA / Aaa	$	173,881	90%
AA / Aa		9,670	5%
A / A		10,391	5%
Non-investment grade		214	0%
Total	$	194,156	100%

Available-For-Sale Equity Securities.  Our equity portfolio consists of $10,154,000 in available-for-sale equity securities, comprising 4.9% of total investments at market value as of September 30, 2007. We account for equity securities as available for sale.  We utilize two outside investment managers to manage our insurance segment’s equity portfolio.  Our board of directors reviews our equity managers’ performance and compliance with our investment guidelines on a quarterly basis.  

13

The amortized cost and estimated fair values of investments in fixed income and equity securities at September 30, 2007 and December 31, 2006 are as follows (in thousands):

September 30, 2007	Cost or Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Fixed maturities:
U.S. treasury notes / bills	$	13,121	$	246	$	-	$	13,367
U.S. government agency mortgage-backed bonds		33,587		10		262		33,335
U.S. government agency collateralized mortgage obligations		51,520		56		475		51,101
Collateralized mortgage obligations		51,759		33		1,232		50,560
U.S. government agency bonds and notes		27,415		178		2		27,591
Government tax-exempt bonds		15,982		32		127		15,887
Corporate bonds		2,398		3		86		2,315
Total fixed maturities		195,782		558		2,184		194,156
Equity securities		10,153		485		484		10,154
Total fixed maturities and equity securities	$	205,935	$	1,043	$	2,668	$	204,310

December 31, 2006	Cost or Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Fixed maturities:
U.S. treasury notes/bills	$	1,999	$	-	$	5	$	1,994
U.S. government agency collateralized mortgage obligations		180		10		-		190
U.S. agency bonds and notes		13,755		1		14		13,742
Corporate bonds		682		28		-		710
Total fixed maturities		16,616		39		19		16,636
Equity securities		4,073		330		-		4,403
Total fixed maturities and equity securities	$	20,689	$	369	$	19	$	21,039

In accordance with SFAS No. 115, Accounting for Certain Investments In Debt and Equity Securities, we evaluate our investment securities on at least a quarterly basis for declines in market value below cost for the purpose of determining whether these declines represent other than temporary declines. A decline in the fair value of a security below cost judged to be other than temporary is recognized as a loss in the current period and its fair value becomes the new cost basis of the security. The following factors are considered in determining whether an investment decline is “other than temporary”:

·

The extent to which the market value of the security is less than its cost basis;

·

The length of time for which the market value of the security is less than its cost basis;

·

The financial condition and near-term prospects of the security’s issuer, taking into consideration the economic prospects of the issuer’s industry and geographical region, to the extent that information is publicly available; and

·

Our ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value.

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The securities acquired as part of API were revalued to market value as of the date of the merger, April 1, 2007. The fixed maturity investments are virtually all investment grade securities. Of our entire invested assets, including cash, agency-backed mortgage obligations, with underlying collateral consisting of GNMA, FHLMC, or FNMA loans comprise 38% of our portfolio; non-agency collateralized mortgage obligations comprise 23% of our portfolio; and the remaining 39% is comprised of U.S. Treasury, government agency bonds and notes, municipal tax exempt bonds, corporate bonds and equities. The majority of the non-agency CMO’s in our portfolio have underlying mortgages categorized as “Prime” quality loans, and none of our CMO’s have underlying mortgages classified as “Subprime.” However, within our portfolio there are eleven CMO securities classified as “Alternative-A” or “Alt-A.”  These Alt - -A securities are generally considered to have underlying mortgages with underwriting characteristics that are stronger than “Subprime” mortgages but less stringent than “Prime” mortgages. All of our Alt-A securities are investment grade, currently rated either AAA, AA or A.

During the three months ended September 30, 2007, we saw a significant and rapid decline in the market value of our Alt-A securities, particularly those with an A rating. In evaluating this decline, we considered the deepening national housing crisis and its potential effects on the underlying collateral and concluded that the decreases in value of our A rated Alt-A securities should be considered to be “other than temporary” as defined in Statements of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities. The amount of the pretax charge to earnings associated with this adjustment for the three months ended September 30, 2007, is $3,140,000 bringing our total carrying value in Alt-A securities to $13,904,000 from $17,044,000 as of September 30, 2007. While we have the ability and intent to hold all of our Alt-A securities indefinitely, we will continue to monitor and evaluate t hese securities and their underlying collateral.

The following table reflects the composition of our Alt-A securities as of September 30, 2007 after the other than temporary impairment (dollars in thousands):

Rating Category	Carrying "Book" Value		Fair Value		% of Portfolio (Fair Value)
AAA	$	2,327	$	2,297	1.0%
AA		4,746		3,997	1.9%
A		6,831		6,831	3.0%
Total	$	13,904	$	13,125	5.9%

Additionally, an impairment charge resulted from our investment in Financial Industries Corporation (“FIC”) for the three months ended September 30, 2007, having previously resolved that declines in FIC’s stock price will be considered to be “other than temporary”. Our policy in regards to our investment in FIC is that we will record pretax charges to earnings should the common stock price on the last day of each interim or annual period fall below the adjusted cost basis of our investment in FIC. During the three months ended September 30, 2007, that charge totaled $39,000, bringing the total amount written off in 2007 to $693,000. For the three and nine months ended September 30, 2006, no impairment charges were recorded related to our investment in FIC. As a consequence of these write-downs, our basis in this stock has declined to $5.80 per share which equals the fair market value of FIC common stock at September 30, 2007. Whil e we continue to have the ability and the intent to hold the stock indefinitely, we previously determined that the additional uncertainty created by FIC’s previous late SEC filings, together with its continued de-listing from any national stock exchanges, dictated that the current quarter decline should be viewed as other than temporary. We will continue to monitor and evaluate the situation at FIC.

15

The following two tables reflect securities whose fair values were lower than the related cost basis at September 30, 2007 and December 31, 2006, respectively (in thousands). However, these declines in value were not deemed to be “other than temporary”. The tables show the fair value and the unrealized losses, aggregated by investment category and category of duration that individual securities have been in a continuous unrealized loss position.

	Less Than 12 Months				12 Months or More				Total
September 30, 2007:	Estimated Fair Value		Unrealized Loss		Estimated Fair Value		Unrealized Loss		Estimated Fair Value		Unrealized Loss
U.S. treasury notes/bills	$	2,000	$	-	$	8,642	$	-	$	10,642	$	-
U.S. government agency mortgage-backed bonds		29,905		262		-		-		29,905		262
U.S. government agency collateralized mortgage obligations		39,920		475		3,858		-		43,778		475
Collateralized mortgage obligations		34,266		1,232		-		-		34,266		1,232
U.S. government agency bonds and notes		9,896		-		14,625		2		24,521		2
Government tax-exempt bonds		11,868		127		-		-		11,868		127
Corporate bonds		2,100		86		214		-		2,314		86
Total fixed income securities	$	129,955	$	2,182	$	27,339	$	2	$	157,294	$	2,184
Total equity securities	$	2,984	$	461	$	3,967	$	23	$	6,951	$	484
Total	$	132,939	$	2,643	$	31,306	$	25	$	164,245	$	2,668

	Less Than 12 Months				12 Months or More				Total
December 31, 2006:	Estimated Fair Value		Unrealized Loss		Estimated Fair Value		Unrealized Loss		Estimated Fair Value		Unrealized Loss
U.S. treasury notes/bills	$	1,995	$	5	$	-	$	-	$	1,995	$	5
U.S. agency bonds and notes		9,459		12		991		2		10,450		14
Total fixed income securities	$	11,454	$	17	$	991	$	2	$	12,445	$	19
Total equity securities	$	-	$	-	$	332	$	-	$	332	$	-
Total	$	11,454	$	17	$	1,323	$	2	$	12,777	$	19

The unrealized losses on the fixed maturities and equities are primarily due to market fluctuations resulting from cyclical and other economic pressures  and not due to changes in the credit worthiness of the issuer. All fixed maturities with an unrealized loss over 12 months or more are investment grade securities. As of September 30, 2007, we believe that these unrealized losses are temporary and that the fair value will recover to a level equal to or greater than the cost basis. In addition, as of September 30, 2007, we had the ability and intent to hold these investments until there is a recovery in fair value, which may be maturity for the applicable securities. In the future, information may come to light or circumstances may change that would cause us to record an other than temporary impairment or sell any of our fixed maturity or equity securities and incur a realized loss.

16

Gross realized gains and losses on fixed maturity and equity securities included in the statement of operations for the three and nine months ended September 30, 2007 and 2006 were as follows (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
Realized gains (losses):
Fixed maturities:
Gross realized gain	$	-	$	-	$	-	$	7
Gross realized loss		(3,141)		-		(3,148)		(1)
Net realized gain (loss)		(3,141)		-		(3,148)		6
Equities:
Gross realized gain		12		90		278		104
Gross realized loss		(66)		-		(789)		-
Net realized gain (loss)		(54)		90		(511)		104
Total net realized gain (loss)	$	(3,195)	$	90	$	(3,659)	$	110

The major categories of the net investment income included in the statement of operations are summarized for the three and nine months ended September 30, 2007 and 2006, as follows (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
Investment income:
Fixed maturities	$	2,631	$	156	$	5,154	$	459
Equity securities		36		6		85		17
Short-term investments and other		261		87		550		192
Finance charges on premiums receivable		31		-		60		-
Structured annuity		21		-		41		-
Total investment income		2,980		249		5,890		668
Investment expense		76		-		147		-
Net investment income	$	2,904	$	249	$	5,743	$	668

As a result of our acquisition of API, the Texas Department of Insurance (“TDI”) required that funds be set aside in an escrow account with a bank to remain until the aggregate remaining redemption obligation of our Series A redeemable preferred stock is less than the amount of the escrow balance, with no withdrawals to be made from this escrow account without prior approval from TDI. To satisfy this condition of the merger, we purchased a fixed income security in March of 2007 in the amount of $2,500,000 paying 5% interest and maturing in March of 2008. This security is included in fixed maturities, available for sale.

At September 30, 2007, investments with a fair market value of $1,352,000 were on deposit with state insurance departments to satisfy regulatory requirements and these securities are included in fixed maturities, available for sale.

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6.

Cash – Restricted

Cash – Restricted represents cash deposits advanced from customers for trade claim transactions that do not close by the end of the period. It occurs when a customer remits payment for a transaction by check instead of via wire transfer. As checks of this size normally take several business days to clear, we ask our customers to pay in advance for transactions expected to close in the near future. At the time of receipt, Cash – Restricted and Accounts Payable are increased for an equal amount as no part of this cash is ours until the transaction closes.

7.

Reinsurance

Reinsurance Premiums Ceded.  Certain premiums are ceded to other insurance companies under reinsurance agreements. These reinsurance agreements provide us with increased capacity to write additional risk and the ability to write specific risk within our capital resources and underwriting guidelines. API enters into reinsurance contracts, which provide coverage for losses in excess of the retention of $250,000 on individual claims and beginning in 2002 through 2005, $350,000 on multiple insured claims related to a single occurrence. The 2006 and 2007 reinsurance treaties provide for these same terms with API retaining an additional 10% of the aforementioned retention levels for 2006 and 20% for 2007. The reinsurance contracts for 2002 through 2007 contain variable premium ceding rates based on loss experience. The ceded premium charged under these contracts will depend upon the development of ultimate losses ceded to the reinsurers under their retrospective treaties. For the three and nine months ended September 30, 2007, we recorded favorable development to ceded premiums of $2,435,000 and $8,071,000, respectively, related to prior year variable premium reinsurance treaties as a result of lower estimated ultimate loss and loss adjustment expenses for treaty years 2002 through 2006. During the quarter ended September 30, 2007, we lowered our estimated ceded accrual rate for the 2007 treaty year to 16.7% from 17.5% of earned premium. The favorable development reflects reductions in our estimates of claim severity as a result of claim closures at less than reserved amounts.

In addition to an adjustment to premiums ceded, estimates of ultimate reinsurance ceded premium amounts compared to the amounts paid on a provisional basis give rise to a balance sheet asset classified as “Other Amounts Receivable Under Reinsurance Contracts” or a balance sheet liability classified as “Funds Held Under Reinsurance Treaties.” Furthermore, each retrospective treaty requires a 24 or 36 month holding period before any premium adjustments or cash can be returned or paid. The ultimate settlement amount is not determined until all losses have been settled under the respective treaties. As of September 30, 2007, API had recorded a balance sheet asset, “Other Amounts Receivable Under Reinsurance Contracts” of $3,399,000 and a balance sheet liability, “Funds Held Under Reinsurance Treaties” of $5,929,000, which represent the differences between the estimates of ultimate reinsurance premiums ceded am ounts for the 2002 through 2007 treaty years as compared to the amounts paid on a provisional basis.

Reinsurance Recoverables.  Ceded reserves for loss and loss adjustment expenses are recorded as reinsurance recoverables. Reinsurance recoverables are the estimated amount of future loss payments that will be recovered from reinsurers, and represent the portion of losses incurred during the period that are estimated to be allocable to reinsurers. There are several factors that can directly affect the ability to accurately forecast the reinsurance recoverables. Many of the factors discussed in Note 8 related to the sensitivities of forecasting total loss and loss adjustment expense reserves also apply when analyzing reinsurance recoverables. Since API cedes excess losses above $250,000 on individual claims and $350,000 on multiple insured claims, the trends related to severity significantly affect this estimate. Current individual claims severity can be above or fall below API’s retention level over the period it takes to resolve a claim.

Similar to the estimate for reserves, due to the long-tailed nature of the medical professional liability line of insurance, relatively small changes in the actuarial assumptions for trends, inflation, severity and frequency for projected ultimate loss and loss adjustment expense reserves can have a greater impact on the recorded balance for reinsurance recoverables than with most other property and casualty insurance lines. While we believe that our estimate for ultimate projected losses related to loss and loss adjustment expense is adequate based on reported and open claim counts, there can be no assurance that additional significant reserve enhancements will not be necessary in the future given the many variables inherent in such estimates and the extended period of time that it can take for claim patterns to emerge.

Reinsurance contracts do not relieve API from its obligations to policyholders. API continually monitors its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. Any amount found to be uncollectible is written off in the period in which the uncollectible amount is identified. As of September 30, 2007, all of API’s reinsurance contracts were with companies in strong financial condition, and we believe there is no need to establish an allowance for uncollectible reinsurance recoverable. API has not experienced any material problems collecting from its reinsurers.

18

Unsecured reinsurance recoverables at September 30, 2007, that exceeded 10% of total reinsurance paid and unpaid loss and loss adjustment expenses are summarized as follows (in thousands):

Company Name	September 30, 2007
Transatlantic Reinsurance	$	4,099
Swiss Reinsurance	$	12,589

Both Transatlantic Reinsurance and Swiss Reinsurance are A.M. Best rated “A+” (Superior).

8.

Reserve for Loss and Loss Adjustment Expense

The reserve for unpaid losses and loss adjustment expenses represents the estimated liability for unpaid claims reported to us, plus claims incurred but not reported and the related estimated loss adjustment expenses. The reserve for losses and loss adjustment expenses is determined based on our actual experience, available industry data and projections as to future claims frequency, severity, inflationary trends and settlement patterns.

We write medical malpractice insurance policies which have a lengthy period for reporting a claim (tail coverage) and a long process of litigating a claim through the courts and whose risk factors expose its reserves for loss and loss adjustment expenses to significant variability. These conditions subject API’s open reported claims and incurred but not reported claims to increases due to inflation, changes in legal proceedings and changes in the law. While the anticipated effects of inflation is implicitly considered when estimating reserves for loss and loss adjustment expenses, an increase in average severity of claims is caused by a number of factors. Future average severities are projected based on historical trends adjusted for changes in underwriting standards, policy provisions and general economic trends. Those anticipated trends are monitored based on actual experience and are modified as necessary to reflect any changes in the development of ultimate losses and loss adjustment expenses. These specific risks, combined with the variability that is inherent in any reserve estimate, could result in significant adverse deviation from our carried reserve amounts. Settlement of claims is subject to considerable uncertainty. We believe the reserves for loss and loss adjustment expenses are reasonably stated as of September 30, 2007.

We recorded $4,624,000 and $7,786,000 for losses and loss adjustment expenses for the three months and the nine months ended September 30, 2007, respectively, which included $7,789,000 for the current accident year and $3,165,000 of favorable development for the three months ended September 30, 2007 and $19,403,000 for the current accident year and $11,617,000 of favorable development for prior report years for the nine months ended September 30, 2007.  The favorable development for both periods was primarily the result of loss severity for the 2002 through 2006 report years developing favorably compared to prior period estimates. In addition, the total number of claims closed with indemnity for these report years were less than prior estimates.

9.

Contingencies

We are involved in various claims and legal actions that have arisen in the ordinary course of business. We believe that any liabilities arising from these actions will not have a significant adverse affect on our financial condition or results of operations.

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10.

Earnings Per Share

Basic earnings per share are based on the weighted average shares outstanding without any dilutive effects considered. Diluted earnings per share reflect dilution from all contingently issuable shares, such as options. A reconciliation of income and weighted average shares outstanding used in the calculation of basic and diluted income per share from operations follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
	(in thousands, except for per share data)
Numerator for basic and diluted income per    common share:
Net income before extraordinary gain	$	5,292	$	409	$	15,004	$	1,569
Extraordinary gain, net of tax		-		-		2,264		-
Net income	$	5,292	$	409	$	17,268	$	1,569
Denominator:
Denominator for basic income per common share – weighted average shares outstanding		7,107		2,767		4,977		2,773
Effect of dilutive stock options and awards		146		125		137		169
Denominator for diluted income per common share – adjusted weighted average shares outstanding		7,253		2,892		5,114		2,942
Net income - basic	$	0.74	$	0.15	$	3.47	$	0.57
Net income - diluted	$	0.73	$	0.14	$	3.37	$	0.53

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11.

Segment Information

The Company’s segments are distinct by type of service provided. Comparative financial data for the three- and nine-month periods ended September 30, 2007 and 2006 are shown as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
Operating revenue:
Insurance services	$	16,720	$	3,726	$	43,219	$	10,556
Financial services		5,660		3,109		18,023		11,517
All other		1,077		590		1,729		3,377
Total segment revenues	$	23,457	$	7,425	$	62,971	$	25,450
Reconciliation to consolidated statement of operations:
Total segment revenues	$	23,457	$	7,425	$	62,971	$	25,450
Less: intercompany dividends		(578)		(300)		(1,353)		(2,668)
Total revenues	$	22,879	$	7,125	$	61,618	$	22,782
Operating income:
Insurance services	$	9,278	$	579	$	24,954	$	2,008
Financial services		753		199		2,424		1,158
All other		(1,109)		(137)		(3,424)		(712)
Total segment operating income	$	8,922	$	641	$	23,954	$	2,454
Income tax expense		3,630		232		8,949		883
Minority interest		-		-		1		2
Income from operations before extraordinary gain		5,292		409		15,004		1,569
Extraordinary gain, net of taxes		-		-		2,264		-
Net income	$	5,292	$	409	$	17,268	$	1,569

	September 30, 2007		December 31, 2006
Balance sheet data:
Indentifiable assets
Insurance services	$	228,832	$	5,625
Financial services		5,542		7,027
All other		48,504		23,624
Total	$	282,878	$	36,276

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12.

Stock-Based Compensation

In December 2004, the Financial Accounting Standards Board issued SFAS No. 123 (revised 2004), Share-Based Payment (SFAS No. 123 (R)). The standard amends SFAS 123, Accounting for Stock-Based Compensation, and concludes that services received from employees in exchange for stock-based compensation results in a cost to the employer that must be recognized in the financial statements. The cost of such awards should be measured at fair value at grant date.

On January 1, 2006 we adopted SFAS No. 123(R). We use the Black-Scholes-Merton option-pricing model to determine the fair value of stock-based awards, consistent with that used for pro forma disclosures under SFAS No. 123, Accounting for Stock-Based Compensation. We have elected the modified prospective transition method as permitted by SFAS No, 123(R) and accordingly prior periods have not been restated to reflect the impact of SFAS No. 123(R). SFAS No. 123(R) requires that stock-based compensation be recorded for all new and unvested stock options expected to vest as the requisite service is rendered beginning January 1, 2006, the first day of our 2006 fiscal year. Stock-based compensation expense for awards granted on or before December 31, 2005, but unvested as of that date, is based on the grant date fair value as determined under the pro forma provisions of SFAS No. 123. For the three and nine months ended September 30 , 2007, we recorded compensation cost related to stock options of $126,000 and $1,145,000 and a related reduction in income taxes of $44,000 and $401,000, respectively. The compensation cost is the total fair value, at date of grant, of stock options that vested during the three and nine month periods. No compensation costs were capitalized in the three and nine month periods ended September 30, 2007.

During the three and nine month periods ended September 30, 2007, 4,000 and 31,000 options were exercised with an intrinsic value of $31,000 and $352,000, respectively. We received proceeds of $49,000 and $183,000 from the exercise of these options during the three and nine month periods ended September 30, 2007, respectively. Based on unvested options outstanding at September 30, 2007 compensation costs to be recorded in future periods are expected to be recognized as follows: 2007, $127,000; 2008, $509,000; 2009, $227,000 and 2010, $20,000.

Our “2005 Incentive and Non-Qualified Stock Option Plan” (“Incentive Plan”). The Incentive Plan provides for the issuance of up to 650,000 shares of common stock to our directors and key employees. A total of 555,000 of these options have been granted as of September 30, 2007 and 95,000 are available for grants. Of those granted, 8,000 shares have been exercised, 283,000 options are exercisable and 264,000 are not yet exercisable. Our previous plan, the “1995 Incentive and Non-Qualified Stock Option Plan,” provided for the issuance of 1,600,000 shares of common stock to our directors and key employees.  All of the approved options have been granted as of September 30, 2007, 1,185,000 shares have been exercised, 256,000 shares are exercisable and 159,000 options have been canceled. Upon the exercise of an option we issue the shares from our authorized, but unissued, shares.

The exercise price for each non-qualified option share is determined by the Compensation Committee of the Board of Directors (“the Committee”). The exercise price of a qualified incentive stock option has to be at least 100% of the fair market value of such shares on the date of grant of the option.  Under the Plans, option grants are limited to a maximum of ten-year terms; however, the Committee has issued all currently outstanding grants with five-year terms. The Committee also determines vesting for each option grant and traditionally has had options vest in two to three approximately equal annual installments beginning one year from the date of grant.

Presented below is a summary of the stock options held by our employees and our directors and the related transactions for the three and nine months ended September 30, 2007.

	Three Months Ended September 30, 2007			Nine Months Ended September 30, 2007
	Shares	Weighted Average Exercise Price		Shares	Weighted Average Exercise Price
Balance at beginning of period	799,000	$	12.79	467,000	$	9.96
Options granted	8,000		17.50	368,000		15.94
Options exercised	(4,000)		11.33	(31,000)		5.94
Options forfeited	0		0	(1,000)		15.90
Balance at end of period	803,000	$	12.85	803,000	$	12.85
Options exercisable	538,000	$	10.83	538,000	$	10.83

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The weighted average fair value of Company stock options granted is $5.04 per option for the nine months ended September 30, 2007. The fair value of the options was calculated using the Black-Scholes-Merton option pricing model with the following assumptions:

	Nine Months ended September 30, 2007
Expected option term	3.7 years
Expected volatility	31.13%
Expected dividend yield	1.73%
Risk-free rate of return	4.49%

The expected volatility assumptions we used are based on the historical volatility of our common stock over the most recent period commensurate with the estimated expected life of our stock options, such estimated life being based on the historical experience of our stock option exercises.

The following table summarizes our outstanding and exercisable options at September 30, 2007:

Stock Options Outstanding						Stock Options Exercisable
Shares	Weighted Average Exercise Price		Aggregate Intrinsic Value (1)		Average Remaining Contractual Life	Shares	Weighted Average Exercise Price		Aggregate Intrinsic Value (1)		Average Remaining Contractual Life
803,000	$	12.85	$	4,456,000	3.2 yrs.	538,000	$	10.83	$	4,075,000	2.6 yrs.

(1)

Based on the $18.40 closing price of our stock at September 30, 2007.

13.

Secondary Stock Offering

On June 19, 2007, we announced that our public offering of 2,100,000 shares of common stock had priced at $16.50 per share. Of the shares offered, 2,000,000 were offered by us, and Kenneth S. Shifrin, our Chairman of the Board and Chief Executive Officer, offered 100,000 of the 582,554 shares he owned at that date.

Net proceeds received by us from the secondary offering were approximately $30,237,000 after deducting underwriting, legal, accounting, and publication fees. Of this total, we contributed $10,000,000 to API to strengthen its capacity to underwrite insurance risks. The balance of the proceeds has been invested primarily in U.S. government and U.S. government agency securities and is available for general corporate purposes including possible acquisitions.

Total common shares outstanding increased from approximately 4,819,000 before the secondary offering to approximately 6,819,000 afterwards.

Pursuant to the secondary offering, the underwriters of the offering were granted a 30-day period to exercise an option to purchase up to 315,000 additional common shares from us. On July 12, 2007 we announced that the underwriters had exercised their over-allotment option to purchase all of these additional shares of common stock at the public offering price of $16.50 per share. Net proceeds received by us related to this over-allotment option were approximately $4,886,000.

Total common shares outstanding increased from approximately 6,819,000 before the sale of the over-allotment option to approximately 7,134,000 afterwards.

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14.

Preferred Stock

In conjunction with the acquisition of API we issued 10,198 shares of Series A redeemable preferred stock, par value $1.00 per share, from the 10,500 shares authorized. Holders of Series A redeemable preferred stock are entitled to cumulative dividends thereon at the rate of three percent (3%) per annum payable on the remaining redemption value per share, in priority to the payments of dividends on the common shares. Holders of our Series A redeemable preferred stock have no preemptive rights and have the same voting rights as the holders of our common stock. The shares are non-certificated and mandatorily redeemable. They will be redeemed ratably at not less than $1,000,000 per year, with all remaining outstanding shares being redeemed by December 31, 2016. In June 2007, 1,019 shares of our Series A redeemable preferred stock were redeemed for a total cash pay-out of $1,060,000, which included accrued dividends of $40,000. In the event of any liquidation, the holders of our Series A redeemable preferred stock receive an amount equal to the remaining redemption value before any distribution is made to the holders of our common stock.

Pursuant to Financial Accounting Standards Board (“FASB”) Statement No. 150,  Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity  (“FASB No. 150”), an issuer is required to classify an instrument as a liability if it is issued in the form of shares that are mandatorily redeemable if it embodies an unconditional obligation that requires the issuer to redeem the shares by transferring the entity’s assets at a specified or determinable date(s) or upon an event that is certain to occur. The preferred stock’s mandatory cash redemption feature coupled with a fixed redemption date and fixed amount requires that it be classified as debt, rather than equity. As of September 30, 2007, the fair market value of the Series A redeemable preferred stock was $8,397,000.

15.

Minority Interest

The 3% minority interest in Asset Management, a subsidiary within our financial services segment, owned by key individuals within Asset Management, was repurchased by APS Investment Services in the current quarter for a nominal amount.  

16.

Income Taxes

As further disclosed in the Extraordinary Gain section of our Management’s Discussion and Analysis section of this Quarterly Report on Form 10-Q, we recorded a tax-free extraordinary gain in the prior quarter in the amount of $2,264,000 as a result of our acquisition of API. The result of this extraordinary gain was to reduce our effective income tax rate for the nine months ended September 30, 2007, from approximately 37.3% to approximately 34.1%.

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

For purposes of this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), “APS,” “we,” “our,” “us” and the “Company” refer to American Physicians Service Group, Inc., together with its subsidiaries, unless the context requires otherwise. The following MD&A should be read in conjunction with the accompanying consolidated financial statements for the three and nine months ended September, 2007, included in Part I, Item 1, As well as the audited, consolidated financial statements and notes in our Annual Report on Form 10-K for the year ended December 31, 2006, which was filed with the United States Securities and Exchange Commission (the “SEC”) on March 28, 2007.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This quarterly report contains forward-looking statements within the meaning of Section 27A of the Securities Act, Section 21E of the Exchange Act and the Private Securities Litigation Reform Act of 1995, about the Company that are subject to risks and uncertainties. All statements other than statements of historical fact included in this document are forward-looking statements.

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You can identify forward-looking statements by the use of words such as “may,” “target,” “should,” “could,” “estimates,” “predicts,” “potential,” “continue,” “anticipates,” “projects,” “forecasts,” “believes,” “plans,” “expects,” “future” and “intends” and similar expressions which are intended to identify forward-looking statements. Forward-looking statements are based on beliefs and assumptions made by management using currently available information, such as market and industry materials, experts’ reports and opinions and trends. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control and difficult to predict and could cause actual results to differ materially from t hose expressed or forecasted in the forward-looking statements. In evaluating forward-looking statements, you should carefully consider the risks and uncertainties referenced in “Risk Factors” in Part II, Item IA. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements and risk factors contained in this quarterly report. Forward-looking statements contained in this quarterly report reflect our view only as of the date of this report. We do not have any obligation, other than as required by law, to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

The following important factors, in addition to those referenced under “Risk Factors” in Part II, Item 1A, could affect the future results of our operations and could cause those results to differ materially from those expressed in or implied by such forward-looking statements:

•

general economic conditions, either nationally or in our market area, that are worse than expected;

•

changes in the healthcare industry;

•

regulatory and legislative actions or decisions that adversely affect our business plans or operations;

•

inflation and changes in the interest rate environment, the performance of financial markets and/or changes in the securities markets;

•

uncertainties inherent in the estimate of loss and loss adjustment expense reserves and reinsurance; changes in the availability or cost of reinsurance;

•

significantly increased competition among insurance providers;

•

potential losses and litigation risk associated with our financial services businesses;

•

loss of key executives, personnel, accounts or customers;

•

our ability to renew our existing reinsurance or obtain new reinsurance; and

•

failure of our reinsurers to pay claims in a timely manner.

The foregoing factors should not be construed as exhaustive and we caution you not to place undue reliance on these forward-looking statements, which speak only as of the date of this quarterly report. In addition to any risks and uncertainties specifically identified in the text surrounding forward-looking statements, you should consult with our other filings under the Securities Act of 1933 and the Securities Act of 1934, for factors that could cause our actual results to differ materially from those presented.

Business Overview

We provide (1) insurance services, specifically medical professional liability insurance in Texas and (2) financial services, including brokerage and investment services to individuals and institutions.

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Insurance Services. We provide medical professional liability insurance primarily in Texas, where our insurance subsidiary, API, has written business for over 30 years. API is authorized to do business in the States of Texas, Arkansas and Oklahoma and specializes in writing medical professional liability insurance for physicians, dentists and other healthcare providers. We became authorized to do business in Oklahoma during the three month period ended September 30, 2007. API currently insures approximately 4,950 physicians, dentists, and other healthcare providers, the vast majority of which are in Texas. Approximately 99% of API’s premiums are written through purchasing groups, which in Texas currently subjects us to less stringent state regulation of premium rates and policy forms. Historically, we operated as the attorney-in-fact manager for API since 1975. In April 2007, we acquired API, thus combining our insurance management experience with an insurance underwriting entity to allow for the increased possibility for expansion into new markets and to assist our efforts for continued growth in existing markets.

Financial Services. We provide investment and investment advisory services to institutions and individuals throughout the United States through the following subsidiaries:

o

APS Financial. APS Financial is a fully licensed broker/dealer that provides brokerage and investment services primarily to institutional and high net worth individual clients. APS Financial also provides portfolio accounting, analysis and other services to insurance companies, banks and public funds. We recognize commission revenue, and the related compensation expense, on a trade date basis.

o

APS Capital. APS Capital is dedicated to the clearing and settlement of trades involving syndicated bank loans, trade claims and distressed private loan portfolios. We seek to develop business with clients who trade in the high-yield bond market. We recognize commission revenue, and the related compensation expense, when the transaction is complete and fully funded.

o

APS Asset Management. APS Asset Management, a registered investment adviser under the Investment Advisers Act of 1940, manages fixed income and equity assets for institutional and individual clients on a fee basis. We recognize fee revenues monthly based on the amount of funds under management.

Recent Transactions

Acquisition.  On April 1, 2007, we acquired all of the issued and outstanding stock of API. The business combination is being accounted for using the purchase method of accounting and, accordingly, the purchase price has been allocated to assets acquired and liabilities assumed based on fair values at the date of acquisition. The total purchase price was $45,167,000 and consisted of consideration of 1,982,499 shares of the Company’s common stock, valued at a per share price of $17.635, or $34,961,000 in aggregate, $35,000 in cash paid in lieu of fractional shares of common stock, 10,197.95 shares of preferred stock valued at $9,179,000, plus costs to complete the acquisition of $992,000. We are required to redeem at least $1 million of the preferred stock each calendar year beginning in 2007, until December 31, 2016, at which time all of the preferred stock must have been redeemed. The preferred stock has a cumulative dividend equal to 3% of the outstanding redemption value per year.  On June 1, 2007, we made the first required payment, redeeming 10% of the preferred shares outstanding and paying the dividend.

Secondary Stock Offering. On June 19, 2007 we announced that our public offering of 2,100,000 shares of common stock had priced at $16.50 per share. Of the shares offered, 2,000,000 were offered by us, and Kenneth S. Shifrin, our Chairman of the Board and Chief Executive Officer, offered 100,000 of the 582,554 shares he owned at that date.

The underwriters of the offering were granted a 30-day period to exercise an option to purchase up to 315,000 additional common shares from APS. On July 12, 2007, we announced that the underwriters had exercised their over-allotment option to purchase all of these additional shares of common stock at the public offering price of $16.50 per share. Total common shares outstanding rose from approximately 4,819,000 before the over-allotment to approximately 7,134,000 afterwards.

Net proceeds received by the Company from the secondary offering, including the over-allotment, were approximately $35,000,000 after subtracting underwriting, legal, accounting and publication fees. Of this total, we contributed $10,000,000 to API to strengthen its capacity to underwrite insurance risks. The balance of the proceeds has been invested primarily in U.S. government and U.S. government agency securities and is available for general corporate purposes including possible acquisitions.

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES.

The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we evaluate our estimates, including those related to: reserve for losses and loss adjustment expenses; death, disability and retirement reserves; reinsurance premiums recoverable/payable; premiums ceded; deferred policy acquisition costs, impairment of assets; bad debts; income taxes; and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form 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 and estimates affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. We periodically review the carrying value of our assets to determine if events and circumstances exist indicating that assets might be impaired. If facts and circumstances support this possibility of impairment, our management will prepare undiscounted and discounted cash flow projections, which require judgments that are both subjective and complex. Management may also obtain independent valuations.

Revenue Recognition. Historically, our insurance services segment recognized revenues in accordance with Staff Accounting Bulletin (“SAB”) No. 101, Revenue Recognition in the Financial Statements. Prior to April 1, 2007, our Insurance Services revenues were historically related to management fees based on the earned premiums of API and included a profit sharing component related to API’s annual earnings. Management fees equaled 13.5% of API’s earned premiums before payment of reinsurance premiums plus profit sharing equal to 50% of API’s pre-tax earnings up to a maximum of 3% of earned premiums before payment of reinsurance premiums. Management fees were recorded, based upon the terms of the management agreement, in the period the related premiums are earned by API. API recognizes premiums as earned ratably over the terms of the related policy. The profit sharing component was historically recognized in the fo urth quarter when it was certain API would have an annual profit. In 2007, however, since the management contract ended March 31, 2007, we recognized the quarter’s profit in March, based on our ability to fully determine the profit sharing base.

As a result of the acquisition, our insurance services segment recognizes revenue in accordance with SFAS No. 60, Accounting and Reporting of Insurance Enterprises. We issue policies written on a claims-made basis. A claims-made policy provides coverage for claims reported during the policy year. We charge both a base premium and a premium maintenance fee. Policies are written for a one-year term and premiums and maintenance fees are earned on a pro rata basis over the term of the policy. Premium maintenance fees are charged to offset the costs incurred by API to issue and maintain policies. Unearned premiums and maintenance fees are determined on a monthly pro rata basis. Upon termination of coverage, policyholders may purchase an extended reporting period (tail) endorsement for additional periods of time. These extended reporting period coverage endorsement premiums are earned when written.

Our financial services revenues are composed primarily of commissions on securities trades and clearing of trade claims and asset management fees. Revenues related to securities transactions are recognized on a trade date basis. Revenues from the clearing and settlement of trades involving syndicated bank loans, trade claims and distressed private loan portfolios are recognized when the transaction is complete and fully funded. Asset management fees are recognized as a percentage of assets under management during the period based upon the terms of agreements with the applicable customers.

Investments. We account for our equity and fixed-income securities as available-for-sale. In the event a decline in fair value of an investment occurs, management may be required to determine if the decline in market value is other than temporary. Our policy is to account for investments as available-for-sale securities which requires that we assess fluctuations in fair value and determine whether these fluctuations are temporary or “other than temporary” as defined in SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,”. Management’s assessments as to the nature of a decline in fair value are based on the quoted market prices at the end of a period, the length of time an investment’s fair value has been in decline and our ability and intent to hold the investment until a recovery in value. If the fair value is less than the carrying value and the decline is determined to be other than temporary, a write-down is recorded against earnings in the period such determination is made.

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Asset Impairment. We periodically review the carrying value of our assets to determine if events and circumstances exist indicating that assets might be impaired. If facts and circumstances support this possibility of impairment, our management will prepare undiscounted and discounted cash flow projections, which require judgments that are both subjective and complex. Management may also obtain independent valuations.  In accordance with SFAS No. 142, “Goodwill and Other Intangibles,” intangible assets with indefinite lives are not amortized but are subject to annual tests for impairment or more often if events or circumstances indicate they may be impaired.  Other identified intangible assets are amortized over their estimated useful lives and are subject to impairment if events or circumstances indicate a possible inability to realize the carrying amount.

Business Combinations. We recorded all assets and liabilities acquired in the acquisition of API, including indefinite-lived intangibles, and other intangibles, at fair value as required by SFAS No. 141, “Accounting for Business Combinations”.  The initial recording of other intangibles requires subjective judgments concerning estimates of the fair value of the acquired assets and liabilities. Based on our review of the fair value of assets acquired in the acquisition of API on April 1, 2007, there was no goodwill and we recorded an extraordinary gain of $2,264,000 during the three months ended June 30, 2007 for the excess of net assets received over cost to acquire.

Reserve for Loss and Loss Adjustment Expense. Loss and loss adjustment expense reserves represent management’s best estimate of the ultimate costs of all reported and unreported losses incurred. The reserves for unpaid losses and loss adjustment expenses are estimated using actuarial analysis. These estimates include expectations of what the ultimate settlement and administration of claims will cost based on the Company’s assessments of facts and circumstances then known, review of historical settlement patterns, estimates in trends in loss severity, frequency, legal theories of liability and other factors. Other factors include the nature of the injury, the judicial climate where the insured event occurred and trends in health care costs. In addition, variables in reserve estimation can be affected by internal and external events, such as economic inflation, legal trends and legislative changes. The est imation of medical professional liability loss and loss adjustment expense is inherently difficult. Injuries may not be discovered until years after the incident, or a claimant may delay pursuing recovery for damages. Medical liability claims are typically resolved over an extended period of time, often five years or more.

The combination of changing conditions and the extended time required for claim resolution results in a loss estimation process that requires actuarial skill and the application of judgment, and such estimates require periodic revisions. Management performs an in-depth review of the reserve for unpaid losses and loss adjustment expenses periodically with assistance from our outside consulting actuary. Management is continually reviewing and updating the data underlying the estimation of the loss and loss adjustment expense reserves and we make adjustments that we believe the emerging data indicates. Any adjustments to reserves that are considered necessary are reflected in the results of operations in the period the estimates are changed.

Reinsurance Premiums Ceded. Under our primary medical professional liability reinsurance contract, certain premiums are ceded to other insurance companies. The reinsurance contract provides coverage for losses in excess of API’s retention of $250,000 on individual claims and beginning in 2002, $350,000 on multiple insured claims related to a single occurrence. The 2006 reinsurance contract provides for these same terms with API retaining 10% of the risk above the aforementioned $250,000 and $350,000 retention levels. The 2007 reinsurance contract provides for the same terms with API retaining 20% of the risk above the $250,000 and $350,000 retention levels. The reinsurance contracts for 2002 through 2007 contain variable premium ceding rates based on loss experience and thus, a portion of policyholder premium ceded to the reinsurers is calculated on a retrospective basis. The variable premium contracts are su bject to a minimum and a maximum premium range to be paid to the reinsurers, depending on the extent of losses actually paid by the reinsurers. A provisional premium is paid during the initial policy year. The actual percentage rate ultimately ceded under these contracts will depend upon the development of ultimate losses ceded to the reinsurers under their retrospective treaties.

To the extent that estimates for unpaid losses and loss adjustment expenses change, the amount of variable reinsurance premiums may also change. The ceded premium estimates are based upon management’s estimates of ultimate losses and loss adjustment expenses and the portion of those losses and loss adjustment expenses that are allocable to reinsurers under the terms of the related reinsurance contracts. Given the uncertainty of the ultimate amounts of losses and loss adjustment expenses, these estimates may vary significantly from the ultimate outcome. In addition to the in-depth review of reserves for unpaid losses and loss adjustment expenses, periodically, API also has its outside consulting actuary review development in the reinsurance layer or excess of $250,000 retention for each open variable premium treaty year. Management reviews these estimates and any adjustments necessary are reflected in the period in which the change in estimate is dete rmined. Adjustment to the premiums ceded could have a material effect on API’s results of operations for the period in which the change is made.

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Reinsurance Recoverables.  Ceded reserves for loss and loss adjustment expenses are recorded as reinsurance recoverables. Reinsurance recoverables are the estimated amount of future loss payments that will be recovered from reinsurers, and represent the portion of losses incurred during the period that are estimated to be allocable to reinsurers. There are several factors that can directly affect the ability to accurately forecast the reinsurance recoverables. Many of the factors discussed above related to the sensitivities of forecasting total loss and loss adjustment expense reserves also apply when analyzing reinsurance recoverables. Since API cedes excess losses above $250,000 on individual claims and $350,000 on multiple insured claims, the trends related to severity significantly affect this estimate. Current individual claims severity can be above or fall below API’s retention level over the period it takes to resolve a clai m. Furthermore, tort reform in Texas has been in effect since the latter part of 2003 and has lowered claim counts but the trends of severity payouts are only beginning to emerge.

Similar to the estimate for reserves, due to the long-tailed nature of the medical professional liability line of insurance, relatively small changes in the actuarial assumptions for trends, inflation, severity, frequency for projected ultimate loss and loss adjustment expense reserves can have a greater impact on the recorded balance for reinsurance recoverables than with most other property and casualty insurance lines. While we believe that our estimate for ultimate projected losses related to loss and loss adjustment expense is adequate based on reported and open claim counts, there can be no assurance that additional significant reserve enhancements will not be necessary in the future given the many variables inherent in such estimates and the extended period of time that it can take for claim patterns to emerge.

Reinsurance contracts do not relieve API from its obligations to policyholders. We continually monitor our reinsurers to minimize our exposure to significant losses from reinsurer insolvencies. Any amount found to be uncollectible is written off in the period in which the uncollectible amount is identified. As of September 30, 2007, all of our reinsurance contracts were with companies in strong financial condition, and management believes there is not a need to establish an allowance for uncollectible reinsurance recoverable. We have not experienced any material problems collecting from our reinsurers.

Stock-Based Compensation. In December 2004, the FASB issued a revision (“SFAS No. 123(R)”) to SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), and we were required to adopt SFAS No. 123(R) in the first quarter of 2006.  SFAS No. 123(R) supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25), and related Interpretations, and requires that all stock-based compensation, including options, be expensed at fair value, as of the grant date, over the vesting period.  Companies are required to use an option pricing model (e.g.: Black-Scholes or Binomial) to determine compensation expense, consistent with the model previously used in the already required disclosures of SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure. The adoption of SFAS No. 123(R) has not h ad a material effect on the Company’s financial position, operations or cash flow.

At September 30, 2007, we have several stock-based compensation plans, which are described more fully in Notes 12 and 13 to the audited consolidated financial statements contained in our most recently filed Annual Report on Form 10-K. Prior to January 1, 2006, we accounted for these plans under the recognition and measurement principles of APB No. 25, under which stock-based employee compensation cost was not reflected in net income, as all options granted under these plans had an exercise price equal to the market value of the underlying common stock on the date of grant.  In accordance with SFAS No. 123, as amended by SFAS No. 148, we provided footnote disclosure of the pro forma stock-based compensation cost, net loss and net loss per share as if the fair-value based method of expense recognition and measurement prescribed by SFAS No. 123 had been applied to all employee options.

Deferred Policy Acquisition Costs.    The costs of acquiring and renewing insurance business that vary with and are directly related to the production of such business are deferred and amortized ratably over the period the related unearned premiums and maintenance fees are earned. Such costs include commissions, premium taxes and certain underwriting and policy issuance costs. Deferred acquisition costs are recorded net of ceding commissions. Deferred policy acquisition costs are reviewed to determine if they are recoverable from future income, including investment income. If such costs are estimated to be unrecoverable, they are expensed in the period the determination is made.

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Income Taxes. We compute income taxes utilizing the asset and liability method. We recognize current and deferred income tax expense, which is comprised of estimated provisions for federal income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance against deferred tax assets is recorded if it is more likely than not that all or some portion of the benefits related to the deferred tax assets will not be realized. We have not established a valuation allowance because we believe it is more likely than not our deferred tax assets will be fully recovered.  In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (FIN 48), which we adopted on January 1, 2007. FIN 48 clarifies the accounting for income tax uncertainties. The company has developed and implemented a process based on the guidelines of FIN 48 to ensure that uncertain tax positions are identified, analyzed and properly reported in the company’s financial statements in accordance with SFAS 109. Based on all known facts and circumstances and current tax law, we believe that the total amount of unrecognized tax benefits as of January 1, and September 30, 2007, is not material to its results of operations, finan cial condition or cash flows. We also believe that the total amount of unrecognized tax benefits as of January 1, and September 30, 2007, if recognized, would not have a material effect on our effective tax rate. We further believe that there are no tax positions for which it is reasonably possible that the unrecognized tax benefits will significantly increase or decrease over the next 12 months producing, individually or in the aggregate, a material effect on our results of operations, financial condition or cash flows.

RESULTS OF OPERATIONS

With the acquisition of API on April 1, 2007, our consolidated revenue and earnings will be predominately derived from medical professional liability insurance provided through our Insurance Services segment. Prior to April 1, 2007, the historical results of operations of our Insurance Services segment were determined by the management fees we received from API pursuant to a management agreement and the expenses incurred in managing API’s operations such as personnel expenses, rent, office expenses and technology costs. The management agreement obligated API to pay management fees to us based on API’s earned premiums before payment of reinsurance premiums. The management fee percentage was 13.5% of API’s earned premiums. In addition, any pre-tax profits of API were shared equally with us (profit sharing) so long as the total amount of profit sharing did not exceed 3% of earned premiums. When we acquired API, our management agreement wi th API was terminated and our consolidated results of operations are no longer affected by management fees from API; but, rather our results of operations are now directly affected by premiums API earns from the sale of medical professional liability insurance, investment income earned on assets held by API, insurance losses and loss adjustment expenses relating to the insurance policies API writes as well as commissions and other insurance underwriting and policy acquisition expenses API incurs.

The following table sets forth selected historical financial and operating data for the Company. The results of operations for the nine months ended September 30, 2007 include the historical financial and operating results of the Company prior to and subsequent to the acquisition of API on April 1, 2007. The results of operations for the three months ended September 30, 2007 includes only the historical financial and operating results of the Company subsequent to the acquisition of API on April 1, 2007.  For comparative purposes, we have also included on a pro forma basis the results of operations for the three months ended and nine months ended September 30, 2007 and 2006 of the Company and API as if the acquisition had occurred on January 1, 2007 and 2006, respectively. Any reference in the MD&A Section below to “on a pro forma basis” is as if the Company acquired API on January 1, 2007 and 2006, respectively.  

The income statement data below for the three months and nine months ended September 30, 2007 and 2006, is derived from our consolidated unaudited financial statements which management believes incorporate all of the adjustments necessary for the fair presentation of the financial condition and results of operations for such periods. All information is presented in accordance with GAAP, but may not be comparable as data stated for periods 2006 and later were impacted by the implementation of SFAS No. 123(R). Actual financial results through September 30, 2007 may not be indicative of future financial performance. Equity compensation expense of approximately $1,200,000 related to our acquisition of API is included in the nine-month period ended September 30, 2007.

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	Three Months Ended September 30,				Three Months Ended September 30,				Nine Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006		2007		2006		2007		2006
	Actual		Actual		Pro forma		Pro forma		Actual		Actual		Pro forma		Pro forma
	(in thousands)
Income Statement Data:									< P>
Gross premiums and maintenance fees written - direct and assumed	$	22,239	$	-	$	22,239	$	24,121	$	37,284	$	-	$	52,749	$	61,560
Premiums ceded		504		-		504		(3,372)		3,922		-		1,515		(5,627)
Change in unearned premiums and maintenance fees		(5,112)		-		(5,112)		(5,666)		(3,129)		-		124		(3,527)
Net premiums and maintenance fees earned		17,631		-		17,631		15,083		38,077		-		54,388		52,406
Investment income, net of investment expenses		2,904		249		2,904		2,068		5,743		668		7,570		5,616
Realized capital gains (losses) - net		(3,195)		90		(3,195)		137		(3,659)		110		(3,452)		280
Management services		70		3,726		70		-		3,765		10,556		106		-
Financial services		5,434		3,048		5,434		2,913		17,623		11,383		17,316		11,032
Other revenue		35		12		35		65		69		65		84		254
Total revenues		22,879		7,125		22,879		20,266		61,618		22,782		76,012		69,588
Losses and loss adjustment expenses		4,624		-		4,624		10,243		7,786		-		18,750		28,465
Other underwriting expenses		3,262		-		3,262		3,631		5,696		-		9,053		9,536
Change in deferred policy acquisition costs		(444)		-		(444)		(427)		(287)		-		(146)		(356)
Management services expenses		-		3,147		-		-		3,823		8,548		-		-
Financial services expenses		4,907		2,914		4,907		2,905		15,599		10,359		15,674		10,348
General and administrative expenses		1,608		423		1,608		642		3,800		1,421		3,934		1,750
Loss from impairment of goodwill		-		-		-		-		1,247		-		1,247		1,247
Total expenses		13,957		6,484		13,957		16,994		37,664		20,328		48,512		50,990
Income from operations		8,922		641		8,922		3,272		23,954		2,454		27,500		18,598
Federal income tax expense (benefit)		3,630		232		3,630		1,170		8,949		883		10,141		6,394
Minority interests		-		-		-		-		1		2		1		2
Net income before extraordinary gain	$	5,292	$	409	$	5,292	$	2,102	$	15,004	$	1,569	$	17,358	$	12,202
Extraordinary gain		-		-		-		-		2,264		-		2,264		-
Net income	$	5,292	$	409	$	5,292	$	2,102	$	17,268	$	1,569	$	19,622	$	12,202
Loss ratios (1) & (4)
Current accident year		44%		-		44%		68%		-		-		56%		58%
Prior years		-18%		-		-18%		0%		-		-		-21%		-3%
Calendar year		26%		-		26%		68%		-		-		35%		55%
Expense ratio (2) & (4)		16%		-		16%		21%		-		-		16%		18%
Combined ratio (3) & (4)		42%		-		42%		89%		-		-		51%		73%

(1)    Loss ratio is defined as the ratio of losses and loss adjustment expenses to net premiums and maintenance fees earned.

(2)    Expense ratio is defined as the ratio of other underwriting expenses and net change in deferred acquisition costs to net premiums and maintenance fees earned.

(3)    Combined ratio is the sum of the loss ratio and the expense ratio.

(4)    Ratios are not applicable for the three months ended September 30, 2006 Actual Column and the nine months ended September 30, 2007 and 2006 Actual Columns as the acquisition of API occurred on April 1, 2007.

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	As of September 30, 2007		As of December 31, 2006
	Historical		Historical		Pro forma
Balance Sheet Data:
Cash and cash equivalents and investments	$	221,824	$	27,161	$	172,215
Premiums and maintenance fees receivable		19,134		-		16,493
Reinsurance recoverables		25,934		-		28,491
All other assets		15,986		9,115		22,006
Total assets		282,878		36,276		239,205
Reserve for losses and loss adjustment expenses		104,858		-		110,089
Unearned premiums and maintenance fees		39,677		-		39,786
All other liabilities		22,575		6,687		25,562
Total liabilities		167,110		6,687		175,437
Minority interest		-		21		21
Total shareholders' equity	$	115,768	$	29,568	$	63,747

The discussion that follows should be read in connection with the unaudited Condensed Financial Statements and Notes thereto included elsewhere in this report. For additional information regarding the pro forma results of operations of the Company and API had the transaction occurred on January 1, 2007 and 2006, respectively, please see Note 3 to the Unaudited Financial Statements.

Revenues increased $15,754,000 (221%) to $22,879,000 from $7,125,000 and increased $38,836,000 (170%) to $61,618,000 from $22,782,000 for the three month and nine month periods ended September 30, 2007, respectively, compared to the same periods in 2006. Our income from operations increased $8,281,000 (1,292%) to $8,922,000 from $641,000 and increased $21,500,000 (876%) to $23,954,000 from $2,454,000 in the three and nine month periods ended September 30, 2007, respectively, compared to the same periods in 2006. Our net income increased $4,883,000 (1,194%) to $5,292,000 from $409,000 and increased $15,699,000 (1,001%) to $17,268,000 from $1,569,000 in the three and nine month periods ended September 30, 2007, respectively, compared to the same periods in 2006. Lastly, our diluted net income per share increased $0.59 (421%) to $0.73 from $0.14 and increased $2.84 (538%) to $3.37 from $0.53 in the three and nine month periods ended September 30, 2007, respe ctively, compared to the same periods in 2006. The explanations for these changes are described below.

Gross premiums and maintenance fees written. Gross premiums and maintenance fees written increased to $22,239,000 and $37,284,000 from $0 for the three and nine months ended September 30, 2007, respectively, as compared to the same periods in 2006 as a result of the acquisition of API on April 1, 2007.  On a pro forma basis, gross premiums and maintenance fees written decreased $1,882,000 (8%) to $22,239,000, from $24,121,000 and $8,811,000 (14%) to $52,749,000 from $61,560,000 for the three and nine month periods ended September 30, 2007, respectively, compared to the same periods in 2006. While API increased in the number of policyholders to 4,967 at September 30, 2007 from 4,578 at September 30, 2006, gross premiums and maintenance fees written decreased due to rate decreases which averaged 13% and 16% for the three and nine months ended September 30, 2007.

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Premiums Ceded. Premiums ceded decreased to $504,000 and $3,922,000 from $0 for the three and nine months ended September 30, 2007, as compared to the same periods in 2006 as a result of the acquisition of API on April 1, 2007. On a pro forma basis, premiums ceded expenses decreased $3,876,000 to $504,000 from ($3,372,000) and $7,142,000 to $1,515,000 from ($5,627,000) for the three and nine months ending September 30, 2007, respectively, as compared to the same periods in 2006. The reinsurance contracts beginning in 2002 through 2007 are variable premium treaties that have various minimum and maximum rates. The actual premium rate will depend upon the ultimate losses ceded to the reinsurer under the related treaty. The Company, supported periodically by outside consulting actuarial reviews, continually monitors the development of claims subject to reinsurance and adjusts premiums ceded for estimated profit sharing provisions based on claims development in the reinsurance layers. The pro forma decrease in premiums ceded of $3,876,000 and $7,142,000 for the three months and nine months ended September 30, 2007, as compared to the same period in 2006, is primarily the result of lower estimated ceding rates due to lower estimated loss and loss adjustment expenses for prior treaty years 2002 through 2006. This prior year favorable development in the reinsurance layer resulted in us recognizing $2,435,000 and $8,071,000 as a reduction to ceded premiums in the three and nine months ended September 30, 2007 as compared to $0 and $4,310,000 of prior year favorable development in the pro forma three and nine months ended September 30, 2006. Based on lower claims frequency than anticipated for the current 2007 treaty, the Company recognized $305,000 as an additional reduction of ceded premium during the current quarter. Additionally, API increased its participation in the excess loss treaty from 10% in 2006 to 20% of any claim in excess of  $250,000 on individual claims and $350,000 on multiple insured claims in 2007, which resulted in a lower cost of reinsurance than in 2006. API increased its retention in 2006 and 2007 based on decreases in claims experience since the passage of tort reform legislation in 2003.

Net Premiums and Maintenance Fees Earned.  Net premiums and maintenance fees earned increased by $17,631,000 and $38,077,000 from $0 for the three and nine months ended September 30, 2007 as compared to the same periods in 2006 as a result of the acquisition of API on April 1, 2007. On a pro forma basis, net premiums and maintenance fees earned increased by $2,548,000 (17%) to $17,631,000 from $15,083,000 and increased by $1,982,000 (4%) to $54,388,000 from $52,406,000 for the three and nine months ended September 30, 2007 as compared to the same periods in 2006. The increase for the three and nine months ending September 30, 2007 as compared to the same periods in 2006 was mainly due to favorable development of $2,435,000 and $8,071,000, respectively, on the 2002-2006 variable premium reinsurance treaties offset by average rate decreases of 13% and 16% for the three and nine months ended September 30, 2007 , respectively.

Investment Income.  Investment income, net of investment expenses increased by $2,655,000 (1,066%) to $2,904,000 from $249,000 and $5,075,000 (760%) to $5,743,000 from $668,000 for the three and nine months ended September 30, 2007, respectively, as compared to the same periods in 2006 as a result of the acquisition of API on April 1, 2007. On a pro forma basis, investment income, net of investment expenses, increased by $836,000 (40%) to $2,904,000 from $2,068,000 and increased $1,954,000 (35%) to $7,570,000 from $5,616,000 for the three and nine months ended September 30, 2007 as compared to the same periods for 2006. On a pro forma basis, invested assets increased by $71,022,000 (53%) to $206,241,000 at September 30, 2007 from $155,617,000 at September 30, 2006 resulting in the increase in investment income. The increase in invested assets resulted primarily from the use of proceeds of our common stock offering as well as from positive net cash flow from operating activities.

Realized Capital Gains (Loss). Realized capital losses increased by $3,285,000 to $3,195,000 from a gain of $90,000 and increased $3,769,000 to $3,659,000 from a gain of $110,000 for the three and nine months ended September 30, 2007 as compared to the same periods of 2006. On a pro forma basis, realized capital losses increased by $3,332,000 to $3,195,000 from a gain of $137,000 and increased $3,732,000 to $3,452,000 from a gain of $280,000 for the three and nine months ended September 30, 2007, respectively, as compared to same periods in 2006. The increase in losses for the three and nine month periods ended September 30, 2007 as compared to the same periods in 2006 is primarily due to other than temporary impairment charges of $3,140,000 in the three months ended September 30, 2007, resulting from fair market value declines in our investment in Alt-A collateralized mortgage-backed securities. See Note 5 to the condensed consolidated fina ncial statements for a more detailed explanation of this other-than temporary impairment of these securities.

Management Services Revenue. Prior to the acquisition of API, the historical results of operations of our insurance services segment were determined by the management fees we received from API pursuant to a management agreement and the expenses incurred in managing API’s operations. In conjunction with the merger with API on April 1, 2007, our management agreement was terminated as of March 31, 2007 and as such is no longer included in our consolidated results of operations. Management services revenue decreased by $3,656,000 to $70,000 from $3,726,000 and decreased $6,791,000 to $3,765,000 from $10,556,000 for the three and nine months ended September 30, 2007, respectively, compared to the same periods in 2006. As a result of our acquisition of API, we recorded management fee revenue including the contingent management fee only through the quarter ended March 31, 2007. However, comp arable periods for the three months and nine months ended September 30, 2006 include management fee revenue on an annual basis.

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Financial Services Revenues. Our financial services revenue increased $2,386,000 (78%) to $5,434,000 from $3,048,000 and increased $6,240,000 (55%) to $17,623,000 from 11,383,000 in the three and nine month periods ended September 30, 2007, respectively, compared to the same periods in 2006.  The increases in both current year periods were primarily the result of higher commission revenues earned at APS Financial, the broker/dealer, which derives most of its revenue from transactions in the fixed income market, in both investment and non-investment grade securities.  Commission revenues increased $1,804,000 (84%) and $5,199,000 (67%) in the three and nine month periods ended September 30, 2007, respectively, compared to the same periods in 2006.  Revenue from our trading in mortgage related securities picked up during the quarter as a result of the well publicized problems in the residential loan market.  Some investors i n this asset class liquidated positions, while others viewed the current market conditions as an opportunity to invest at distressed price levels.  Revenue from trading of corporate high yield bonds was also satisfactory during the third quarter due to customer activity in investments of certain distressed and bankrupt companies.  Also contributing to our increased revenues was the continued growth of transactions in bank debt and trade claims which increased $551,000 (160%) to $896,000 from $345,000 and $1,691,000 (143%) to $2,870,000 from $1,179,000 for the three and nine month periods ended September 30, 2007, respectively, compared to the same periods in 2006.

Loss and Loss Adjustment Expenses.  As a result of the acquisition of API on April 1, 2007, loss and loss adjustment expenses increased to $4,624,000 and $7,786,000 from $0 for the three and nine months ended September 30, 2007, respectively, as compared to the same periods in 2006. On a pro forma basis, loss and loss adjustment expenses for the three months ended September 30, 2007 decreased by $5,619,000 (55%) to $4,624,000 from $10,243,000 for the three months ended September 30, 2006. The decrease of $5,619,000 on a pro forma basis is the result of a lower accident year loss and loss adjustment expense and higher favorable development on prior year losses as compared to 2006. For the three months ended September 30, 2007, current accident year loss and loss adjustment expenses totaled $7,789,000 based on 89 claims reported and prior year losses developed favorably $3,165,000 as a result of reductions in our estimates of cl aims severity, principally the 2002 through 2006 report years. For the three months ended September 30, 2006, current accident year loss and loss adjustment expenses were $10,259,000 based on 160 claims reported and there was $21,000 favorable development for the three months ended. On a pro forma basis, for the nine months ended September 30, 2007, loss and loss adjustment expenses decreased by $9,715,000 (34%) to $18,750,000 from $28,465,000 for the nine months ended September 30, 2006. The decrease on a pro forma basis is the result of higher favorable development on prior year losses of $11,556,000 for the nine months ended September 30, 2007 as compared to $1,735,000 of favorable development on prior year losses for the nine months ended September 30, 2006. The effects of 2003 tort reform in Texas on average claim severity post-reform are emerging favorably and resulting in improved claim development patterns. Since the passage of reform, API has favorably settled a number of post-tort reform claims from the 2004 and 2005 report years. On a pro forma basis, even though reported claims have decreased for the nine months ended September 30, 2007 by 123 to 286 from 409 for the nine months ended September 30, 2006, our current 2007 accident year loss and loss adjustment expenses remains comparable to the 2006 accident year. We continue to accrue our current accident year losses conservatively based on increases in policyholder count from 4,578 as of September 30, 2006 to 4,967 as of September 30, 2007.

We continually review and update the data underlying the estimation of the loss and loss adjustment expense reserves and make adjustments that we believe the emerging data warrant. Any adjustments to reserves that are considered necessary are reflected in the results of operations in the period the estimates are changed. As of September 30, 2007, we continue to reserve at the upper end of the reserve range.

Other Underwriting Expenses and Net Change in Deferred Acquisition Costs.  Other underwriting expenses increased to $3,262,000 and $5,696,000 from $0 for the three and the nine months ended September 30, 2007, respectively, as compared to the same periods in 2006 as a result of the acquisition of API on April 1, 2007. On a pro forma basis, other underwriting expenses decreased by $369,000 (10%) to $3,262,000 from $3,631,000 and decreased $483,000 (5%) to $9,053,000 from $9,536,000 for the three months and the nine months ended September 30, 2007, respectively, as compared to the same periods in 2006. Other underwriting expenses consist primarily of commissions to agents, premium taxes and other general underwriting expenses related to managing our insurance services segment. The pro forma decrease of $369,000 and $483,000 for the three and nine months ended September 30, 2007, respectively as compared to the same periods for Septem ber 30, 2006, is mainly attributable to conversion and higher merger related expenses and agent commissions in the prior year period as compared to the current year. Net change in deferred acquisition costs decreased to $(444,000) and $(287,000) from $0 for the three months and the nine months ended September 30, 2007, respectively, as compared to the same periods in 2006 as a result of the acquisition of API on April 1, 2007.  On a pro forma basis, the net change in deferred acquisition costs, which is comprised of the change in deferred and amortized commissions paid to agents on new and renewal business and deferred and amortized premium taxes, decreased for three months ending September 30, 2007 by $17,000 (4%) to $(444,000) from $(427,000) for the comparable period in 2006 due to the new costs capitalized exceeding amortization of expenses. Deferred acquisition costs increased for nine months ending September 30, 2007, by $210,000 (59%) to $(146,000) from $(356,000) for the comparable period i n 2006 due to the amortization of expenses exceeding new costs capitalized.

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Management Service Expenses. Prior to the acquisition of API, the historical results of operations of our insurance services segment were determined by the management fees we received from API pursuant to a management agreement and the expenses incurred in managing API’s operations.  In conjunction with the merger with API on April 1, 2007, our management agreement was terminated as of March 31, 2007 and as such is no longer included in our consolidated results of operations. Thus, as a result of the merger, insurance management services expenses decreased by $3,147,000 (100%) to $ 0 from $3,147,000 and $4,725,000 (55%) to $3,823,000 from $8,548,000 in the three and nine month periods ended September 30, 2007, respectively, compared to the same periods in 2006. Insurance services expenses were recorded only through the quarter ended March 31, 2007. However, comparable periods for the three months and nine mont hs ended September 30, 2006 include insurance services expenses on an annual basis.  

Financial Services Expenses. Our financial services expenses increased $1,993,000 (68%) to $4,907,000 from $2,914,000 and increased $5,240,000 (51%) to $15,599,000 from $10,359,000 in the three and nine month periods ended September 30, 2007, respectively, compared to the same periods in 2006. The primary reason for the current year increase is a $1,427,000 (86%) and $4,011,000 (64%) increase in commission expense in the current year three and nine month periods, respectively, compared to the same periods in 2006. This resulted from the increase of commissions paid on non-investment grade bond and trade claim transactions mentioned above. In addition, incentive compensation costs increased $62,000 (36%) and $659,000 (122%) in the current three and nine months, respectively, as a result of increased profits and surpassing certain minimum thresholds earlier in the year. Legal and professional expenses were higher by $101,000 (77%) and $25 0,000 (98%) for the current year three and nine months, respectively, due to costs incurred for litigation concerning certain transactions and for expenses to further our efforts to become compliant with the Sarbanes-Oxley Act of 2002. In addition, a claim was settled in the current period in the amount of $160,000 resulting from a disputed trade claim transaction.

General and Administrative Expenses. General and administrative expenses increased $1,185,000 (280%) to $1,608,000 from $423,000 and increased $2,379,000 (167%) to $3,800,000 from $1,421,000 in the three month and nine month periods ended September 30, 2007, respectively, compared to the same periods in 2006. The increase in general and administrative expenses in the current quarter includes higher salaries of $144,000 or 82% resulting from our hiring a new Chief Operating Officer and new administrative assistant in April of 2007; higher incentive compensation of $171,000 or 131%, a formula-driven expense that is higher in 2007 due to the large increase in net earnings; higher board fees of $265,000 or 2,263% resulting from deferred compensation awarded as a result of the successful merger as well as due to a greater number of directors and a greater number of board meetings necessitated by the merger with API and th e common stock secondary offering; higher professional fees of $181,000 or 337% resulting from internal control expenditures to further our efforts to become compliant with the Sarbanes-Oxley Act of 2002; and higher interest of $281,000 resulting from interest and preferred stock dividends due to our preferred share holders. The increase in general and administrative expenses for the nine months ended September 30, 2007, current year includes higher salaries of $252,000 or 48%; higher incentive compensation of $679,000 or 178%; higher board fees of $415,000 or 470%; higher legal and professional of $284,000 or 174%; and higher interest expense of $379,000. All of the explanations provided for the current quarter variances apply to the nine month variances.

Loss from Impairment of Goodwill. Goodwill arose upon the repurchase of an interest in APS Insurance Services from a minority holder in 2003. Goodwill was determined to exist based on earnings expected to be generated from the management agreement with API. With our purchase of API and termination of the management agreement the question of impairment of the goodwill was raised. Upon review, we determined that the original circumstances creating the goodwill no longer existed and that the entire $1,247,000 balance was impaired. The goodwill was written off in the quarter ended June 30, 2007.

Minority Interest. The 3% minority interest in Asset Management, a subsidiary within our financial services segment, owned by key individuals within Asset Management, was repurchased by APS Investment Services in the current quarter for a nominal amount.  

Extraordinary Gain. Our extraordinary gain represents the excess of the assets received over the costs to acquire all of the issued and outstanding stock of API. The business combination is being accounted for using the purchase method of accounting and, accordingly, the purchase price has been allocated to assets acquired and liabilities assumed based on fair values at April 1, 2007, the date of acquisition. The total purchase price was approximately $45,167,000 and consisted of consideration of 1,982,499 shares of the Company’s common stock, valued at a per share price of $17.635, or $34,961,000 in aggregate, $35,000 in cash paid in lieu of fractional shares of common stock, 10,197.95 shares of preferred stock valued at $9,179,000, plus costs to complete the acquisition of $992,000. The net fair value of the assets acquired and the liabilities assumed was $47,431,000. The resulting excess of assets received over costs to acquire was r ecorded as an extraordinary gain in accordance with SFAS No. 141, “Accounting for Business Combinations”

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LIQUIDITY AND CAPITAL RESOURCES

The primary sources of our liquidity for the nine months ended September 30, 2007, are funds provided by insurance premiums collected, net investment income, recoveries from reinsurers and proceeds from the maturity and sale of invested assets and principal receipts from our mortgage-backed securities. In addition, a large non-recurring source of funds in 2007 resulted from our secondary common stock offering of 2,315,000 shares. The primary uses of cash are losses from insurance claims, loss adjustment expenses, operating expenses, the acquisition of invested assets and fixed assets, reinsurance premiums and federal income taxes.

Cash Flows. Our total cash and cash equivalents balance at September 30, 2007, was $14,788,000, an increase of $10,546,000 (249%) in the current year as cash provided by operating and financing activities more than offset net cash used in investing activities. Our cash flows provided from operating activities totaled $7,043,000 for the current year on the strength of net income before extraordinary gains of $15,004,000. Our Insurance Services segment generated the bulk of the cash received from operating activities, the result of increased premium and maintenance fee receipts and decreased claims payouts. Cash provided by financing activities contributed $32,342,000 for the nine months ended September 30, 2007 as a result of cash received from our secondary offering of common stock totaling approximately $30,237,000 as well as cash received from an over-allotment sale of an additional 315,000 shares which contributed another $4,846,000. Part ially offsetting this was a dividend paid to our common stock shareholders ($1,416,000) and a partial redemption of our preferred stock ($1,018,000). Our cash flows used in investing activities totaled $28,839,000 in 2007 primarily as a result of purchases of available-for-sale fixed income securities in excess of proceeds from their sale. Partially offsetting this use of cash from investing activities was cash totaling $9,910,000 received as part of the assets acquired from our acquisition of API. For details of the amounts described above, refer to the Condensed Consolidated Statements of Cash Flows on page 7 of this Form 10-Q.

Historically, we have maintained a strong working capital position and, as a result, we have been able to satisfy our operational and capital expenditure requirements with cash generated from our operating and investing activities. These same sources of funds have also allowed us to pursue investment and expansion opportunities consistent with our growth plans. Although there can be no assurance our operating activities will provide positive cash flow for the remainder of 2007, we are optimistic that our working capital requirements will be met for the foreseeable future for the following reasons: (1) our current cash position is very strong, with a balance of approximately $15,000,000; (2) a large portion of our approximate $206,000,000 investment portfolio is in short-term, highly liquid bonds and other fixed income securities, and (3) we renewed a line of credit in April 2007 that is described below.

Line of Credit. We renewed a $3,000,000 line of credit that was originally established in November 2003 with PlainsCapital Bank. The line of credit calls for interest payments only to be made on any amount drawn until April 15, 2008, when the entire amount of the line of credit, principal and interest then remaining unpaid, becomes due and payable. At September 30, 2007, there had never been any advances taken against this line of credit. We are in compliance with the covenants of the loan agreement, including requirements for a minimum of $5,000,000 of unencumbered liquidity and a minimum 2 to 1 net worth ratio.

Capital Expenditures. In April 2007 we entered into a contract with a vendor to provide us with, and assist in the implementation of an integrated policy and claims administration system. The total cash outflow for the project is anticipated to be approximately $2,100,000 over the next 15 to 18 months.  Our capital expenditures for equipment were $710,000 in the first nine months of 2007 of which approximately $449,000 were expenditures related to the initial phase of this software implementation project. We expect capital expenditures for the remainder of 2007 to be approximately $600,000 for this system upgrade project and are expected to be funded through cash on hand.

Restrictions on Dividends by API. In addition to restrictions on dividends and distributions applicable to all Texas stock insurance companies, for so long as any Series A redeemable preferred stock is outstanding, the Texas Department of Insurance prohibits API from paying dividends to us in any fiscal year unless and until we have complied with our redemption and dividend payment obligations to the holders of our Series A redeemable preferred stock for that year. We have also agreed that, without prior approval of the Texas Department of Insurance, aggregate annual distributions to us in respect of API’s capital stock may not exceed the lesser of 10% of API’s prior year-end policyholder statutory earned surplus or API’s prior year net income, and in no event may exceed API’s statutory earned surplus.

Escrow Account. In connection with the API acquisition, the Texas Department of Insurance has required us to place $2,500,000 into an escrow account with a bank, to remain in escrow until the aggregate remaining redemption and dividend obligation relating to our Series A redeemable preferred stock is less than the amount of the escrow balance. No withdrawals may be made from this escrow account without prior approval from the Texas Department of Insurance.

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ADOPTION OF RECENT ACCOUNTING PRONOUNCEMENTS

In February 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards, or SFAS, No. 155, Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statement Nos. 133 and 140. SFAS No. 155 becomes effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. This Statement permits fair value remeasurement for 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 No. 133; 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; clarifies that concentrations of cr edit risk in the form of subordination are not embedded derivatives; and amends Statement 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. We do not expect the adoption of this standard to have a material effect on our financial position, results of operations or cash flows.

In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (FIN 48), which we adopted on January 1, 2007. FIN 48 clarifies the accounting for income tax uncertainties. The company has developed and implemented a process based on the guidelines of FIN 48 to ensure that uncertain tax positions are identified, analyzed and properly reported in the company’s financial statements in accordance with SFAS 109. Based on all known facts and circumstances and current tax law, we believe that the total amount of unrecognized tax benefits as of January 1, and September 30, 2007 is not material to its results of operations, financial condition or cash flows. We also believe that the total amount of unrecognized tax benefits as of January 1, and September 30, 2007, if recognized, would not have a material effe ct on its effective tax rate. We further believe that there are no tax positions for which it is reasonably possible that the unrecognized tax benefits will significantly increase or decrease over the next 12 months producing, individually or in the aggregate, a material effect on the company’s results of operations, financial condition or cash flows.

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards, or SFAS No. 157, “Accounting for Fair Value Measurements”, effective for fiscal years beginning after November 15, 2007. This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP) and expands disclosures about fair value measurements. Accordingly, this Statement does not require any new fair value measurements. However, for some entities, the application of this Statement will change current practice. We do not expect the adoption of this standard to have a material effect on our financial position, results of operations or cash flows.

In February, 2007 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards, or SFAS, No. 159, “Accounting for the Fair Value Option for Financial Assets and Financial Liabilities” an amendment of FASB Statement No. 115. This Statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. We do not expect the adoption of this standard to have a material effect on our financial position, results of operations or cash flows.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are principally exposed to three types of market risk related to our investment operations, including credit risk, interest rate risk, and equity price risk. The term market risk refers to the risk of a loss arising from adverse changes in market rates and prices such as interest rates, credit risk, equity prices and foreign currency exchange rates.

We invest our assets primarily in fixed-maturity securities, which as of September 30, 2007 and December 31, 2006 comprised approximately 94% and 79% of total investments at market value. As of September 30, 2007 and December 31, 2006, the fair value of investments in fixed maturity securities was $194,156,000 and $16,636,000. The significant increase in fixed-income maturities is the result of the acquisition of API on April 1, 2007.

The fixed-income maturities consist predominately of investment grade U.S. government agency and non-agency collateralized mortgage obligations and U.S. government agency mortgage-backed bonds for the purpose of generating ample cash flow to meet claim funding requirements while maintaining a reasonable investment yield.  

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We have exposure to credit risk primarily as a holder of fixed-income securities. We control this exposure by emphasizing investment grade quality in the fixed-income securities we purchase. At September 30, 2007 and at December 31, 2006, substantially all of our fixed-income portfolio consisted of investment grade securities. We believe that this concentration of investment grade securities limits our exposure to credit risk on our fixed-income investments.

Of our entire invested assets, including cash, agency-backed mortgage obligations, with underlying collateral consisting of GNMA, FHLMC, or FNMA loans comprise 38% of our portfolio; non-agency collateralized mortgage obligations comprise 23% of our portfolio; and the remaining 39% is comprised of U.S. Treasury, government agency bonds and notes, municipal tax exempt bonds, corporate bonds and equities.  The majority of the non-agency CMO’s in our portfolio have underlying mortgages categorized as “Prime” quality loans, and none of our CMO’s have underlying mortgages classified as “Subprime.” However, within our portfolio there are eleven CMO securities classified as “Alternative-A” or “Alt-A.”  These Alt-A securities are generally considered to have underlying mortgages with underwriting characteristics that are stronger than “Subprime” mortgages but less stringent than “Prime” ; mortgages. All of our Alt-A securities are investment grade, currently rated either AAA, AA or A.

During the three months ended September 30, 2007, we saw a significant and rapid decline in the market value of our Alt-A securities, particularly those with an A rating. In evaluating this decline, combined with the deepening national housing crisis and its potential effects on the underlying collateral, we have concluded that the decreases in value of our A rated Alt-A securities should be considered to be “other than temporary” as defined in Statements of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities. The amount of the pretax charge to earnings associated with this adjustment for the three months ended September 30, 2007, is $3,140,000 bringing our total carrying value in Alt-A securities to $13,904,000 from $17,044,000 as of September 30, 2007. While we to have the ability and intent to hold all of our Alt-A securities indefinitely, we will continue to monitor and ev aluate these securities and their underlying collateral.

The value of the fixed-income maturities are also subject to interest rate risk. As market interest rates decrease, the value portfolio increases with the opposite holding true in rising interest rate environments. All of our fixed income securities are designated as available-for-sale and, accordingly, are presented at fair value on our balance sheets. Fixed rate securities may have their fair market value adversely affected due to a rise in interest rates, and we may suffer losses in principal if forced to sell securities that have declined in market value due to changes in interest rates. We believe we are in a position to keep our fixed-income investments until maturity since we do not invest in fixed maturity securities for trading purposes.

Equity securities comprised approximately 5% and 21.0% of total investments at market value as of September 30, 2007 and December 31, 2006, respectively. As of September 30, 2007 and December 31, 2006, the fair value of investments in equity securities was $10,154,000 and $4,403,000, respectively.

Equity securities are subject to equity price risk, which is defined as the potential for loss in market value due to a decline in equity prices. The value of common stock equity investments is dependent upon the general conditions in the securities markets and the business and financial performance of the individual companies in the portfolio. Values are typically based on future economic prospects as perceived by investors in the equity markets. We regularly review the carrying value of our investments and identify and record losses when events and circumstances indicate that such declines in the fair value of such assets below our accounting basis are other-than-temporary.

An additional impairment charge was taken in the current quarter on our investment in Financial Industries Corporation (“FIC”) having previously resolved that declines in FIC’s stock price will be considered to be “other than temporary” as defined in Statements of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities. Our policy in regards to our investment in FIC is that we will record pretax charges to earnings should the common stock price on the last day of each interim or annual period fall below the adjusted cost basis of our investment in FIC. During the three months ended September 30, 2007, that charge totaled $39,000, bringing the total amount written off in 2007 to $693,000. As a consequence of these write-downs, our basis in this stock has declined to $5.80 per share which equals the fair market value of FIC common stock at September 30, 2007. While we co ntinue to have the ability and the intent to hold the stock indefinitely, we concluded that the additional uncertainty created by FIC’s late SEC filings, together with its continued de-listing from any national stock exchanges, dictated that the current quarter decline should be viewed as other than temporary. We will continue to monitor and evaluate the situation at FIC.

The remainder of the investment portfolio consists of cash and highly liquid short-term investments.

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As mentioned above, our invested assets are subject to interest rate risk and equity price risk. The following table presents the effect as of September 30, 2007 on current estimated fair values of the fixed-maturity securities available-for-sale and equity securities assuming a 100-basis point (1%) increase in market interest rates and a 10% decline in equity prices.

	Carrying Value		Estimated Fair Value at Current Market Rates/Prices		Estimated Fair Value at Adjusted Market Rates/Prices (1)
			(in thousands)
Interest rate risk:
Fixed-maturities; available for sale	$	194,156	$	194,156	$	182,419
Equity price risk:
Equity securities		10,154		10,154		9,139

(1)

Adjusted rates assume a 100 basis point (1%) increase in market rates for fixed rate securities and a 10% decline in equity market values.

For all our financial assets and liabilities, we seek to maintain reasonable average durations, consistent with the maximization of income, without sacrificing investment quality and providing for liquidity and diversification.

The estimated fair values at current market rates for financial instruments subject to interest rate risk and equity price risk in the table above are the same as those included elsewhere herein. The estimated fair values are calculated using simulation modeling based on the most likely outcome, assuming a 100-basis point shift in interest rates.

This sensitivity analysis provides only a limited, point-in-time view of the market risk sensitivity of certain of our financial instruments. The actual impact of market interest rate and price changes on the financial instruments may differ significantly from those shown in the sensitivity analysis. The sensitivity analysis is further limited, as it does not consider any actions that we could take in response to actual and/or anticipated changes in interest rates and equity prices.

We are also subject to credit risk with respect to our reinsurers. Although our reinsurers are liable to us to the extent we cede risk to them, we are ultimately liable to our policyholders on all risks we have reinsured. As a result, reinsurance agreements do not limit our ultimate obligations to pay claims to policyholders and we may not recover claims made to our reinsurers.

Additionally, our revenues generated through commissions at our financial services segment also expose us to market risk. Changes in interest rates could have an impact at our broker/dealer subsidiary, APS Financial. The general level of interest rates may trend higher or lower, and this move may impact our level of business in different fixed-income sectors. If a generally improving economy is the impetus behind higher rates, then while our investment grade business may drop off, our high yield business might improve with improving credit conditions. A volatile interest rate environment could also impact our business as this type of market condition can lead to investor uncertainty and their corresponding willingness to commit funds.

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ITEM 4.  CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurances of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. As of the end of the period covered by this report, and under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of these disclosure procedures. Based on this evaluation and subject to the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective in reaching a reasonable level of assurance of achieving management’s desired controls and procedures objectives.

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

As part of a continuing effort to improve our business processes we are evaluating our internal controls and may update certain controls to accommodate any modifications to our business processes or accounting procedures.

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PART II

OTHER INFORMATION

ITEM 1.  Legal Proceedings

We are involved in various claims and legal actions that have arisen in the ordinary course of business. Management believes that any liabilities arising from these actions will not have a significant adverse effect on our financial condition or results of operations.

ITEM 1A.  Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A. Risk Factors in our Quarterly Report on Form 10-Q for the period ended June 30, 2007, and our Registration Statement on Form S-1, which became effective on June 20, 2007, which could materially affect our business, financial condition or future results. The risks described in those reports are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial could have a material adverse effect on our business, financial condition and results of operations.

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

Items 2(a) through (d) are inapplicable.

(e)  Stock Repurchases for the three months ended September 30, 2007:

Period	(a) Total Number of shares Purchased (1)	(b) Average Price Paid Per Share		(c)  Total Number  of Shares Purchased as Part of Publicly Announced Plans or Programs	(d)  Maximum Dollar Value of Shares that May yet be Purchased under the Plans or Programs (2)
July 1, 2007 – July 31, 2007	-0-	$	-0-	-0-	$	1,053,000
Aug 1, 2007 – Aug 31, 2007	1,023	$	17.60	1,023	$	1,035,000
Sept 1, 2007 – Sept 30, 2007	1,000	$	18.05	1,000	$	2,017,000

(1)

All of the total shares purchased were purchased in open market transactions.

(2)

Our original share repurchase program was announced August 17, 2004, was increased in $2,000,000 increments on December 12, 2005 and on June 30, 2006 and by $1,000,000 on September 7, 2007. As of September 30, 2007, we have a maximum dollar value of $2,017,000 remaining for the future purchase of shares under the Stock Repurchase program.

Our open market stock repurchases are made in reliance upon Rule 10b-18 of the Exchange Act safe harbor from certain market manipulation claims for purchases by an issuer of its own common stock. Under this rule, we may not open trading in our shares, may not trade in the last thirty minutes of the trading session, may bid no more than the current bid or last trade, and may purchase no more in a single day than 25% of the average daily trading volume for the last four calendar weeks, unless certain rules for larger block trades are followed. Our stock option plan allows us to accept shares owned by an optionee immediately prior to the exercise of an option in payment for the option exercise. Additionally, we consider unsolicited offers to sell shares back to us and make a decision on purchasing them based on the price and our business needs at the time of the offer. We give priority in our repurchases to shares offered in option exercises, followed by ope n market purchases and finally unsolicited offers from shareholders. We do not reissue any shares acquired in repurchases, instead canceling them upon acquisition.

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ITEM 3.  Defaults Upon Senior Securities

Not Applicable

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

There were no matters submitted to vote to security holders during the three months ended September 30, 2007.

ITEM 5.  Other Information

Not Applicable

ITEM 6.  Exhibits

1.1

Underwriting Agreement to sell 2.3 million shares of the Company’s common stock. (2)

3.2

Amended and Restated Bylaws of American Physicians Service Group, Inc. adopted September 7, 2007 (4)

10.1

Managing General Agency Agreement dated April 1, 2007 between American Physicians Service Group, Inc. and American Physicians Insurance Agency. (1)

10.2

Advisory Services Agreement dated April 1, 2007 between API Advisory, LLC and American Physicians Service Group, Inc. (1)

10.3

Order by Texas Department of Insurance dated January 26, 2007 approving the conversion from a reciprocal exchange to a stock insurance company and merger agreement. (1)

10.4

Order by Texas Department of Insurance dated April 2, 2007 approving the Articles of Incorporation of American Physicians Insurance Company. (1)

10.5

Excess of Loss Reinsurance contract effective January 1, 2007 between American Physicians Insurance Exchange and the Reinsurers. (2)

10.6

Revolving Promissory Note dated April 15, 2007 between American Physicians Service Group, Inc. and PlainsCapital Bank. (3)

10.7

Amendment to 2005 Incentive and Non-Qualified Stock Option Plan of American Physicians Service Group, Inc. (4)

10.8

Form of Stock Option Agreement (Non-Qualified). (4)

31.1

Section 302 Certification of Chief Executive Officer (4)

31.2

Section 302 Certification of Chief Financial Officer (4)

32.1

Section 906 Certification of Chief Executive Officer (4)

32.2

Section 906 Certification of Chief Financial Officer (4)

________________

(1)

Filed as an Exhibit to the Registration Statement on Form S-1, Registration No. 333-143241, of the Company filed on May 24, 2007, and incorporated herein by reference.

(2)

Filed as an Exhibit to the Registration Statement on Form S-1/A, Registration No. 333-143241, of the Company filed on June 18, 2007, and incorporated herein by reference.

(3)

Filed as an Exhibit to the June 30, 2007 Quarterly Report on Form 10-Q filed on August 17, 2007, and incorporated herein by reference.

(4)

Filed herewith.

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Signature

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	American Physicians Service Group, Inc.
Date:  November 5, 2007	/s/ William H. Hayes
	William H. Hayes, Chief Financial Officer

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EX-3

Exhibit 3.2

AMENDED AND RESTATED BYLAWS

OF

AMERICAN PHYSICIANS SERVICE GROUP, INC.

A Texas Corporation

(Adopted September 7, 2007)

TABLE OF CONTENTS

	Page
PREAMBLE	1
ARTICLE ONE:  OFFICES	1
1.01     Registered Office and Agent	1
1.02     Other Offices	1
ARTICLE TWO:  SHAREHOLDERS	1
2.01     Annual Meetings	1
2.02     Special Meetings	1
2.03     Place of Meetings	1
2.04     Notice	1
2.05     Voting List	2
2.06     Voting of Shares	2
2.07     Quorum	2
2.08     Majority Vote; Withdrawal of Quorum	2
2.09     Method of Voting; Proxies	3
2.10     Closing of Transfer Books; Record Date	3
2.11     Order of Business	3
2.12     Shareholder Proposals	4
ARTICLE THREE:  DIRECTORS	4
3.01     Management	4
3.02     Number; Election; Term; Qualification	5
3.03     Decrease in Number	5
3.04     Removal	5
3.05     Vacancies and Newly-Created Directorships	5
3.06     First Meeting	5
3.07     Regular Meetings	5
3.08     Special Meetings	6
3.09     Quorum; Majority Vote	6
3.10     Procedure; Minutes	6
3.11     Presumption of Assent	6
3.12     Compensation	6
3.13     Notification of Nominations	6
ARTICLE FOUR:  COMMITTEES	7
4.01     Designation	7
4.02     Number; Qualification; Term	7
4.03     Authority	8
4.04     Committee Changes	8
4.05     Regular Meetings	8
4.06     Special Meetings	8
4.07     Quorum; Majority Vote	9
4.08     Minutes	9
4.09     Compensation	9
4.10     Responsibility	9

ARTICLE FIVE:  GENERAL PROVISIONS RELATING TO MEETINGS	9
5.01     Notice	9
5.02     Waiver of Notice	9
5.03     Telephone and Similar Meetings	9
5.04     Action Without Meeting	9
ARTICLE SIX:  OFFICERS AND OTHER AGENTS	10
6.01     Number; Titles; Election; Term	10
6.02     Removal	10
6.03     Vacancies	10
6.04     Authority	10
6.05     Compensation	10
6.06     Chairman of the Board	10
6.07     President	10
6.08     Vice Presidents	10
6.09     Treasurer	11
6.10     Assistant Treasurers	11
6.11     Secretary	11
6.12     Assistant Secretaries	11
ARTICLE SEVEN:  CERTIFICATES AND SHAREHOLDERS	11
7.01     Certificated and Uncertificated Shares	11
7.02     Lost, Stolen, or Destroyed Certificates	11
7.03     Transfer of Shares	12
7.04     Registered Shareholders	12
ARTICLE EIGHT:  MISCELLANEOUS PROVISIONS	12
8.01     Fiscal Year	12
8.02     Seal	12
8.03     Resignation	12
8.04     Securities of Other Corporations	13
8.05     Amendment	13
8.06     Invalid Provisions	13
8.07     Headings	13

AMENDED AND RESTATED BYLAWS

OF

AMERICAN PHYSICIANS SERVICE GROUP, INC.

A Texas corporation

 PREAMBLE

These bylaws are subject to, and governed by, the Texas Business Corporation Act and the articles of incorporation of American Physicians Service Group, Inc. (the “Corporation”).  In the event of a direct conflict between the provisions of these bylaws and the mandatory provisions of the Texas Business Corporation Act or the provisions of the articles of incorporation of the Corporation, such provisions of the Texas Business Corporation Act or the articles of incorporation of the Corporation, as the case may be, will be controlling.

ARTICLE ONE:OFFICES

1.01  Registered Office and Agent.  The registered office and registered agent of the Corporation shall be as designated from time to time by the appropriate filing by the Corporation in the office of the Secretary of State of Texas.

1.02  Other Offices.  The corporation may also have offices at such other places, both within and without the State of Texas, as the board of directors may from time to time determine or the business of the Corporation may require.

ARTICLE TWO:SHAREHOLDERS

2.01  Annual Meetings.  An annual meeting of shareholders of the Corporation shall be held during each calendar year on such date and at such time as shall be designated from time to time, by the board of directors and stated in the notice of the meeting.  At such meeting, the shareholders shall elect directors and transact such other business as may properly be brought before the meeting.

2.02  Special Meetings.  Subject to the rights of the holders of any class or series of stock having a preference over the Common Stock as to dividends or upon liquidation, a special meeting of the shareholders may be called at any time only by the chairman of the board, the president, or a majority of the entire board of directors.  Only such business shall be transacted at a special meeting as is specified in the notice of any special meeting.

2.03  Place of Meetings.  The annual meeting of shareholders may be held at any place within or without the State of Texas as may be designated by the board of directors.  Special meetings of shareholders may be held at any place within or without the State of Texas as may be designated by the person or persons calling such special meeting as provided in Section 2.02.  If no place for a meeting is designated, it shall be held at the registered office of the Corporation.

2.04  Notice.  Written or printed notice stating the place, day, and time of each meeting of shareholders, and, in case of a special meeting, the purpose or purposes for which the meeting is called shall be delivered not less than ten nor more than 60 days before the date of the meeting, either personally or by mail, by or at the direction of the chairman of the board, the president, the secretary, or the person calling the meeting, to each shareholder of record entitled to vote at such meeting.

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2.05  Voting List.  At least ten days before each meeting of shareholders, the secretary shall prepare a complete list of shareholders entitled to vote at such meeting, arranged in alphabetical order, including the address of each shareholder and the number of voting shares held by each shareholder.  For a period of ten days prior to such meeting, such list shall be kept on file at the registered office of the Corporation and shall be subject to inspection by any shareholder during usual business hours.  Such list shall be produced at such meeting, and at all times during such meeting shall be subject to inspection by any shareholder.  The original stock transfer books shall be prima facie evidence as to who are the shareholders entitled to examine such list or stock transfer books.

2.06  Voting of Shares.  Treasury shares, shares of the Corporation’s own stock owned by another corporation the majority of the voting stock of which is owned or controlled by the Corporation, and shares of the Corporation’s own stock held by the Corporation in a fiduciary capacity shall not be shares entitled to vote or to be counted in determining the total number of outstanding shares.  Shares held by an administrator, executor, guardian, or conservator may be voted by him, either in person or by proxy, without transfer of such shares into his name so long as such shares form a part of the estate and are in the possession of the estate being served by him.  Shares standing in the name of a trustee may be voted by him, either in person or by proxy, only after the shares have been transferred into his name as trustee .  Shares standing in the name of a receiver may be voted by such receiver, and shares held by or under the control of a receiver may be voted by such receiver without transfer of such shares into his name if authority to do so is contained in the court order by which such receiver was appointed.  Shares standing in the name of another domestic or foreign corporation of any type or kind may be voted by such officer, agent, or proxy as the bylaws of such corporation may provide or, in the absence of such provision, as the board of directors of such corporation may determine.  A shareholder whose shares are pledged shall be entitled to vote such shares until they have been transferred into the name of the pledgee, and thereafter, the pledgee shall be entitled to vote such shares.

2.07  Quorum.  The holders of a majority of the outstanding shares entitled to vote, present in person or represented by proxy, shall constitute a quorum at any meeting of shareholders, except as otherwise provided by law, the articles of incorporation, or these bylaws.  If a quorum shall not be present or represented at any meeting of shareholders, a majority of the shareholders entitled to vote at the meeting, who are present in person or represented by proxy, may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present or represented.  At any reconvening of an adjourned meeting at which a quorum shall be present or represented any business may be transacted which could have been transacted at the original meeting, if a quorum had been present or represented.  For purposes of determining the presence or absence of a quorum under this Section 2.07, abstentions and broker non-votes (as such terms are defined in Section 2.08) shall be treated as shares present and entitled to vote.

2.08  Majority Vote; Withdrawal of Quorum.  Subject to the rights of the holders of one or more series of preferred shares of the Corporation, voting separately by class or series, to elect directors pursuant to the terms of one or more series of such preferred shares, the election of directors shall be determined by a plurality of the votes cast by the shareholders entitled to vote thereon and represented in person or by proxy at the meeting at which a quorum is present.  All other matters shall be determined by the affirmative vote of a majority of the votes that were voted for or against the matter cast by the shareholders entitled to vote thereon and represented in person or by proxy at the meeting at which a quorum is present, unless the matter is one on which, by express provision of law, the articles of incorporation, or these bylaws, a different vote is required, in which event such express provision shall govern and control the decision of such matter.  Abstentions and broker non-votes shall not be counted as a vote for or against such matter (even though such shares are considered present and entitled to vote for purposes of determining a quorum pursuant to Section 2.07).  The term “abstentions” shall refer to shares which are not voted “for” or “against” a particular question by a holder or holders present in person or by proxy at a meeting and entitled to vote such shares on such question.  The term “broker non-vote” shall refer to shares held by brokers or nominees as to which instructions have not been received from the beneficial owners or persons entitled to vote and that the broker or nominee does not have discretionary power to vote on the particular question on which the vote is being counted.  The shareholders present at a duly convened me eting may continue to transact business until adjournment, notwithstanding any withdrawal of shareholders which may leave less than a quorum remaining.  

2

2.09  Method of Voting; Proxies.  Every shareholder of record shall be entitled at every meeting of shareholders to one vote on each matter submitted to a vote, for every share standing in his name on the original stock transfer books of the Corporation except to the extent that the voting rights of the shares of any class or classes are limited or denied by the articles of incorporation.  Such books shall be prima facie evidence as to the identity of shareholders entitled to vote.  At any meeting of shareholders, every shareholder having the right to vote may vote either in person or by a proxy executed in writing by the shareholder or by his duly authorized attorney-in-fact.  Each such proxy shall be filed with the secretary of the Corporation before or at the time of the meeting.  No proxy shall be valid after 11 months from the date of its ex ecution, unless otherwise provided in the proxy.  If no date is stated on a proxy, such proxy shall be presumed to have been executed on the date of the meeting at which it is to be voted.  Each proxy shall be revocable, unless expressly provided therein to be irrevocable, or unless otherwise made irrevocable by law.  Each shareholder entitled to vote at any meeting of shareholders may authorize not in excess of two persons to act for such shareholder by a proxy signed by such shareholder or such shareholder’s attorney-in-fact.  Any such proxy shall be delivered to the secretary of such meeting at or prior to the time designated for holding such meeting, but in any event not later than the time designated in the order of business for so delivering such proxies.

2.10  Closing of Transfer Books; Record Date.  For the purpose of determining shareholders entitled to notice of or to vote at any meeting of shareholders or any reconvening thereof or entitled to receive payment of any dividend or in order to make a determination of shareholders for any other proper purpose, the board of directors may provide that the stock transfer books of the Corporation shall be closed for a stated period but not to exceed in any event 60 days.  If the stock transfer books are closed for the purpose of determining shareholders entitled to notice of or to vote at a meeting of shareholders, such books shall be closed for at least ten days immediately preceding such meeting.  In lieu of closing the stock transfer books, the board of directors may fix in advance a date as the record date for any such determinat ion of shareholders, such date in any case to be not more than 60 days and, in case of a meeting of shareholders, not less than ten days prior to the date on which the particular action requiring such determination of shareholders is to be taken.  If the stock transfer books are not closed and if no record date is fixed for the determination of shareholders entitled to notice of or to vote at a meeting of shareholders or entitled to receive payment of a dividend, the date on which the notice of the meeting is mailed or the date on which the resolution of the board of directors declaring such dividend is adopted, as the case may be, shall be the record date for such determination of shareholders.

2.11  Order of Business.  At each meeting of the shareholders, the chairman of the board, or in the absence of the chairman of the board, the president, shall act as chairman.  The order of business at each such meeting shall be as determined by the chairman of the meeting.  The chairman of the meeting shall have the right and authority to prescribe such rules, regulations and procedures and to do all such acts and things as are necessary or desirable for the proper conduct of the meeting, including, without limitation, the establishment of procedures for the maintenance of order and safety, limitations on the time allotted to questions or comments on the affairs of the Corporation, restrictions on entry to such meeting after the time prescribed for the commencement thereof, and the opening and closing of the voting polls.

No business may be transacted at an annual meeting of shareholders, other than business that is either (a) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the board of directors (or any duly authorized committee thereof), (b) otherwise properly brought before the annual meeting by or at the direction of the board of directors (or any duly authorized committee thereof) or (c) otherwise properly brought before the annual meeting by any shareholder of the Corporation pursuant to Section 2.12 or 3.13 (i) who is a shareholder of record on the date of the giving of the notice provided for in Section 2.12 or 3.13, as the case may be and on the record date for the determination of shareholders entitled to vote at such annual meeting and who is otherwise entitled to vote at the meeting and (ii) who complies with the notice procedures set forth in Section 2.12 or 3.13, as the case may be.

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2.12  Shareholder Proposals.  In addition to any other applicable requirements, for business to be properly brought before an annual meeting by a shareholder, such shareholder must have given timely notice thereof in proper written form to the secretary of the Corporation.  A shareholder’s notice shall be timely if delivered to, or mailed to and received by, the secretary of the Corporation at the Corporation’s principal executive office not less than 120 days nor more than 150 days prior to the anniversary date of the immediately preceding annual meeting (the “Anniversary Date”); PROVIDED, HOWEVER, that in the event the annual meeting is scheduled to be held on a date that is not within 30 days before or 60 days after the Anniversary Date, a shareholder’s notice shall be timely if delivered to, or mailed to and received by, the secreta ry of the Corporation at the Corporation’s principal executive office not later than the close of business on the 10th day following the day on which Public Announcement of the date of such annual meeting is first made by the Corporation.  For the purposes of this Section 2.12, a “Public Announcement” shall mean:  (i) disclosure in a press release reported by the Dow Jones News Service, Associated Press or comparable national news service, (ii) a report or other document filed publicly with the Securities and Exchange Commission (including without limitation a Form 8-K) or (iii) a letter or report sent to shareholders of record of the Corporation at the time of the mailing of such letter or report.

A shareholder’s notice to the secretary of the Corporation shall set forth as to each matter proposed to be brought before an annual meeting:  (i) a brief description of the business the shareholder desires to bring before such annual meeting and the reasons for conducting such business at such annual meeting, (ii) the name and address, as they appear on the stock transfer books of the Corporation, of the shareholder proposing such business, (iii) the class and number of shares of the capital stock of the Corporation beneficially owned by the shareholder proposing such business, (iv) the names and addresses of the beneficial owners, if any, of any capital stock of the Corporation registered in such shareholder’s name on such books, and the class and number of shares of the capital stock of the Corporation beneficially owned by such beneficial owners, (v) a description of all arrangements or understandings between such shareholder and any other person or persons (including their names) in connection with the proposal of such business by such shareholder and any material interest of such shareholder in such business, (vi) a representation that such shareholder intends to appear in person or by proxy at the annual meeting to bring such business before the meeting, and (vii) any material interest of the shareholder proposing to bring such business before such meeting (or any other shareholders known to be supporting such proposal) in such proposal.

If the secretary of the Corporation determines that any shareholder proposal was not made in a timely fashion in accordance with the provisions of this Section 2.12 or that the information provided in a shareholder’s notice does not satisfy the information requirements of this Section 2.12 in any material respect, such proposal shall not be presented for action at the annual meeting in question.  If the secretary of the Corporation does not make a determination as to the validity of any shareholder proposal in the manner set forth above, the chairman of the annual meeting shall determine whether the shareholder proposal was made in accordance with the terms of this Section 2.12.  If the chairman of the annual meeting determines that any shareholder proposal was not made in a timely fashion in accordance with the provisions of this Section 2.12 or that the information provided in a shareholder’s notice does n ot satisfy the information requirements of this Section 2.12 in any material respect, such proposal shall not be presented for action at the annual meeting in question.  If the secretary of the Corporation or the chairman of the annual meeting determines that a shareholder proposal was made in accordance with the requirements of this Section 2.12, the chairman of the annual meeting shall so declare at the annual meeting.

Notwithstanding the foregoing provisions of this Section 2.12, a shareholder shall also comply with all applicable requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the rules and regulations thereunder with respect to the matters set forth in this Section 2.12, and nothing in this Section 2.12 shall be deemed to affect any rights of shareholders to request inclusion of proposals in the Corporation’s proxy statement pursuant to Rule 14a-8 under the Exchange Act.

ARTICLE THREE:DIRECTORS

3.01  Management.  The business and affairs of the Corporation shall be managed by the board of directors, subject to the restrictions imposed by law, the articles of incorporation, or these bylaws.

4

3.02  Number; Election; Term; Qualification.  The first board of directors shall consist of the number of directors named in the articles of incorporation.  Thereafter, the number of directors which shall constitute the entire board of directors shall be determined from time to time exclusively by resolution of the board of directors adopted by the affirmative votes of a majority of the members of the entire board, but shall never be less than one.  At each annual meeting of shareholders, directors shall be elected to hold office until the next annual meeting of shareholders and until their successors are elected and qualified.  No director need be a shareholder, a resident of the State of Texas, or a citizen of the United States.

3.03  Decrease in Number.  No decrease in the number of directors constituting the entire board of directors shall have the effect of shortening the term of any incumbent director.

3.04  Removal.  At any meeting of shareholders called expressly for that purpose, any director or the entire board of directors may be removed, but only for cause, by a vote of the holders of a majority of the shares then entitled to vote on the election of directors.  For purposes of this Section, “cause” shall mean the willful and continuous failure of a director to substantially perform such director’s duties to the Corporation (other than any such failure resulting from incapacity due to physical or mental illness) or the willful engaging by a director in gross misconduct materially and demonstrably injurious to the Corporation.

3.05  Vacancies and Newly-Created Directorships.

(a) Vacancies.  Any vacancy occurring in the board of directors may be filled in accordance with Section 3.05(c) or may be filled by the affirmative vote of a majority of the remaining directors though less than a quorum of the board of directors.  A director elected to fill a vacancy will be elected for the unexpired term of his or her predecessor in office.

(b) Newly-Created Directorships.  A directorship to be filled by reason of an increase in the number of directors may be filled in accordance with Section 3.05(c) or may be filled by the board of directors for a term of office continuing only until the next election of one or more directors by the shareholders; provided that the board of directors may not fill more than three such directorships during the period between any two successive annual meetings of shareholders.

(c) Election by Shareholders.  Any vacancy occurring in the board of directors or any directorship to be filled by reason of an increase in the number of directors may be filled, unless previously filled in accordance with Section 3.05(a) or Section 3.05(b), by election at an annual or special meeting of shareholders called for that purpose.

3.06  First Meeting.  Each newly elected board of directors may hold its first meeting for the purpose of organization and the transaction of business, if a quorum is present, immediately after and at the same place as the annual meeting of shareholders, and notice of such meeting shall not be necessary.

3.07  Regular Meetings.  Regular meetings of the board of directors may be held without notice at such times and places as may be designated from time to time by resolution of the board of directors and communicated to all directors.

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3.08  Special Meetings.  A special meeting of the board of directors shall be held whenever called by any director at such time and place as such director shall designate in the notice of such special meeting.  The director calling any special meeting shall cause notice of such special meeting to be given to each director at least 24 hours before such special meeting.  Neither the business to be transacted at, nor the purpose of, any special meeting of the board of directors need be specified in the notice or waiver of notice of any special meeting.

3.09  Quorum; Majority Vote.  At all meetings of the board of directors, a majority of the directors, fixed in the manner provided in these bylaws, shall constitute a quorum for the transaction of business.  If a quorum is not present at a meeting, a majority of the directors present may adjourn the meeting from time to time, without notice other than an announcement at the meeting, until a quorum is present.  The vote of a majority of the directors present at a meeting at which a quorum is in attendance shall be the act of the board of directors, unless the vote of a different number is required by the articles of incorporation or these bylaws.

3.10  Procedure; Minutes.  At meetings of the board of directors, business shall be transacted in such order as the board of directors may determine from time to time.  The board of directors shall appoint at each meeting a person to preside at the meeting and a person to act as secretary of the meeting.  The secretary of the meeting shall prepare minutes of the meeting which shall be delivered to the secretary of the Corporation for placement in the minute books of the Corporation.

3.11  Presumption of Assent.  A director of the Corporation who is present at any meeting of the board of directors at which action on any matter is taken shall be presumed to have assented to the action unless his dissent shall be entered in the minutes of the meeting or unless he shall file his written dissent to such action with the person acting as secretary of the meeting before the adjournment thereof or shall forward any dissent by certified or registered mail to the secretary of the Corporation immediately after the adjournment of the meeting.  Such right to dissent shall not apply to a director who voted in favor of such action.

3.12  Compensation.  Directors, in their capacity as directors, may receive, by resolution of the board of directors, a fixed sum and expenses of attendance, if any, for attending meetings of the board of directors or a stated salary.  No director shall be precluded from serving the Corporation in any other capacity or receiving compensation therefor.

3.13  Notification of Nominations.  Nominations of persons for election to the board of directors may be made by the board of directors (or a committee thereof) or by any shareholder of the Corporation entitled to vote for the election of directors.  Any shareholder of the Corporation entitled to vote for the election of directors at a meeting may nominate persons for election as directors only if written notice is timely made by such shareholder to the secretary of the Corporation of such shareholder’s intent to make such a nomination.  A shareholder’s notice shall be timely if delivered to, or mailed to and received by, the secretary of the Corporation at the Corporation’s principal executive offices (a) in the case of an annual meeting, not less than 120 days nor more than 150 days prior to the anniversary date of the immediately preceding annual meeting of shareholders; PROVIDED, HOWEVER, that in the event that the annual meeting is called for a date that is not within 30 days before or 60 days after such anniversary date, notice by the shareholder in order to be timely must be so received not later than the close of business on the 10th day following the day on which such notice of the date of the annual meeting was mailed or Public Announcement of the date of the annual meeting was made, whichever first occurs; and (b) in the case of a special meeting of shareholders called for the purpose of electing directors, not later than the close of business on the 10th day following the day on which such notice of the date of the special meeting was mailed or Public Announcement of the date of the special meeting was made, whichever first occurs.

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A shareholder’s notice to the Corporation shall set forth as to each person whom the shareholder proposes to nominate for election or re-election as a director:  (1) the name, age, business address and residence address of such person; (2) the principal occupation or employment of such person; (3) the class and number of shares of the capital stock of the Corporation which are beneficially owned by such person on the date of such shareholder notice; and (4) any other information relating to the person that would be required to be disclosed in a proxy statement or other filings required to be made in connection with solicitations of proxies for election of directors pursuant to Section 14 of the Exchange Act and the rules and regulations promulgated thereunder.  A shareholder’s notice to the secretary of the Corporation shall further set forth as to the shareholder giving such notice:  (1) the name and a ddress, as they appear on the stock transfer books of the Corporation, of such shareholder and of the beneficial owners (if any) of the capital stock of the Corporation registered in such shareholder’s name and the name and address of other shareholders known by such shareholder to be supporting such nominee(s); (2) the class and number of shares of the capital stock of the Corporation which are held of record, beneficially owned or represented by proxy by such shareholder and by any other shareholders known by such shareholder to be supporting such nominee(s) on the record date for the annual meeting in question (if such date shall then have been made publicly available) and on the date of such shareholder’s notice; (3) a description of all arrangements or understandings between such shareholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by such shareholder and (4) any other information relating to such shareholder that would be required to be disclosed in a proxy statement or other filings required to be made in connection with solicitations of proxies for election of directors pursuant to Section 14 of the Exchange Act and the rules and regulations promulgated thereunder.  Such notice must be accompanied by a written consent of each proposed nominee to being named as a nominee and to serve as a director if elected.

If the secretary of the Corporation determines that any shareholder nomination was not made in accordance with the terms of this Section 3.13 or that the information provided in a shareholder’s notice does not satisfy the informational requirements of this Section 3.13 in any material respect, then such nomination shall not be considered at the annual meeting in question.  If the secretary of the Corporation does not make a determination as to whether a nomination was made in accordance with the provisions of this Section 3.13, then the chairman of the annual meeting shall determine whether a nomination was made in accordance with such provisions.  If the chairman of the annual meeting determines that any shareholder nomination was not made in accordance with the terms of this Section 3.13 or that the information provided in a shareholder’s notice does not satisfy the informational requirements of this Secti on 3.13 in any material respect, then such nomination shall not be considered at the annual meeting in question.  If the secretary of the Corporation or the chairman of the annual meeting determines that a nomination was made in accordance with the terms of this Section 3.13, the chairman of the annual meeting shall so declare at the annual meeting.

Notwithstanding anything to the contrary in the second paragraph of this Section 3.13, in the event that the number of directors to be elected to the board of directors is increased and there is no Public Announcement by the Corporation naming all of the nominees for director or specifying the size of the increased board of directors at least 90 days prior to the Anniversary Date, a shareholder’s notice required by this Section 3.13 shall also be considered timely, but only with respect to nominees for any new positions created by such increase, if such notice shall be delivered to, or mailed to and received by, the Corporation at its principal executive office not later than the close of business on the 10th day following the day on which such Public Announcement is first made by the Corporation.

No person shall be elected by the shareholders as a director of the Corporation unless nominated in accordance with the procedures set forth in this Section 3.13.

ARTICLE FOUR:COMMITTEES

4.01  Designation.  The board of directors may, by resolution adopted by a majority of the entire board of directors, designate executive and other committees.

4.02  Number; Qualification; Term.  Each committee shall consist of one or more directors appointed by resolution adopted by a majority of the entire board of directors.  The number of committee members may be increased or decreased from time to time by resolution adopted by a majority of the entire board of directors.  Each committee member shall serve as such until the expiration of his term as a director or his earlier resignation, unless sooner removed as a committee member or as a director.

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4.03  Authority.  The executive committee, unless expressly restricted in the resolution adopted by a majority of the entire board of directors establishing the executive committee, shall have and may exercise all of the authority of the board of directors in the management of the business and affairs of the Corporation.  Each other committee, to the extent expressly provided for in the resolution adopted by a majority of the entire board of directors establishing such committee, shall have and may exercise all of the authority of the board of directors in the management of the business and affairs of the Corporation.  Each other committee, to the extent expressly provided for in the resolution adopted by a majority of the entire board of directors establishing such committee, shall have and may exercise all of the authority of the board of directors in th e management of the business and affairs of the Corporation.  However, no committee shall have the authority of the board of directors in reference to:

(a)

amending the articles of incorporation;

(b)

approving a plan of merger or consolidation;

(c)

recommending to the shareholders the sale, lease, or exchange of all or substantially all of the property and assets of the Corporation otherwise than in the usual and regular course of its business;

(d)

recommending to the shareholders a voluntary dissolution of the Corporation or a revocation thereof;

(e)

amending, altering, or repealing these bylaws or adopting new bylaws;

(f)

filling vacancies in or removing members of the board of directors or of any committee;

(g)

electing or removing officers or committee members;

(h)

fixing the compensation of any committee member; and

(i)

altering or repealing any resolution of the board of directors which by its terms provides that it shall not be amendable or repealable.

In the resolution adopted by a majority of the entire board of directors establishing an executive or other committee, the board of directors may expressly authorize such committee to declare dividends or to authorize the issuance of shares of the Corporation.

4.04  Committee Changes.  The board of directors shall have the power at any time to fill vacancies in, to change the membership of, and to discharge any committee.  However, a committee member may be removed by the board of directors, only if, in the judgment of the board of directors, the best interests of the Corporation will be served thereby, but such removal shall be without prejudice to the contract rights, if any, of the person so removed.

4.05  Regular Meetings.  Regular meetings of any committee may be held without notice at such times and places as may be designated from time to time by resolution of the committee and communicated to all committee members.

4.06  Special Meetings.  A special meeting of any committee may be held whenever called by any committee member at such time and place as such committee member shall designate in the notice of such special meeting.  The committee member calling any special meeting shall cause notice of such special meeting to be given to each committee member at least 12 hours before such special meeting.  Neither the business to be transacted at, nor the purpose of, any special meeting of any committee need be specified in the notice or waiver of notice of any special meeting.

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4.07  Quorum; Majority Vote.  At all meetings of any committee, a majority of the number of committee members designated by the board of directors shall constitute a quorum for the transaction of business.  If a quorum is not present at a meeting of any committee, a majority of the committee members present may adjourn the meeting from time to time, without notice other than an announcement at the meeting, until a quorum is present.  The vote of a majority of the committee members present at any meeting at which a quorum is in attendance shall be the act of a committee, unless the vote of a different number is required by the articles of incorporation or these bylaws.

4.08  Minutes.  Each committee shall cause minutes of its proceedings to be prepared and shall report the same to the board of directors upon the request of the board of directors.  The minutes of the proceedings of each committee shall be delivered to the secretary of the Corporation for placement in the minute books of the Corporation.

4.09  Compensation.  Committee members may, by resolution of the board of directors, be allowed a fixed sum and expenses of attendance, if any, for attending any committee meetings or a stated salary.

4.10  Responsibility.  The designation of any committee and the delegation of authority to it shall not operate to relieve the board of directors or any director of any responsibility imposed upon it or such director by law.

ARTICLE FIVE:GENERAL PROVISIONS RELATING TO MEETINGS

5.01  Notice.  Whenever by law, the articles of incorporation, or these bylaws, notice is required to be given to any shareholder, director, or committee member and no provision is made as to how such notice shall be given, it shall be construed to mean that notice may be given either (a) in person, (b) in writing, by mail, (c) except in the case of a shareholder, by telegram, telex, cable, telecopy, or similar means, or (d) by any other method permitted by law.  Any notice required or permitted to be given hereunder (other than personal notice) shall be addressed to such shareholder, director, or committee member at his address as it appears on the books of the Corporation or, in the case of a shareholder, on the stock transfer records of the Corporation or at such other place as such shareholder, director, or committee member is kn own to be at the time notice is mailed or transmitted.  Any notice required or permitted to be given by mail shall be deemed to be delivered and given at the time when the same is deposited in the United States mail, postage prepaid.  Any notice required or permitted to be given by telegram, telex, cable, telecopy, or similar means shall be deemed to be delivered and given at the time transmitted.

5.02  Waiver of Notice.  Whenever by law, the articles of incorporation, or these bylaws, any notice is required to be given to any shareholder, director, or committee member of the Corporation a waiver thereof in writing signed by the person or persons entitled to such notice, whether before or after the time notice should have been given, shall be equivalent to the giving of such notice.  Attendance of a director at a meeting shall constitute a waiver of notice of such meeting, except where a director attends a meeting for the express purpose of objecting to the transaction of any business on the ground that the meeting is not lawfully called or convened.

5.03  Telephone and Similar Meetings.  Shareholders, directors, or committee members may participate in and hold a meeting by means of a conference telephone or similar communications equipment by means of which persons participating in the meeting can hear each other.  Participation in such a meeting shall constitute presence in person at such meeting, except where a person participates in the meeting for the express purpose of objecting to the transaction of any business on the ground that the meeting is not lawfully called or convened.

5.04  Action Without Meeting.  Any action which may be taken, or is required by law, the articles of incorporation, or these bylaws to be taken, at a meeting of shareholders, directors, or committee members may be taken without a meeting if a consent in writing, setting forth the action so taken, shall be signed by all of the shareholders, directors, or committee members, as the case may be, entitled to vote with respect to the subject matter thereof, and such consent shall have the same force and effect, as of the date stated therein, as a unanimous vote of such shareholders, directors, or committee members, as the case may be, and may be stated as such in any document filed with the Secretary of State of Texas or in any certificate or other document delivered to any person.  The consent may be in one or more counterparts so long as each shareholder, director, or committee member signs one of the counterparts.  The signed consent shall be placed in the minute books of the Corporation.

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ARTICLE SIX:OFFICERS AND OTHER AGENTS

6.01  Number; Titles; Election; Term.  The Corporation shall have a president, one or more vice presidents (and, in the case of each vice president, with such descriptive title, if any, as the board of directors shall determine), a secretary, a treasurer, and such other officers and agents as the board of directors may deem desirable.  The board of directors shall elect a president, vice president, treasurer, and secretary at its first meeting at which a quorum shall be present after the annual meeting of shareholders or whenever a vacancy exists.  The board of directors then, or from time to time, may also elect or appoint one or more other officers or agents as it shall deem advisable.  Each officer and agent shall hold office until his successor has been elected or appointed and qualified, or, if earlier, at his death, r esignation, or removal.  Any two or more offices may be held by the same person.  No officer or agent need be a shareholder, a director, a resident of the State of Texas, or a citizen of the United States.

6.02  Removal.  Any officer or agent elected or appointed by the board of directors may be removed by the board of directors, whenever, in the judgment of the board of directors, the best interests of the Corporation will be served thereby, but such removal shall be without prejudice to the contract rights, if any, of the person so removed.  Election or appointment of an officer or agent shall not of itself create contract rights.

6.03  Vacancies.  Any vacancy occurring in any office of the Corporation (by death, resignation, removal, or otherwise) may be filled by the board of directors.

6.04  Authority.  Officers shall have such authority and perform such duties in the management of the Corporation as are provided in these bylaws or as may be determined by resolution of the board of directors not inconsistent with these bylaws.

6.05  Compensation.  The compensation, if any, of officers shall be fixed, increased, or decreased from time to time by the chairman of the board; provided, that the board of directors may by resolution withdraw the authority of the chairman of the board to fix, increase, or decrease officers compensation and retain such authority for itself or delegate such authority to any other officer or officers of the Corporation.

6.06  Chairman of the Board.  The chairman of the board, if a person is elected to such office by the board of directors, shall be the chief executive officer of the Corporation and, subject to the supervision of the board of directors, shall have general management of the business and property of the Corporation in the ordinary course of its business with all such powers with respect to such business and property as may be reasonably incident to such responsibilities, including; but not limited to, the power to employ, discharge, or suspend employees or agents of the Corporation, to fix the compensation of officers (unless such power has been withdrawn by resolution of the board of directors), to fix the compensation of employees and agents, and to suspend, with or without cause, any officer of the Corporation pending final action by the board of directors with respect to continued suspension, removal, or reinstatement of such officer.  The chairman of the board shall see that all orders and resolutions of the board are carried into effect and shall perform such other duties and have such other authority and powers as the board of directors may from time to time prescribe.

6.07  President.  The president shall be the chief operating and administrative officer of the Corporation and, subject to the supervision of the board of directors and the chairman of the board, shall have charge of the actual day to day operations and management of the Corporation and its property with all such powers with respect to such operations and management as may be reasonably incident to such responsibilities.  If the board of directors has not elected a person to the office of chairman of the board, the president shall exercise all of the powers and discharge all of the duties of the chairman of the board.  As between the Corporation and third parties, any action taken by the president in the performance of the duties of the chairman of the board shall be conclusive evidence that there is no chairman of the board.

6.08  Vice Presidents.  Each vice president shall have such powers and duties as may be prescribed from time to time by the board of directors or as may be delegated from time to time by the president and (in the order as designated by the board of directors, or in the absence of such designation, as determined by the length of time each has held the office of vice president continuously) shall exercise the powers of the president during that officer’s absence or inability to act.

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6.09  Treasurer.  The treasurer shall have custody of the Corporation’s funds and securities, shall keep full and accurate accounts of receipts and disbursements, and shall deposit all moneys and valuable effects in the name and to the credit of the Corporation in such depository or depositories as may be designated by the board of directors.  Additionally, the treasurer shall have the power to endorse for deposit, collection or otherwise, all checks, drafts, notes, bills of exchange, and other commercial paper payable to the corporation and to give proper receipts and discharges for all payments to the Corporation.  The treasurer shall perform such other duties as may be prescribed from time to time by the board of directors or as may be delegated from time to time by the president.

6.10  Assistant Treasurers.  Each assistant treasurer shall perform such duties as may be prescribed from time to time by the board of directors or as may be delegated from time to time by the president.  The assistant treasurers (in the order as designated by the board of directors or, in the absence of such designation, as determined by the length of time each has held the office of assistant treasurer continuously) shall exercise the powers of the treasurer during that officer’s absence or inability to act.

6.11  Secretary.  The secretary shall maintain minutes of all meetings of the board of directors, of any committee, and of the shareholders or consents in lieu of such minutes in the Corporation’s minute books, and shall cause notice of such meetings to be given when requested by any person authorized to call such meetings.  With respect to any contract, deed, deed of trust, mortgage, or other instrument executed by the Corporation through its duly authorized officer or officers, the attestation to such execution by the secretary shall not be necessary to constitute such contract, deed, deed of trust, mortgage, or other instrument a valid and binding obligation against the Corporation unless the resolution, if any, of the board of directors authorizing such execution expressly states that such attestation is necessary.  The secretary shall have charge of the certificate books, stock transfer books, and stock papers as the board of directors may direct, all of which shall at all reasonable times be open to inspection by any director.  The secretary shall perform such other duties as may be prescribed from time to time by the board of directors or as may be delegated from time to time by the president.

6.12  Assistant Secretaries.  Each assistant secretary shall perform such duties as may be prescribed from time to time by the board of directors or as may be delegated from time to time by the president.  The assistant secretaries (in the order designated by the board of directors or, in the absence of such designation, as determined by the length of time each has held the office of assistant secretary continuously) shall exercise the power of the secretary during that officer’s absence or inability to act.

ARTICLE SEVEN:CERTIFICATES AND SHAREHOLDERS

7.01  Certificated and Uncertificated Shares.  The shares of the Corporation shall be represented by certificates, provided that the board of directors may provide by resolution or resolutions that some or all of any or all classes or series of its stock shall be uncertificated shares.  Any such resolution shall not apply to shares represented by a certificate until such certificate is surrendered to the Corporation.  Notwithstanding the adoption of such a resolution by the board of directors, every holder of stock represented by certificates, and upon request every holder of uncertificated shares, shall be entitled to have a certificate representing the number of shares registered in certificate form.  The certificates for shares of stock of the Corporation shall be in such form as shall be approved by the board of directo rs in conformity with law.  The certificates shall be consecutively numbered, shall be entered as they are issued in the books of the Corporation or in the records of the Corporation’s designated transfer agent, if any, and shall state the shareholder’s name, the number of shares, and such other matters as may be required by law.  The certificates shall be signed by the president or any vice president and also by the secretary, an assistant secretary, or any other officer, and may be sealed with the seal of the Corporation or a facsimile thereof.  If any certificate is countersigned by a transfer agent or registered by a registrar, either of which is other than the Corporation itself or an employee of the Corporation, the signatures of the foregoing officers may be a facsimile.

7.02  Lost, Stolen, or Destroyed Certificates.  The Corporation shall issue a new certificate in place of any certificate for shares previously issued if the registered owner of the certificate:

(a)

Claim.  Makes proof by affidavit in form and substance satisfactory to the board of directors, that a previously issued certificate for shares has been lost, destroyed, or stolen;

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(b)

Timely Request.  Requests the issuance of a new certificate before the Corporation has notice that the certificate has been acquired by a purchaser for value in good faith and without notice of an adverse claim;

(c)

Bond.  If requested by the board of directors, delivers to the Corporation a bond, in form and substance satisfactory, to the board of directors, with such surety or sureties and with fixed or open penalty, as the board of directors may direct, in its discretion, to indemnify the Corporation (and its transfer agent and registrar, if any) against any claim that may be made on account of the alleged loss, destruction, or theft of the certificate; and

(d)

Other Requirements.  Satisfies any other reasonable requirements imposed by the board of directors.

When a certificate has been lost, destroyed, or stolen, and the shareholder of record fails to notify the Corporation within a reasonable time after he has notice of it, and the Corporation registers a transfer of the shares represented by the certificate before receiving such notification, the shareholder of record is precluded from making any claim against the Corporation for the transfer or for a new certificate.

7.03  Transfer of Shares.  Shares of stock of the Corporation shall be transferable only on the books of the Corporation by the shareholders thereof in person or by their duly authorized attorneys or legal representatives.  

(a)

Certificated Shares.  Upon surrender to the Corporation or the transfer agent of the Corporation of a certificate representing shares duly endorsed or accompanied by proper evidence of succession, assignment, or authority to transfer, the Corporation or its transfer agent shall issue a new certificate to the person entitled thereto, cancel the old certificate, and record the transaction upon its books.

(b)

Uncertificated Shares.  Upon presenting the Corporation or the transfer agent of the Corporation with an instruction requesting the registration of transfer of uncertificated shares, made by the registered owner of such uncertificated shares or any other appropriate person or by an agent who has actual authority to act on behalf of the appropriate person, the Corporation or its transfer agent shall register the transfer as requested.

7.04  Registered Shareholders.  The Corporation shall be entitled to treat the shareholder of record as the shareholder in fact of any shares and, accordingly, shall not be bound to recognize any equitable or other claim to or interest in such shares on the part of any other person, whether or not it shall have actual or other notice thereof, except as otherwise provided by law.

ARTICLE EIGHT:MISCELLANEOUS PROVISIONS

8.01  Fiscal Year.  The fiscal year of the Corporation shall be fixed by the board of directors; provided, that if such fiscal year is not fixed by the board of directors it shall be the calendar year.

8.02  Seal.  The seal, if any, of the corporation shall be in such form as may be approved from time to time by the board of directors.  If the board of directors approves a seal, the affixation of such seal shall not be required to create a valid and binding obligation against the Corporation.

8.03  Resignation.  A director, committee member, officer, or agent may resign by so stating at any meeting of the board of directors or by giving written notice to the corporation.  The effective time of such resignation shall be any time specified in the statement made at the board of directors’ meeting or in the written notice given to the Corporation, but in no event may the effective time of such resignation be prior to the time such statement is made or such notice is given.  If no effective time is specified in the resignation, the resignation shall be effective immediately.  Unless a resignation specifies otherwise, it is effective without being accepted.

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8.04  Securities of Other Corporations.  The president or any vice president of the Corporation or any other person authorized by resolution of the board of directors shall have the power and authority to transfer, endorse for transfer, vote, consent, or take any other action with respect to any securities of another issuer which may be held or owned by the Corporation and to make, execute, and deliver any waiver, proxy, or consent with respect to any such securities.

8.05  Amendment.  The power to alter, amend, or repeal these bylaws or to adopt new bylaws is vested in the board of directors, subject to repeal or change by action of the shareholders.  The shareholders shall not make, repeal, alter, amend, or rescind the bylaws of the Corporation except by the vote of the holders of not less than 80% of the total voting power of all shares of stock of the Corporation entitled to vote in the election of directors, considered for purposes of this Section as one class.

8.06  Invalid Provisions.  If any provision of these bylaws is held to be illegal, invalid, or unenforceable under present or future laws, such provision shall be fully severable; these bylaws shall be construed and enforced as if such illegal, invalid or unenforceable provision had never comprised a part hereof; and the remaining provisions hereof shall remain in full force and effect and shall not be affected by the illegal, invalid, or unenforceable provision or by its severance herefrom.  Furthermore, in lieu of such illegal, invalid, or unenforceable provision there shall be added automatically as a part of these bylaws a provision as similar in terms to such illegal, invalid, or unenforceable provision as may be possible and be legal, valid, and enforceable.

8.07  Headings.  The headings used in these bylaws are for reference purposes only and do not affect in any way the meaning or interpretation of these bylaws.

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EX-10

Exhibit 10.7

AMENDMENT TO
2005 INCENTIVE AND NON-QUALIFIED STOCK OPTION PLAN

March 22, 2007

This Amendment to the 2005 Incentive and Non-Qualified Stock Option Plan (this “Amendment”) amends that certain 2005 Incentive and Non-Qualified Stock Option Plan (the “2005 Incentive Plan”) adopted by the shareholders of American Physicians Service Group, Inc. (the “Company”) on June 14, 2005.

R E C I T A L S:

The 2005 Incentive Plan currently provides for the issuance of up to 350,000 shares of common stock of the Company. The Company’s Board of Directors has determined that it is advisable, fair and in the best interests of the Company and its shareholders to amend the 2005 Incentive Plan to provide for the issuance of up to an additional 300,000 shares of common stock, in order to continue to provide to the persons who are responsible for the continued growth of the Company’s business an opportunity to acquire a proprietary interest in the Company.

The 2005 Incentive Plan currently provides for the Company to be able to, at any time, offer to exchange or buy out any previously granted Option for a payment in cash, common stock of the Company or another stock option under the 2005 Incentive Plan. The Company’s Board of Directors has determined that it is advisable, fair and in the best interests of the Company and its shareholders to amend the 2005 Incentive Plan to delete this provision of the 2005 Incentive Plan, in order to better protect shareholders during the remaining life of the 2005 Incentive Plan.

A G R E E M E N T:

NOW, THEREFORE, the 2005 Incentive Plan is amended as follows:

1.

Definitions.

A.

Unless otherwise specifically defined in this Amendment, capitalized terms shall have the definitions set forth in the 2005 Incentive Plan.

2.

Stock Subject to the 2005 Incentive Plan.  Article IV of the 2005 Incentive Plan is hereby deleted in its entirety and replaced with the following:

IV. Stock Subject to Plan

The aggregate number of shares of Common Stock that may be issued pursuant to Options granted under this Plan shall not exceed 650,000 shares of Common Stock (subject to adjustment as provided in Article VIII). Such shares may consist of authorized but unissued shares of Common Stock or previously issued shares of Common Stock reacquired by the Corporation. Any of such shares which remain unissued and which are not subject to outstanding Options at the termination of this Plan shall cease to be subject to this Plan, but, until termination of this Plan, the Corporation shall at all times make available a sufficient number of shares to meet the requirements of this Plan. Should any Option hereunder expire or terminate prior to its exercise in full, the shares of Common Stock theretofore subject to such Option may again be subject to an Option granted under this Plan to the extent permitted under Rule 16b-3. The aggregate num ber of shares which may be issued under this  Plan shall be subject to adjustment as provided in Article VIII hereof. Exercise of an Option in any manner pursuant to the terms of this Plan and the related Option Agreement shall result in a decrease in the number of shares of Common Stock which may thereafter be available, for purposes of the Plan, by the number of shares as to which the Option is exercised. Separate stock certificates shall be issued by the Corporation for those shares acquired pursuant to the exercise of an Incentive Stock Option and for those shares acquired pursuant to the exercise of any Non-Qualified Stock Options.

3.

Exchange Provisions Deleted. Article XIII of the 2005 Incentive Plan is hereby deleted in its entirety and replaced with the following:

XIII. Governing Law

This Plan shall be governed by the laws of the State of Texas.

4.

2005 Incentive Plan. Except as specifically amended hereby, the 2005 Incentive Plan shall remain binding and enforceable in accordance with its terms.

[signature page follows]

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IN WITNESS WHEREOF, the undersigned has executed this amendment as of the date first written above.

American Physicians Service Group, Inc.

By:

/s/ W.H. Hayes

W.H. Hayes

Senior Vice-President – Finance

Signature Page to Amendment to 2005 Stock Incentive Plan

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EX-10

Exhibit 10.8

STOCK OPTION AGREEMENT (NON-QUALIFIED)

CERTIFICATE NO. E-

This STOCK OPTION AGREEMENT (the "Agreement") is made effective as of ______________________, by and between American Physicians Service Group, Inc., (the "Company"), and ____________________________ (the “Optionee").

Whereas Optionee is a valuable and trusted employee and or director of the Company, and the Company considers it desirable and in its best interests that Optionee be given an inducement to acquire a further proprietary interest in the Company and an added incentive to advance the interests of the Company by possessing an option to purchase shares of the Company's common stock, par value $0.10 (the "Common Stock"), in accordance with the 1995 Incentive Stock Option Plan of the Company (the "Plan").

NOW, THEREFORE, in consideration of the premises, it is agreed by and between the parties as follows:

1.

Grant of Non-Qualified Stock Option.  The Company hereby grants to Optionee the right, privilege and option (the "Option") to purchase ___________ shares of Common Stock (the "Option Shares") at the purchase price of $_________ per share (the "Option Price"), as a Non-Qualified Stock Option, in the manner and subject to the conditions hereinafter provided.

2.

Time of Exercise of Option.  Subject to the limitations contained herein, the aforesaid option may be exercised at any time, and from time to time, in whole or in part, during the period ending five (5) years from the date of this agreement or until the termination thereof as provided in Section 4 below.

3.

Method of Exercise.  The Option shall be exercised by written notice directed to the Board of Directors of the Company, at the Company's principal place of business, specifying the number of shares of Common Stock purchased and accompanied by payment of the option price in a form suitable to the Company.  With the consent of the Option Committee, such payment may be in the form of shares of Company stock owned by the Optionee immediately prior to the exercise of the Option.

(a)  This option is exercisable with respect to the shares in cumulative annual installments as indicated below:

Date Number of Shares

(b)  The Company shall make immediate delivery of such shares, provided that if any law or regulation requires the Company to take any action with respect to the shares specified in such notice before the issuance thereof, then the date of delivery of such shares shall be extended for the period necessary to take such action.

(c)  The Option may be exercised within the above limitations and subject to the limitations contained within this section, as to any part of all of the shares covered thereby.

4.

Termination of Option.  Except as herein otherwise stated, the Option to the extent not heretofore exercised shall terminate upon the first to occur of the following dates:

(a)  The expiration of the option period as set out in Section 2 above.

(b)  The expiration of three (3) months after the date on which an Optionee's employment by the Company or director relationship with the Company is terminated for any reason other than death or permanent and total disability;

(c)  The expiration of twelve (12) months after the date on which Optionee's employment by the Company or director relationship with the Company is terminated by reason of Optionee's permanent and total disability;

(d)  In the event of Optionee's death while serving as director of, or in the employ of, the Company, his/her executors or administrators may exercise, within twelve (12) months following the date of death, the Option as to any of the Option Shares not theretofore exercised during the lifetime of Optionee; or

(e)  The expiration of ten (10) years following the grant of this Option, commencing the effective date set forth above.

5.

Reclassification, Consolidation or Merger.  If all or any portion of the Option shall be exercised subsequent to any share dividend, split-up, recapitalization, merger, consolidation, combination or exchange of shares, separation, reorganization or liquidation occurring after the date hereof, as a result of which shares of any class of the capital stock of the Company shall be issued in respect of the then issued and outstanding Common Stock, or Common Stock shall be changed into the same or a different number of shares of the same or another class or classes of the capital stock of the Company, the person or persons so exercising the Option shall receive, for the aggregate price paid upon such exercise, the aggregate number and class of shares of the capital stock of the Company which, if Common Stock (as authorized at the date hereof) had been purchased immediately prior to such event at the price per share set forth in Section 1 hereof, su ch person or persons would be holding at the time of such exercise; provided, however, that no fractional share shall be issued upon any such exercise, and the aggregate price paid shall be appropriately reduced on account of any fractional share not issued.  No adjustment shall be made in the minimum number of shares which may be purchased at any one time, as fixed by subsection 3(c) hereof.

2

6.

Withholding of Tax.  To the extent that the exercise of this Option or the disposition of shares of Common Stock acquired by exercise of this Option results in compensation income to Optionee for federal or state income tax purpose, Optionee shall deliver to the Company at the time of such exercise or disposition such amount of money or shares of Common Stock as the Company may require to meet its obligation under applicable tax laws or regulations, and, if Optionee fails to do so, the Company is authorized to withhold from any cash or Common Stock remuneration then or thereafter payable to Optionee any tax required to be withheld by reason of such resulting compensation income.  Upon an exercise of this Option, the Company is further authorized in its discretion to satisfy any such withholding requirement out of any cash or shares of Common Stock distributable to Optionee upon such exercise.

7.

Rights Prior to Exercise of Option.  This Option is not transferable by Optionee, except in the event of his/her death as provided in Subsection 4(c) above, and during his/her lifetime is exercisable only by him/her; provided that this Option and the rights granted hereunder may be transferred with the prior written consent of the Committee that administers the Plan.  Optionee and any transferee shall have no rights as a shareholder with respect to the Option Shares until payment of the Option Price and delivery to him of such shares as herein provided.

8.

Modification and Waiver.  Except for the Plan, this Agreement constitutes the entire Agreement between the parties pertaining to the subject matter contained in it and supersedes all prior and contemporaneous agreements, representations and understandings of the parties.  No supplement, modification or amendment of this Agreement shall be binding unless executed in writing by the party to be charged therewith.  No waiver of any of the provisions of this Agreement shall be deemed, or shall constitute a continuing waiver.

9.

Applicable Law and Venue.  This Agreement has been executed by the Company at, and shall be deemed to be performable in, Travis County, Texas.  For these and other reasons, the parties agree that this Agreement shall be governed by and construed in accordance with the laws of the State of Texas.

10.

Jurisdiction.  The parties agree that the courts of the State of Texas, and any courts whose jurisdiction is derivative on the jurisdiction of the courts of the State of Texas, shall have exclusive personal jurisdiction over all parties to this Agreement.

11.

Headings.  The subject headings of the sections of this Agreement are included for purposes of convenience only, and shall not affect the construction or interpretation of any of its provisions.

12.

Counterparts.  This Agreement may be executed simultaneously in one or more identical counterparts, each of which for all purposes shall be deemed an original, and all of which shall constitute, collectively, one instrument; but in making proof of this Agreement, it shall not be necessary to produce or account for more than one executed counterpart.

3

IN WITNESS WHEREOF, the parties to this Agreement have duly executed it on the dates indicated below, to be effective, however, as of the date first hereinabove written.

Date:	By:
		Kenneth S. Shifrin, Chairman of the Board
		Optionee:
Date:	By:
		Address
		Address
		Social Security Number

4

EX-31

Exhibit 31.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

PURSUANT TO RULE 13a-14(a) AND 15d-14(a) UNDER

THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED

CERTIFICATION

I, Kenneth  S. Shifrin, certify that:

1.

I have reviewed this quarterly report on Form 10-Q of American Physicians Service Group, Inc.;

2.

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

3.

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

4.

the registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a)

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

(b)

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

(c)

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

5.

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

(a)

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

(b)

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

Date:  November 5, 2007	/s/ Kenneth S. Shifrin
	Kenneth S. Shifrin
	Chairman of the Board

EX-31

Exhibit 31.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER

PURSUANT TO RULE 13a-14(a) AND 15d-14(a) UNDER

THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED

CERTIFICATION

I, William H. Hayes, certify that:

1.

I have reviewed this quarterly report on Form 10-Q of American Physicians Service Group, Inc.;

2.

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

3.

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

4.

the registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a)

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

(b)

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

(c)

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

5.

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

(a)

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

(b)

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

Date:  November 5, 2007	/s/ William H. Hayes
	William H. Hayes
	Senior Vice President-Finance

EX-32

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of American Physicians Service Group, Inc. (the ”Company”) on Form 10-Q for the quarter ending September 30, 2007 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned, in the capacity and on the date indicated below, hereby certifies pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of his knowledge:

1.

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

2.

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operation of the Company.

/s/ Kenneth S. Shifrin	November 5, 2007
Kenneth S. Shifrin	Date
Chief Executive Officer

EX-32

Exhibit 32.2

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of American Physicians Service Group, Inc. (the ”Company”) on Form 10-Q for the quarter ending September 30, 2007 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned, in the capacity and on the date indicated below, hereby certifies pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of his knowledge:

1.

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

2.

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operation of the Company.

/s/ William H. Hayes	November 5, 2007
William H. Hayes	Date
Chief Financial Officer