e10vq

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549

Form 10-Q


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarter ended March 31, 2010
or
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-14094

Meadowbrook Insurance Group, Inc.

(Exact name of Registrant as specified in its charter)


Michigan		38-2626206
(State of Incorporation)		(IRS Employer Identification No.)

26255 American Drive,

Southfield, Michigan 48034

(Address, zip code of principal executive offices)

(248) 358-1100

(Registrant’s telephone number, including area code)

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

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

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


Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o

(Do not check if a smaller reporting company)

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

The aggregate number of shares of the Registrant’s Common Stock, $.01 par value, outstanding on May 4, 2010, was 54,211,542.

PART 1 — FINANCIAL INFORMATION

ITEM 1 FINANCIAL STATEMENTS

MEADOWBROOK INSURANCE GROUP, INC.

CONSOLIDATED STATEMENTS OF INCOME
For the Three Months Ended March 31,


	2010			2009
	(Unaudited)
	(In thousands, except share data)

Revenues
Premiums earned
Gross	$	179,613		$	155,014
Ceded		(28,172	)		(25,976	)

Net earned premiums		151,441			129,038
Net commissions and fees		9,868			10,237
Net investment income		13,029			12,342
Realized losses:
Total other-than-temporary impairments on securities		(305	)		(2,051	)
Portion of loss recognized in other comprehensive income		—			—

Net other-than-temporary impairments on securities recognized in earnings		(305	)		(2,051	)
Net realized gains excluding other-than-temporary impairments on securities		171			59

Net realized losses		(134	)		(1,992	)

Total revenues		174,204			149,625

Expenses
Losses and loss adjustment expenses		99,321			93,806
Reinsurance recoveries		(11,841	)		(18,911	)

Net losses and loss adjustment expenses		87,480			74,895
Policy acquisition and other underwriting expenses		51,879			38,993
General selling & administrative expenses		5,906			8,166
General corporate expenses		1,977			1,922
Amortization expense		1,401			1,508
Interest expense		2,443			2,782

Total expenses		151,086			128,266

Income before taxes and equity earnings		23,118			21,359

Federal and state income tax expense		7,658			7,869
Equity earnings of affiliates, net of tax		522			—
Equity earnings of unconsolidated subsidiaries, net of tax		452			50

Net income	$	16,434		$	13,540

Earnings Per Share
Basic	$	0.30		$	0.24
Diluted	$	0.30		$	0.24
Weighted average number of common shares
Basic		55,272,310			57,392,499
Diluted		55,477,098			57,410,327
Dividends paid per common share	$	0.03		$	0.02

The accompanying notes are an integral part of the Consolidated Financial Statements.

MEADOWBROOK INSURANCE GROUP, INC.

CONSOLIDATED BALANCE SHEETS


	March 31,			December 31,
	2010			2009
	(Unaudited)
	(In thousands, except share data)

ASSETS
Investments
Debt securities available for sale, at fair value (amortized cost of $1,093,396 and $1,045,454)	$	1,141,412		$	1,088,554
Equity securities available for sale, at fair value (amortized cost of $26,793 and $26,919)		29,232			28,342
Cash and cash equivalents		72,691			86,319
Accrued investment income		12,477			11,599
Premiums and agent balances receivable, net		178,275			155,327
Reinsurance recoverable on:
Paid losses		7,727			7,724
Unpaid losses		269,524			266,801
Prepaid reinsurance premiums		35,523			35,298
Deferred policy acquisition costs		76,988			68,787
Deferred federal income taxes		4,060			5,645
Goodwill		118,842			118,842
Other intangible assets		39,912			41,301
Other assets		73,070			75,277

Total assets	$	2,059,733		$	1,989,816


LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Losses and loss adjustment expenses	$	978,448		$	949,177
Unearned premiums		353,475			325,915
Debt		47,063			49,875
Debentures		80,930			80,930
Accounts payable and accrued expenses		40,320			34,251
Funds held and reinsurance balances payable		29,360			29,161
Payable to insurance companies		3,985			3,314
Other liabilities		14,609			14,312

Total liabilities		1,548,190			1,486,935

Shareholders’ Equity
Common stock, $0.01 stated value; authorized 75,000,000 shares; 54,261,542 and 55,519,970 shares issued and outstanding		543			555
Additional paid-in capital		297,461			304,930
Retained earnings		184,261			172,441
Note receivable from officer		(818	)		(825	)
Accumulated other comprehensive income		30,096			25,780

Total shareholders’ equity		511,543			502,881

Total liabilities and shareholders’ equity	$	2,059,733		$	1,989,816

The accompanying notes are an integral part of the Consolidated Financial Statements.

MEADOWBROOK INSURANCE GROUP, INC.

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY


													Accumulated
				Additional						Note			Other			Total
	Common			Paid-In			Retained			Receivable			Comprehensive			Shareholders’
	Stock			Capital			Earnings			from Officer			(Loss) Income			Equity
	(In thousands)

Balances December 31, 2009	$	555		$	304,930		$	172,441		$	(825	)	$	25,780		$	502,881
Net income		—			—			16,434			—			—			16,434
Dividends declared and paid		—			—			(1,647	)		—			—			(1,647	)
Net unrealized appreciation on available for sale securities		—			—			—			—			4,347			4,347
Net deferred derivative gain — hedging activity		—			—			—			—			(178	)		(178	)
Stock award		2			273									—			275
Long term incentive plan; stock award for 2009-2011 plan years		—			251			—			—			—			251
Repurchase of 1,456,000 shares of common stock		(14	)		(7,993	)		(2,967	)		—			—			(10,974	)
Change in investment of affiliates, net of tax		—			—			—			—			90			90
Change in investment of unconsolidated subsidiaries		—			—			—			—			57			57
Note receivable from officer		—			—			—			7			—			7

Balances March 31, 2010	$	543		$	297,461		$	184,261		$	(818	)	$	30,096		$	511,543

The accompanying notes are an integral part of the Consolidated Financial Statements.

MEADOWBROOK INSURANCE GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Three Months Ended March 31,


	2010			2009
	(Unaudited)
	(In thousands)

Cash Flows From Operating Activities
Net income	$	16,434		$	13,540
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of other intangible assets		1,401			1,508
Amortization of deferred debenture issuance costs		66			121
Depreciation of furniture, equipment, and building		1,309			1,221
Net amortization of discount and premiums on bonds		981			815
Loss on sale of investments, net		156			2,014
Gain on sale of fixed assets		(22	)		(22	)
Long-term incentive plan expense		251			203
Stock award		310			—
Equity earnings of affiliates, net of taxes		(522	)		—
Equity earnings of unconsolidated subsidiaries, net of tax		(452	)		—
Deferred income tax expense		47			1,710
Changes in operating assets and liabilities:
Decrease (increase) in:
Premiums and agent balances receivable		(22,948	)		(9,336	)
Reinsurance recoverable on paid and unpaid losses		(2,726	)		(2,140	)
Prepaid reinsurance premiums		(225	)		(500	)
Deferred policy acquisition costs		(8,201	)		(811	)
Other assets		(2,220	)		(216	)
Increase (decrease) in:
Losses and loss adjustment expenses		29,271			11,993
Unearned premiums		27,560			4,978
Payable to insurance companies		671			(2,947	)
Funds held and reinsurance balances payable		199			525
Other liabilities		3,336			685

Total adjustments		28,242			9,801

Net cash provided by operating activities		44,676			23,341

Cash Flows From Investing Activities
Purchase of debt securities available for sale		(73,468	)		(59,740	)
Proceeds from sales and maturities of debt securities available for sale		28,166			35,685
Purchase of equity securities available for sale		—			(198	)
Proceeds from sales of equity securities available for sale		137			—
Capital expenditures		(1,040	)		(360	)
Acquisition of rights renewals		(12	)		—
Other investing activities		159			1,065

Net cash used in investing activities		(46,058	)		(23,548	)

Cash Flows From Financing Activities
Payment of lines of credit		(2,813	)		(2,375	)
Book overdrafts		1,519			712
Dividends paid on common stock(1)		—			(1,149	)
Cash payment for payroll taxes associated with long-term incentive plan net stock issuance		(35	)		(330	)
Share repurchases		(10,883	)		—
Other financing activities		(34	)		(31	)

Net cash used in financing activities		(12,246	)		(3,173	)

Net decrease in cash and cash equivalents		(13,628	)		(3,380	)
Cash and cash equivalents, beginning of period		86,319			76,588

Cash and cash equivalents, end of period	$	72,691		$	73,208

Supplemental Disclosure of Non-Cash Investing and Financing Activities:


(1)		Dividend of $1,647,046 was paid on April 5, 2010

The accompanying notes are an integral part of the Consolidated Financial Statements.

MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 — Summary of Significant Accounting Policies

Basis of Presentation and Management Representation

The consolidated financial statements include accounts, after elimination of intercompany accounts and transactions, of Meadowbrook Insurance Group, Inc. (the “Company” or “Meadowbrook”), its wholly owned subsidiary Star Insurance Company (“Star”), and Star’s wholly owned subsidiaries, Savers Property and Casualty Insurance Company (“Savers”), Williamsburg National Insurance Company (“Williamsburg”), and Ameritrust Insurance Corporation (“Ameritrust”). The consolidated financial statements also include Meadowbrook, Inc., Crest Financial Corporation, and their respective subsidiaries. In addition, the consolidated financial statements also include ProCentury Corporation (“ProCentury”) and its wholly owned subsidiaries. ProCentury’s wholly owned subsidiaries consist of Century Surety Company (“Century”) and its wholly owned subsidiary ProCentury Insurance Company (“PIC”). In addition, ProCentury Risk Partners Insurance Company, Ltd., is a wholly owned subsidiary of ProCentury. Star, Savers, Williamsburg, Ameritrust, Century, and PIC are collectively referred to as the Insurance Company Subsidiaries.

In the opinion of management, the consolidated financial statements reflect all normal recurring adjustments necessary to present a fair statement of the results for the interim period. Preparation of financial statements under generally accepted accounting principles (“GAAP”) requires management to make estimates. Actual results could differ from those estimates. The results of operations for the three months ended March 31, 2010 are not necessarily indicative of the results expected for the full year.

These financial statements and the notes thereto should be read in conjunction with the Company’s audited financial statements and accompanying notes included in its Annual Report on Form 10-K, as filed with the United States Securities and Exchange Commission, for the year ended December 31, 2009.

Revenue Recognition

Premiums written, which include direct, assumed and ceded are recognized as earned on a pro rata basis over the life of the policy term. Unearned premiums represent the portion of premiums written that are applicable to the unexpired terms of policies in force. Provisions for unearned premiums on reinsurance assumed from others are made on the basis of ceding reports when received and actuarial estimates.

Assumed premium estimates specifically relate to the mandatory assumed pool business from the National Council on Compensation Insurance (“NCCI”), or residual market business. The pool cedes workers’ compensation business to participating companies based upon the individual company’s market share by state. The activity is reported from NCCI to participating companies on a two quarter lag. To accommodate this lag, the Company estimates premium and loss activity based on historical and market based results. Historically, the Company has not experienced any material difficulties or disputes in collecting balances from NCCI; therefore, no provision for doubtful accounts is recorded related to the assumed premium estimate.

Fee income, which includes risk management consulting, loss control, and claim services, is recognized during the period the services are provided. Depending on the terms of the contract, claim processing fees are recognized as revenue over the estimated life of the claims, or the estimated life of the contract. For those contracts that provide services beyond the expiration or termination of the contract, fees are deferred in an amount equal to management’s estimate of the Company’s obligation to continue to provide services in the future.

Commission income, which includes reinsurance placement, is recorded on the later of the effective date or the billing date of the policies on which they were earned. Commission income is reported net of any sub-producer commission expense. Any commission adjustments that occur subsequent to the earnings process are recognized upon notification from the insurance companies. Profit sharing commissions from insurance companies are recognized when determinable, which is when such commissions are received.

MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Earnings Per Share

For the three months ended March 31, 2010, there were no outstanding options that have been excluded from the diluted earnings per share. Outstanding options of 1,500 for the three months ended March 31, 2009 have been excluded from the diluted earnings per share, as they were anti-dilutive. There were no shares issuable pursuant to stock options included in diluted earnings per share for the three months ended March 31, 2010 and 2009.

Shares related to the Company’s Long Term Incentive Plan (“LTIP”) included in diluted earnings per share were 204,788 and 17,828 for the three months ended March 31, 2010 and 2009, respectively.

Shares issued pursuant to a restricted stock award granted on February 23, 2010 were 202,500 out of the 2002 Stock Option Plan. Shares retired for tax withholding were 4,928 resulting in a net issuance of 197,572 which are included in our weighted average number of common shares for the three months ended March 31, 2010.

Income Taxes

As of March 31, 2010 and December 31, 2009, the Company did not have any unrecognized tax benefits.

Interest costs and penalties related to income taxes are classified as interest expense and other administrative expenses, respectively. As of March 31, 2010 and December 31, 2009, the Company had no accrued interest or penalties related to uncertain tax positions.

Reclassifications and redefining segment reporting:

During the three months ended March 31, 2010, the Company made certain reclassifications to the expense classifications in the Consolidated Statement of Income. These reclassifications were made to enable the user of the financial statements to calculate the GAAP combined ratio directly from the Consolidated Statement of Income. The reclassifications were the result of a comprehensive cost allocation study that allowed us to align the underlying internal salary and administrative costs with the underlying function of those costs. Previously, internal salary and administrative costs were charged to the Insurance Company Subsidiaries based upon an estimated management fee and later eliminated during consolidation. Under this new methodology, the actual costs are reimbursed by the Insurance Company Subsidiaries and the expenses are eliminated as a reimbursement of costs. As such, the nature of the costs retain their underlying function in the consolidation process. The Consolidated Statement of Income for the three months ended March 31, 2009 has been reclassified to conform to this revised presentation.

The following table sets forth the reclassification of expense line items for the three months ended March 31, 2009 (in thousands):


	As Reported			Reclassification			Reclassified
Losses and loss adjustment expenses	$	88,698		$	5,108		$	93,806
Reinsurance recoverables		(18,911	)		—			(18,911	)

Net losses and loss adjustment expenses		69,787			5,108			74,895

Salaries and employee benefits		19,827			(19,827	)		—
Policy acquisition and other underwriting expenses		23,969			15,024			38,993
Other administrative expenses		10,393			(10,393	)		—
General selling and administrative expenses		—			8,166			8,166
General corporate expenses		—			1,922			1,922
Amortization expense		1,508			—			1,508
Interest expense		2,782			—			2,782

Total expenses	$	128,266		$	—		$	128,266

MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

In addition, as part of this study, the Company re-evaluated its operating segments. As a result of this re-evaluation, the Company concluded that the previously reported Agency Operations segment should no longer be considered a separate segment of the Company as Agency Operations now represents less than 2% of the Company’s consolidated revenues and less than 1% of the Company’s consolidated pre-tax profits. As such, the Company will only report one operating segment — Specialty Insurance Operations.

Recent Accounting Pronouncements

In June 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (“ASC”) 810, Consolidation (previously SFAS No. 167, Amendments to FASB Interpretation No. 46(R). ASC 810, contains consolidation guidance applicable to variable interest entities. The guidance further requires enhanced disclosures, including disclosure of significant judgments and assumptions as to whether a variable interest entity must be consolidated, and how involvement with the variable interest entity affects a company’s financial statements. The guidance is effective for annual periods beginning after November 15, 2009. The Company adopted ASC 810 in the first quarter of 2010. The adoption of ASC 810 did not have a material impact on its financial condition or results of operations.

In January 2010, the FASB issued Accounting Standards Update (“ASU”) 2010-06 Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. Effective for interim and annual reporting periods beginning after December 15, 2009, ASU 2010-06 requires additional disclosures for financial instrument transfers in and out of Levels 1 and 2; and clarifies existing disclosure requirements around the level of disaggregation and for the inputs and valuation techniques. These additional disclosures are provided in Note 5 — Fair Value Measurements.

Effective for fiscal years beginning after December 15, 2010, ASU 2010-06 requires additional disclosures for activity in Level 3 fair value measurements. The adoption of this guidance is not expected to have a significant impact on our disclosures.


NOTE 2 —	Restricted Stock Awards

On February 23, 2010, the Company issued 202,500 restricted stock awards (“RSAs”), to eight executives of the Company, out of its 2002 Amended and Restated Stock Option Plan (the “Plan”). The RSAs vest over a four year period. The first twenty percent vested on February 23, 2010 and the remaining eighty percent will vest annually on a straight line basis over the requisite service period, which ends February 23, 2014. The unvested RSAs are subject to forfeiture in the event the employee is terminated for “Good Cause” or voluntarily resigns their employment without “Good Reason” as provided for in the employee’s respective employment agreements. In accordance with Accounting Standard Codification (“ASC”) 718, — Compensation — Stock Compensation, the Company recorded approximately $310,000 of compensation expense for the three months ended March 31, 2010.


NOTE 3 —	Debt

Credit Facilities

On July 31, 2008, the Company executed $100 million in senior credit facilities (the “Credit Facilities”). The Credit Facilities included a $65.0 million term loan facility, which was fully funded upon the closing of its Merger with ProCentury and a $35.0 million revolving credit facility, which was partially funded upon closing of the Merger. As of March 31, 2010, the outstanding balance on its term loan facility was $47.1 million. The Company did not have an outstanding balance on its revolving credit facility as of March 31, 2010. The undrawn portion of the revolving credit facility is available to finance working capital and for general corporate purposes, including but not limited to, surplus contributions to its Insurance Company Subsidiaries to support premium growth or strategic acquisitions. At December 31, 2009, the Company had an outstanding balance of $49.9 million on its term loan and did not have an outstanding balance on its revolving credit facility.

MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The principal amount outstanding under the Credit Facilities provides for interest at LIBOR, plus the applicable margin, or at the Company’s option, the base rate. The base rate is defined as the higher of the lending bank’s prime rate or the Federal Funds rate, plus 0.50%, plus the applicable margin. The applicable margin is determined by the consolidated indebtedness to consolidated total capital ratio. In addition, the Credit Facilities provide for an unused facility fee ranging between twenty basis points and forty basis points, based on our consolidated leverage ratio as defined by the Credit Facilities. At March 31, 2010, the interest rate on the Company’s term loan was 5.95%, which consisted of a fixed rate of 3.95%, as described in Note 6 — Derivative Instruments, plus an applicable margin of 2.00%.

The debt covenants applicable to the Credit Facilities consist of: (1) minimum consolidated net worth starting at eighty percent of pro forma consolidated net worth after giving effect to the acquisition of ProCentury, with quarterly increases thereafter, (2) minimum Risk Based Capital Ratio for Star and Century Surety of 1.75 to 1.00, (3) maximum permitted consolidated leverage ratio of 0.35 to 1.00, (4) minimum consolidated debt service coverage ratio of 1.25 to 1.00, and (5) minimum A.M. Best Company rating of “B++.” As of March 31, 2010, the Company was in compliance with these debt covenants.

Debentures

The following table summarizes the principal amounts and variables associated with the Company’s debentures (in thousands):


										Interest
										Rate at
Year of			Year		Year					March 31,			Principal
Issuance		Description	Callable		Due		Interest Rate Terms			2010(1)			Amount

	2003	Junior subordinated debentures		2008		2033		Three-month LIBOR, plus 4.05	%		4.34	%	$	10,310
	2004	Senior debentures		2009		2034		Three-month LIBOR, plus 4.00	%		4.25	%		13,000
	2004	Senior debentures		2009		2034		Three-month LIBOR, plus 4.20	%		4.45	%		12,000
	2005	Junior subordinated debentures		2010		2035		Three-month LIBOR, plus 3.58	%		3.84	%		20,620
		Junior subordinated debentures(2)		2007		2032		Three-month LIBOR, plus 4.00	%		4.25	%		15,000
		Junior subordinated debentures(2)		2008		2033		Three-month LIBOR, plus 4.10	%		4.35	%		10,000

											Total		$	80,930


(1)		The underlying three-month LIBOR rate varies as a result of the interest rate reset dates used in determining the three-month LIBOR rate, which varies for each long-term debt item each quarter.

(2)		Represents the junior subordinated debentures acquired in conjunction with the ProCentury Merger (the “Merger”) on July 31, 2008.

Excluding the junior subordinated debentures acquired in conjunction with the ProCentury Merger, the Company received a total of $53.3 million in net proceeds from the issuance of the above long-term debt, of which $26.2 million was contributed to the surplus of its Insurance Company Subsidiaries and the remaining balance was used for general corporate purposes. Associated with the issuance of the above long-term debt, the Company incurred approximately $1.7 million in issuance costs for commissions paid to the placement agents in the transactions.

The issuance costs associated with these debentures have been capitalized and are included in other assets on the balance sheet. As of June 30, 2007, these issuance costs were being amortized over a seven year period as a component of interest expense. The seven year amortization period represented management’s best estimate of the estimated useful life of the bonds related to both the senior debentures and junior subordinated debentures. Beginning July 1, 2007, the Company reevaluated its best estimate and determined a five year amortization period

MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

to be a more accurate representation of the estimated useful life. Therefore, this change in amortization period from seven years to five years has been applied prospectively beginning July 1, 2007.

The junior subordinated debentures issued in 2003 and 2005 were issued in conjunction with the issuance of $10.0 million and $20.0 million in mandatory redeemable trust preferred securities to a trust formed by an institutional investor from the Company’s unconsolidated subsidiary trusts, respectively.

In relation to the junior subordinated debentures acquired in conjunction with the ProCentury Merger, the Company also acquired the remaining unamortized portion of the capitalized issuance costs associated with these debentures. The remaining unamortized portion of the issuance costs acquired was $625,000. These are included in other assets on the balance sheet. The remaining balance is being amortized over a five year period beginning August 1, 2008, as a component of interest expense.

The junior subordinated debentures are unsecured obligations of the Company and are junior to the right of payment to all senior indebtedness of the Company. The Company has guaranteed that the payments made to both Trusts will be distributed by the Trusts to the holders of the trust preferred securities.

The Company estimates that the fair value of the above mentioned junior subordinated debentures and senior debentures issued approximate the gross proceeds of cash received at the time of issuance.


NOTE 4 —	Investments

The estimated fair value of investments in securities is determined based on published market quotations and broker/dealer quotations. The cost or amortized cost, gross unrealized gains, losses, non-credit other than temporary impairments (“OTTI”) and estimated fair value of investments in securities classified as available for sale at March 31, 2010 and December 31, 2009 were as follows (in thousands):


	March 31, 2010
	Cost or		Gross Unrealized
	Amortized							Non-Credit			Estimated
	Cost		Gains		Losses			OTTI(1)			Fair Value

Debt Securities:
U.S. Government and agencies	$	24,155	$	1,052	$	(28	)	$	—		$	25,179
Obligations of states and political subs		507,498		21,148		(650	)		—			527,996
Corporate securities		304,773		12,829		(769	)		(12	)		316,821
Redeemable preferred stocks		2,689		1,916		—			—			4,605
Residential mortgage-backed securities		200,933		12,486		(78	)		(558	)		212,783
Commercial mortgage-backed securities		29,896		769		(362	)		—			30,303
Other asset-backed securities		23,452		1,255		(154	)		(828	)		23,725

Total debt securities available for sale		1,093,396		51,455		(2,041	)		(1,398	)		1,141,412

Equity Securities:
Perpetual preferred stock		12,005		1,997		(69	)		—			13,933
Common stock		14,788		987		(476	)		—			15,299

Total equity securities available for sale		26,793		2,984		(545	)		—			29,232

Total securities available for sale	$	1,120,189	$	54,439	$	(2,586	)	$	(1,398	)	$	1,170,644

MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	December 31, 2009
	Cost or		Gross Unrealized
	Amortized							Non-Credit			Estimated
	Cost		Gains		Losses			OTTI(1)			Fair Value

Debt Securities:
U.S. Government and agencies	$	26,177	$	1,037	$	(60	)	$	—		$	27,154
Obligations of states and political subs		499,384		21,566		(816	)		—			520,134
Corporate securities		257,187		10,872		(892	)		(22	)		267,145
Redeemable preferred stocks		2,689		1,349		(38	)		—			4,000
Residential mortgage-backed securities		214,562		11,379		(114	)		(615	)		225,212
Commercial mortgage-backed securities		24,015		292		(579	)		—			23,728
Other asset-backed securities		21,440		983		(181	)		(1,061	)		21,181

Total debt securities available for sale		1,045,454		47,478		(2,680	)		(1,698	)		1,088,554

Equity Securities:
Perpetual preferred stock		12,131		1,350		(168	)		—			13,313
Common stock		14,788		691		(450	)		—			15,029

Total equity securities available for sale		26,919		2,041		(618	)		—			28,342

Total securities available for sale	$	1,072,373	$	49,519	$	(3,298	)	$	(1,698	)	$	1,116,896


(1)		Includes unrealized gains (losses) related to securities with non-credit OTTI.

Gross unrealized gains, losses, and non-credit OTTI on available for sale securities as of March 31, 2010 and December 31, 2009 were as follows (in thousands):


	March 31,			December 31,
	2010			2009

Unrealized gains	$	54,439		$	49,519
Unrealized losses		(2,586	)		(3,298	)
Non-credit OTTI(1)		(1,398	)		(1,698	)

Net unrealized gains		50,455			44,523
Deferred federal income tax expense		(17,659	)		(15,583	)
Valuation allowance adjustment on deferred income taxes		1,185			694

Net unrealized gains on investments, net of deferred federal income taxes	$	33,981		$	29,634


(1)		Includes unrealized gains (losses) related to securities with non-credit OTTI.

MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Net realized (losses) gains on securities, including OTTI, for the three months ended March 31, 2010 and 2009 were as follows (in thousands):


	For the Three Months
	Ended March 31,
	2010			2009

Realized (losses) gains:
Debt securities:
Gross realized gains	$	148		$	56
Gross realized losses		(314	)		(1,752	)

Total debt securities		(166	)		(1,696	)

Equity Securities:
Gross realized gains		10			—
Gross realized losses		—			(317	)

Total equity securities		10			(317	)

Net realized losses	$	(156	)	$	(2,013	)

OTTI included in realized losses on securities above	$	(305	)	$	(2,051	)

Proceeds from the sales of fixed maturity securities available for sale were $416,000 for the three months ended March 31, 2010. There were no sales of fixed maturity securities available for sale for the three months ended March 31, 2009.

At March 31, 2010, the amortized cost and estimated fair value of available for sale debt securities by contractual maturity are shown below. Expected maturities may differ from contractual maturities, because certain borrowers may have the right to call or prepay obligations with or without call or prepayment penalties (in thousands):


	Available for Sale
			Estimated Fair
	Amortized Cost		Value

Due in one year or less	$	35,960	$	37,014
Due after one year through five years		183,629		193,353
Due after five years through ten years		458,040		478,977
Due after ten years		161,486		165,255
Mortgage-backed securities, collateralized obligations and other asset-backed securities		254,281		266,813

	$	1,093,396	$	1,141,412

MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Net investment income for the three months ended March 31, 2010 and 2009 was as follows (in thousands):


	For the Three Months
	Ended March 31,
	2010		2009

Net Investment Income Earned From:
Debt securities	$	12,580	$	11,725
Equity Securities		536		523
Cash and cash equivalents		184		377

Total gross investment income		13,300		12,625
Less investment expenses		271		283

Net investment income	$	13,029	$	12,342

Other Than Temporary Impairments of Securities and Unrealized Losses on Investments

At March 31, 2010 and December 31, 2009, the Company had 107 and 127 securities that were in an unrealized loss position, respectively. Of the securities held at March 31, 2010, twenty-seven had an aggregate $18.9 million and $1.8 million fair value and unrealized loss, respectively, and have been in an unrealized loss position for more than twelve months. Of the securities held at December 31, 2009, forty-one had an aggregate $30.0 million and $2.3 million fair value and unrealized loss, respectively, and have been in an unrealized loss position for more than twelve months.

Available for sale securities are reviewed for declines in fair value that are determined to be other-than-temporary. For a debt security, if the Company intends to sell a security and it is more likely than not the Company will be required to sell a debt security before recovery of its amortized cost basis and the fair value of the debt security is below amortized cost, the Company concludes that an OTTI has occurred and the amortized cost is written down to current fair value, with a corresponding charge to realized loss in the Consolidated Statements of Income. If the Company does not intend to sell a debt security and it is not more likely than not the Company will be required to sell a debt security before recovery of its amortized cost basis but the present value of the cash flows expected to be collected is less than the amortized cost of the debt security (referred to as the credit loss), the Company concludes that an OTTI has occurred. In this instance, accounting guidance requires the bifurcation of the total OTTI into the amount related to the credit loss, which is recognized in earnings and the non-credit OTTI, which is recorded in Other Comprehensive Income as an unrealized non-credit OTTI in the Consolidated Statements of Comprehensive Income.

When assessing the Company’s intent to sell a debt security and if it is more likely than not we will be required to sell a debt security before recovery of its cost basis, facts and circumstances such as, but not limited to, decisions to reposition our security portfolio, sale of securities to meet cash flow needs and sales of securities to capitalize on favorable pricing, are evaluated. In order to determine the amount of the credit loss for a debt security, the Company calculates the recovery value by performing a discounted cash flow analysis based on the current cash flows and future cash flows expected to be recovered. The discount rate is the effective interest rate implicit in the underlying debt security upon issuance. The effective interest rate is the original yield or the coupon if the debt security was previously impaired. If an OTTI exists and there is not sufficient cash flows or other information to determine a recovery value of the security, the Company concludes that the entire OTTI is credit-related and the amortized cost for the security is written down to current fair value with a corresponding charge to realized loss in the Consolidated Statements of Income.

MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

To determine the recovery period of a debt security, the Company considers the facts and circumstances surrounding the underlying issuer including, but not limited to the following:


	•	Historical and implied volatility of the security;

	•	Length of time and extent to which the fair value has been less than amortized cost;

	•	Conditions specifically related to the security such as default rates, loss severities, loan to value ratios, current levels of subordination, third party guarantees, and vintage;

	•	Specific conditions in an industry or geographic area;

	•	Any changes to the rating of the security by a rating agency;

	•	Failure, if any, of the issuer of the security to make scheduled payments; and

	•	Recoveries or additional declines in fair value subsequent to the balance sheet date.

In periods subsequent to the recognition of an OTTI, the security is accounted for as if it had been purchased on the measurement date of the OTTI. Therefore, for a fixed maturity security, the discount or reduced premium is reflected in net investment income over the contractual term of the investment in a manner that produces a constant effective yield.

For an equity security, if the Company does not have the ability and intent to hold the security for a sufficient period of time to allow for a recovery in value, the Company concludes that an OTTI has occurred, and the cost of the equity security is written down to the current fair value, with a corresponding charge to realized loss within the Consolidated Statements of Income. When assessing the Company’s ability and intent to hold the equity security to recovery, the Company considers, among other things, the severity and duration of the decline in fair value of the equity security, as well as the cause of decline, a fundamental analysis of the liquidity, business prospects and overall financial condition of the issuer.

After the Company’s review of its investment portfolio in relation to this policy, the Company recorded a credit OTTI loss of $305,000 for the three months ended March 31, 2010, of which no non-credit related OTTI losses were recognized in other comprehensive income. For the three months ended March 31, 2009, the Company recorded an OTTI loss of $2.1 million.

MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The fair value and amount of unrealized losses segregated by the time period the investment has been in an unrealized loss position were as follows for the periods ended (in thousands):


	March 31, 2010
	Less Than 12 months					Greater Than 12 months					Total
	Fair Value of		Gross			Fair Value of		Gross			Fair Value of		Gross
	Investments		Unrealized			Investments		Unrealized			Investments		Unrealized
	with		Losses and			with		Losses and			with		Losses and
	Unrealized		Non-Credit			Unrealized		Non-Credit			Unrealized		Non-Credit
	Losses		OTTI			Losses		OTTI			Losses		OTTI

Debt Securities:
U.S. Government and agencies	$	3,467	$	(28	)	$	—	$	—		$	3,467	$	(28	)
Obligations of states and political subs		53,135		(498	)		6,327		(152	)		59,462		(650	)
Corporate securities		60,590		(781	)		—		—			60,590		(781	)
Redeemable preferred stocks		—		—			—		—			—		—
Residential mortgage-backed securities		5,791		(63	)		4,613		(573	)		10,404		(636	)
Commercial mortgage-backed securities		7,184		(46	)		281		(316	)		7,465		(362	)
Other asset-backed securities		2,389		(743	)		1,119		(239	)		3,508		(982	)

Total debt securities		132,556		(2,159	)		12,340		(1,280	)		144,896		(3,439	)

Equity Securities:
Perpetual preferred stock		—		—			1,440		(69	)		1,440		(69	)
Common stock		—		—			5,084		(476	)		5,084		(476	)

Total equity securities		—		—			6,524		(545	)		6,524		(545	)

Total securities	$	132,556	$	(2,159	)	$	18,864	$	(1,825	)	$	151,420	$	(3,984	)


	December 31, 2009
	Less Than 12 months					Greater Than 12 months					Total
	Fair Value of		Gross			Fair Value of		Gross			Fair Value of		Gross
	Investments		Unrealized			Investments		Unrealized			Investments		Unrealized
	with		Losses and			with		Losses and			with		Losses and
	Unrealized		Non-Credit			Unrealized		Non-Credit			Unrealized		Non-Credit
	Losses		OTTI			Losses		OTTI			Losses		OTTI

Debt Securities:
U.S. Government and agencies	$	3,546	$	(60	)	$	—	$	—		$	3,546	$	(60	)
Obligations of states and political subs		53,577		(640	)		7,115		(176	)		60,692		(816	)
Corporate securities		55,276		(912	)		199		(2	)		55,475		(914	)
Redeemable preferred stocks		—		—			721		(38	)		721		(38	)
Residential mortgage-backed securities		5,971		(79	)		4,596		(650	)		10,567		(729	)
Commercial mortgage-backed securities		3,286		(20	)		8,109		(559	)		11,395		(579	)
Other asset-backed securities		3,177		(972	)		1,354		(270	)		4,531		(1,242	)

Total debt securities		124,833		(2,683	)		22,094		(1,695	)		146,927		(4,378	)

Equity Securities:
Perpetual preferred stock		103		(24	)		2,862		(144	)		2,965		(168	)
Common stock		—		—			5,074		(450	)		5,074		(450	)

Total equity securities		103		(24	)		7,936		(594	)		8,039		(618	)

Total securities	$	124,936	$	(2,707	)	$	30,030	$	(2,289	)	$	154,966	$	(4,996	)

MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Changes in the amount of credit loss on fixed maturities for which a portion of an OTTI related to other factors was recognized in other comprehensive income were as follows (in thousands):


Balance as of January 1, 2010	$	(547	)
Additional credit impairments on:
Previously impaired securities		(245	)
Securities for which an impairment was not previously recognized		—
Reductions		—

Balance as of March 31, 2010	$	(792	)


NOTE 5 —	Fair Value Measurements

The Company’s available for sale investment portfolio consists primarily of debt securities. The change in fair value of these investments is recorded as a component of other comprehensive income. In addition, the Company has eight interest rate swaps that are designated as cash flow hedges. The Company records these interest rate swap transactions at fair value on the balance sheet and the effective portion of the changes in fair value are accounted for within other comprehensive income.

Fair value measurement accounting guidance establishes a three-level hierarchy for fair value measurements that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (“observable inputs”) and the reporting entity’s own assumptions about market participants’ assumptions (“unobservable inputs”). The hierarchy level assigned to each security in the Company’s available for sale portfolio is based upon its assessment of the transparency and reliability of the inputs used in the valuation as of the measurement date. The three hierarchy levels are defined as follows:


	•	Level 1 — Observable unadjusted quoted prices in active markets for identical securities.

The fair value measurements of exchange-traded preferred and common equities, and mutual funds were based on Level 1 inputs, or quoted market prices in active markets.

The fair value measurements of a slight portion of the Company’s fixed income securities, comprising 2.9% of the fair value of the total fixed income portfolio, were based on Level 1 inputs.


	•	Level 2 — Observable inputs other than quoted prices in active markets for identical securities, including: quoted prices in active markets for similar securities; quoted prices for identical or similar securities in markets that are not active; inputs other than quoted prices that are observable for the security (e.g., interest rates, yield curves observable at commonly quoted intervals, volatilities, prepayment speeds, credit risks, default rates); and inputs derived from or corroborated by observable market data by correlation or other means.

The fair value measurements of substantially all of the Company’s fixed income securities, comprising 96.7% of the fair value of the total fixed income portfolio, were based on Level 2 inputs.

The fair values of the Company’s interest rate swaps were based on Level 2 inputs.


	•	Level 3 — Unobservable inputs, including the reporting entity’s own data (e.g., cash flow estimates), as long as there are no contrary data indicating market participants would use different assumptions.

The fair value measurements for eighteen securities, comprising 0.4% of the fair value of the total fixed income portfolio, were based on Level 3 inputs, due to the limited availability of corroborating market data. Inputs for valuation of these securities included benchmark yields, broker quotes, and models based on cash flows and other inputs.

MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The fair values of securities were based on market values obtained from an independent pricing service that were evaluated using pricing models that vary by asset class and incorporate available trade, bid, and other market information and price quotes from well established independent broker-dealers. The independent pricing service monitors market indicators, industry and economic events, and for broker-quoted only securities, obtains quotes from market makers or broker-dealers that it recognizes to be market participants.

The following table presents the Company’s assets and liabilities measured at fair value on a recurring basis, classified by the valuation hierarchy as of March 31, 2010 (in thousands):


			Fair Value Measurements Using
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
	March 31, 2010		Assets		Inputs		Inputs
	Total		(Level 1)		(Level 2)		(Level 3)

Debt Securities:
U.S. Government and agencies	$	25,179	$	—	$	25,179	$	—
Obligations of states and political subs		527,996		—		527,996		—
Corporate securities		316,821		—		315,669		1,152
Redeemable preferred stocks		4,605		4,605		—		—
Residential mortgage-backed securities		212,783		—		212,782		1
Commercial mortgage-backed securities		30,303		—		30,303		—
Other asset-backed securities		23,725		—		20,247		3,478

Total debt securities available for sale		1,141,412		4,605		1,132,176		4,631

Equity Securities:
Perpetual preferred stock		13,933		13,933		—		—
Common stock		15,299		15,299		—		—

Total equity securities available for sale		29,232		29,232		—		—

Total securities available for sale	$	1,170,644	$	33,837	$	1,132,176	$	4,631

Derivatives — interest rate swaps	$	6,202		—	$	6,202		—

MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following table presents changes in Level 3 available for sale investments measured at fair value on a recurring basis as of March 31, 2010 (in thousands):


	Fair Value
	Measurement
	Using Significant
	Unobservable
	Inputs - Level 3

Balance as of January 1, 2010	$	4,161
Total gains or losses (realized/unrealized):
Included in earnings		(27	)
Included in other comprehensive income		45
Purchases, issuances and settlements		420
Transfers in and out of Level 3		32

Balance as of March 31, 2010	$	4,631

Total credit losses for the period that are included in earnings attributable to the change in unrealized losses on Level 3 assets still held at the reporting date amounted to $47,000.

The Company’s policy on recognizing transfers between hierarchy levels is determined at the end of the reporting period. During the quarter ended March 31, 2010, there were no transfers in or out of level 1 securities, and no transfers into level 2 securities. There was one structured security that was transferred out of level 2 and into level 3, because it was determined that its fair value could no longer be based on a non-binding quote from a well established independent broker-dealer. There were no securities transferred out of level 3.


NOTE 6 —	Derivative Instruments

The Company has entered into interest rate swap transactions to mitigate its interest rate risk on its existing debt obligations. These interest rate swap transactions have been designated as cash flow hedges and are deemed highly effective hedges. These interest rate swap transactions are recorded at fair value on the balance sheet and the effective portion of the changes in fair value are accounted for within other comprehensive income. The interest differential to be paid or received is accrued and recognized as an adjustment to interest expense.

The following table summarizes the rates and amounts associated with the Company’s interest rate swaps (in thousands):

Fixed

Amount at

Expiration

Fixed

March 31,

Effective Date

Date

Debt Instrument

Counterparty Interest Rate Terms

Rate

2010

10/6/2005

9/16/2010

Junior subordinated debentures

Three-month LIBOR, plus 3.58%

8.340

20,000

4/23/2008

5/24/2011

Senior debentures

Three-month LIBOR, plus 4.20%

7.720

7,000

4/23/2008

6/30/2013

Junior subordinated debentures

Three-month LIBOR, plus 4.05%

8.020

10,000

4/29/2008

4/29/2013

Senior debentures

Three-month LIBOR, plus 4.00%

7.940

13,000

7/31/2008

7/31/2013

Term loan(1)

Three-month LIBOR

3.950

47,063

8/15/2008

8/15/2013

Junior subordinated debentures(2)

Three-month LIBOR

3.780

10,000

9/4/2008

9/4/2013

Junior subordinated debentures(2)

Three-month LIBOR

3.790

15,000


(1)		The Company is required to make fixed rate interest payments on the current balance of the term loan, amortizing in accordance with the term loan amortization schedule. The Company fixed only the variable interest portion of the loan. The actual interest payments associated with the term loan also include an additional rate of 2.00% in accordance with the credit agreement.

MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(2)		The Company fixed only the variable interest portion of the debt. The actual interest payments associated with the debentures also include an additional rate of 4.10% and 4.00% on the $10.0 million and $15.0 million debentures, respectively.

In relation to the above interest rate swaps, the net interest expense incurred for the three months ended March 31, 2010, was approximately $1.2 million. The net interest expense incurred for the three months ended March 31, 2009, was approximately $798,000.

As of March 31, 2010 and December 31, 2009, the total fair value of the interest rate swaps was approximately ($6.2 million) and ($5.9 million), respectively. Accumulated other comprehensive income at March 31, 2010 and December 31, 2009, included accumulated loss on the cash flow hedge, net of taxes, of approximately $4.0 million and $3.9 million, respectively.

In December 2005, the Company entered into a $6.0 million convertible note receivable with an unaffiliated insurance agency. The effective interest rate of the convertible note is equal to the three-month LIBOR, plus 5.2% and is due 90 days after the receipt of the agency’s 2013 audited financial statements. This agency has been a producer for the Company for over ten years. As security for the loan, the borrower granted the Company a security interest in its accounts, cash, general intangibles, and other intangible property. Also, the shareholder pledged 100% of the common shares of three insurance agencies, the common shares owned by the shareholder in another agency, and executed a personal guaranty. This note is convertible at the option of the Company based upon a pre-determined formula.


NOTE 7 —	Shareholders’ Equity

At March 31, 2010, shareholders’ equity was $511.5 million, or a book value of $9.43 per common share, compared to $502.9 million, or a book value of $9.06 per common share, at December 31, 2009.

At the Company’s Board of Directors meeting on February 12, 2010, the Board authorized management to purchase up to 5.0 million shares of the Company’s common stock in market transactions for a period not to exceed twenty-four months. This share repurchase plan replaced the existing share repurchase plan authorized in July 2008. For the three months ended March 31, 2010, the Company purchased and retired approximately 1.5 million shares of common stock for a total cost of approximately $11.0 million. There were no share repurchases in the three months ended March 31, 2009.

For the three months ended March 31, 2010, the Company had $1.6 million of cash dividends payable on April 5, 2010. For the three months ended March 31, 2009, cash dividends paid to common shareholders totaled $1.1 million. On April 30, 2010, the Company’s Board of Directors declared a quarterly dividend of $0.03 per common share. The dividend is payable on June 1, 2010, to shareholders of record as of May 14, 2010.

When evaluating the declaration of a dividend, the Company’s Board of Directors considers a variety of factors, including but not limited to, cash flow, liquidity needs, results of operations, industry conditions, and our overall financial condition. As a holding company, the ability to pay cash dividends is partially dependent on dividends and other permitted payments from its Insurance Company Subsidiaries.


NOTE 8 —	Commitments and Contingencies

The Company, and its subsidiaries, are subject at times to various claims, lawsuits and proceedings relating principally to alleged errors or omissions in the placement of insurance, claims administration, consulting services and other business transactions arising in the ordinary course of business. Where appropriate, the Company vigorously defends such claims, lawsuits and proceedings. Some of these claims, lawsuits and proceedings seek damages, including consequential, exemplary or punitive damages, in amounts that could, if awarded, be significant. Most of the claims, lawsuits and proceedings arising in the ordinary course of business are covered by errors and omissions insurance or other appropriate insurance. In terms of deductibles associated with such insurance, the

MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Company has established provisions against these items, which are believed to be adequate in light of current information and legal advice. In accordance with accounting guidance, if it is probable that an asset has been impaired or a liability has been incurred as of the date of the financial statements and the amount of loss is estimable; an accrual for the costs to resolve these claims is recorded by the Company in the accompanying consolidated balance sheets. Period expenses related to the defense of such claims are included in other operating expenses in the accompanying consolidated statements of income. Management, with the assistance of outside counsel, adjusts such provisions according to new developments or changes in the strategy in dealing with such matters. On the basis of current information, the Company does not expect the outcome of the claims, lawsuits and proceedings to which the Company is subject to, either individually, or in the aggregate, will have a material adverse effect on the Company’s financial condition. However, it is possible that future results of operations or cash flows for any particular quarter or annual period could be materially affected by an unfavorable resolution of any such matters.


NOTE 9 —	Earnings Per Share

Basic earnings per share are based on the weighted average number of common shares outstanding during the year, while diluted earnings per share includes the weighted average number of common shares and potential dilution from shares issuable pursuant to stock options or stock awards using the treasury stock method.

The following table is a reconciliation of the income and share data used in the basic and diluted earnings per share computations for the three months ended March 31 (in thousands, except per share amounts):


	2010		2009

Net income, as reported	$	16,434	$	13,540

Common shares:
Basic
Weighted average shares outstanding		55,272,310		57,392,499

Diluted
Weighted average shares outstanding		55,272,310		57,392,499
Dilutive effect of:
Share awards under long term incentive plan		204,788		17,828

Total		55,477,098		57,410,327

Net income per common share
Basic	$	0.30	$	0.24
Diluted	$	0.30	$	0.24

ITEM 2 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

For the Periods ended March 31, 2010 and 2009

Forward-Looking Statements

This quarterly report may provide information including certain statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These include statements regarding the intent, belief, or current expectations of management, including, but not limited to, those statements that use the words “believes,” “expects,” “anticipates,” “estimates,” or similar expressions. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve a number of risks and uncertainties, and results could differ materially from those indicated by such forward-looking statements. Among the important factors that could cause actual results to differ materially from those indicated by such forward-looking statements are: the frequency and severity of claims; uncertainties inherent in reserve estimates; catastrophic events; a change in the demand for, pricing of, availability or collectability of reinsurance; increased rate pressure on premiums; ability to obtain rate increases in current market conditions; investment rate of return; changes in and adherence to insurance regulation; actions taken by regulators, rating agencies or lenders; attainment of certain processing efficiencies; changing rates of inflation; general economic conditions and other risks identified in our reports and registration statements filed with the Securities and Exchange Commission. We are not under any obligation to (and expressly disclaim any such obligation to) update or alter our forward-looking statements whether as a result of new information, future events or otherwise.

Business Overview

We are a publicly traded specialty insurance underwriter and insurance administration services company. We market and underwrite specialty property and casualty insurance programs and products on both an admitted and non-admitted basis through a broad and diverse network of independent retail, wholesale program administrators and general agents, who value service, specialized knowledge, and focused expertise. Our primary focus is on niche or specialty products and program business and risk management solutions for our customers. The services and coverages we provide are tailored to meet specific requirements of defined client groups and their members, which may include specialty program underwriting; admitted and excess and surplus lines insurance products; alternative risk transfer solutions, and insurance administration services. Program business refers to an aggregation of individually underwritten risks that have some characteristic and/or are distributed through a select group of general agencies, retail agencies and program administrators. We provide various types of property and casualty insurance coverage, primarily to associations or similar groups of members and to the specified classes of business of our agents. With our specialty programs and products, we seek to combine profitable underwriting, investment returns and efficient capital management to deliver consistent long-term growth in shareholder value. We also earn commission revenue, which represents 1.8% of our total revenue, through the operation of its retail property and casualty insurance agencies, located in Michigan, California, and Florida. These agencies produce commercial, personal lines, life and accident and health insurance, with more than fifty unaffiliated insurance carriers. These agencies produce an immaterial amount of business for our affiliated Insurance Company Subsidiaries

Our programs are diversified geographically, by class and line of business, type of insured and distribution. In the workers’ compensation line of business, we have a regional focus in California, New England, Florida, and Nevada. Within the commercial automobile and commercial multiple peril line of business, we have a regional focus in the Southeast and California. In the general liability line of business, we have a focus in Texas. Our fee-for-service business is managed on a regional basis with an emphasis in the Midwest, New England, and Southeastern regions. Our corporate strategy emphasizes a regional focus and diverse sources of revenue between underwritten premiums, service fee revenue and commissions. This allows us to leverage our fixed costs over a larger revenue base and take advantage of new opportunities.

Critical Accounting Policies

In certain circumstances, we are required to make estimates and assumptions that affect amounts reported in our consolidated financial statements and related footnotes. We evaluate these estimates and assumptions on an on-going basis based on a variety of factors. There can be no assurance, however, that actual results will not be materially different than our estimates and assumptions, and that reported results of operation will not be affected by accounting adjustments needed to reflect changes in these estimates and assumptions. The accounting estimates and related risks described in our Annual Report on Form 10-K as filed with the United States Securities and Exchange Commission on March 15, 2010, are those that we consider to be our critical accounting estimates. For the three months ended March 31, 2010, there have been no material changes in regard to any of our critical accounting estimates.

Reclassifications and redefining segment reporting

During the three months ended March 31, 2010, we made certain reclassifications to the expense classifications in the Consolidated Statement of Income. These reclassifications enable the user of the financial statements to calculate the GAAP combined ratio directly from the Consolidated Statement of Income. The reclassifications were the result of a comprehensive cost allocation study that allowed us to align the underlying internal salary and administrative costs with the underlying function of those costs. Previously, internal salary and administrative costs were charged to the Insurance Company Subsidiaries based upon an estimated management fee and later eliminated during consolidation. Under this new methodology the actual costs are reimbursed by the Insurance Company Subsidiaries and the expenses are eliminated as a reimbursement of costs. As such, the nature of the costs retain their underlying function in the consolidation process. The Consolidated Statement of Income for the three months ended March 31, 2009 has been reclassified to conform to this revised presentation.

The following table sets forth the reclassification of expense line items for the three months ended March 31, 2009 (in thousands):


	As Reported			Reclassification			Reclassified

Losses and loss adjustment expenses	$	88,698		$	5,108		$	93,806
Reinsurance recoverables		(18,911	)		—			(18,911	)

Net losses and loss adjustment expenses		69,787			5,108			74,895

Salaries and employee benefits		19,827			(19,827	)		—
Policy acquisition and other underwriting expenses		23,969			15,024			38,993
Other administrative expenses		10,393			(10,393	)		—
General selling and administrative expenses		—			8,166			8,166
General corporate expenses		—			1,922			1,922
Amortization expense		1,508			—			1,508
Interest expense		2,782			—			2,782

Total expenses	$	128,266		$	—		$	128,266

In addition, as part of the cost allocation analysis, we re-evaluated our operating segments. As a result of this re-evaluation, we concluded that the previously reported Agency Operations segment should no longer be considered a separate segment as Agency Operations now represents less than 2% of our consolidated revenues and less than 1% of our consolidated pre-tax profits. As such, we will only report one operating segment — Specialty Insurance Operations.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009

Executive Overview

Our results for the first quarter of 2010 include the positive impact from continued selective growth, coupled with our adherence to strict corporate underwriting guidelines, as well as a focus on current accident year price

adequacy, and the benefits derived from leveraging of fixed costs. Our generally accepted accounting principles (“GAAP”) combined ratio was 92.1% for the first quarter of 2010 compared to 88.2% for the comparable quarter in 2009. Net operating income increased $484,000 from $16.3 million for the first quarter of 2009 to $16.8 million for the first quarter of 2010.

Gross written premium increased $47.2 million, or 29.5%, to $207.2 million, compared to $160.0 million in 2009. This growth is largely from workers’ compensation initiatives that were implemented in the second half of 2009 primarily in the Midwest and Western states, and the expansion of transportation business in the Southeast. We continue to focus on maintaining a diversified book of business, and equally as important, price adequacy. The majority of the new business we wrote in 2009 was roll-over business that had a proven, profitable track record, and we have been able to achieve rate increases on top of what had previously been charged.

Results of Operations

Net income for the three months ended March 31, 2010, was $16.4 million, or $0.30 per dilutive share, compared to net income of $13.5 million, or $0.24 per dilutive share, for the comparable period of 2009. Net operating income, a non-GAAP measure, increased $484,000, or 3.0%, to $16.8 million, or $0.30 per dilutive share, compared to net operating income of $16.3 million, or $0.28 per dilutive share for the comparable period in 2009, with lower weighted average shares outstanding. Total weighted average shares outstanding for the three months ended March 31, 2010 were 55,477,098, compared to 57,410,327 for the comparable period in 2009. This decrease reflects the impact of our share repurchase program in which we repurchased 1,456,000 shares during the first quarter of 2010. We currently have approximately 3.5 million more shares within the plan available for repurchase.

Revenues

Revenues for the three months ended March 31, 2010, increased $24.6 million, or 16.4%, to $174.2 million, from $149.6 million for the comparable period in 2009. This increase primarily reflects overall growth within our existing programs and new business that was implemented in 2009 and 2010.

The following table sets forth the components of revenues (in thousands):


	For the Three Months
	Ended March 31,
	2010			2009

Revenue:
Net earned premiums	$	151,441		$	129,038
Management administrative fees		4,956			5,250
Claims fees		1,746			1,966
Investment income		13,029			12,342
Commission revenue		3,166			3,021
Net realized losses		(134	)		(1,992	)

Total revenue	$	174,204		$	149,625

Net earned premiums increased $22.4 million, or 17.4%, to $151.4 million for the three months ended March 31, 2010, from $129.0 million in the comparable period in 2009. This increase was primarily the result of growth within our existing programs and the new business we began writing in 2009.

Management fees decreased $0.3 million, or 5.6%, to $5.0 million for the three months ended March 31, 2010, from $5.3 million for the comparable period in 2009. This decrease primarily reflects the impact of a program we previously managed that decided to perform its own policy administration services, as well as a slight decrease in fees related to some of our self-insured programs, caused by a decrease in premium volume from continued competition and challenging economic conditions.

Claim fees decreased $0.2 million, or 11.2%, to $1.8 million for the three months ended March 31, 2010, from $2.0 million for the comparable period in 2009. This decrease is primarily the result of the fact that the previously

mentioned program is now administering their claims in house and an anticipated decrease resulting from the termination of one unprofitable program.

Net investment income increased $0.7 million, or 5.6%, to $13.0 million in 2010 from $12.3 million in 2009. This increase primarily reflects the increase in average invested assets from $1.1 billion in 2009 to $1.2 billion in 2010. This increase is the result of positive cash flows generated from operations that were primarily due to favorable underwriting results. The average investment yield for March 31, 2010 was 4.3% compared to 4.5% in 2009. The current pre-tax book yield was 4.4%. The current after-tax book yield was 3.3% compared to 3.3% in 2009. The effective duration of the investment portfolio is 5.2 years at March 31, 2010, compared to 4.6 years at March 31, 2009.

Expenses

Expenses increased $22.8 million from $128.3 million for the three months ended March 31, 2009 to $151.1 million for the three months ended March 31, 2010. This increase is reflective of the growth in our underwriting operations.

The following table sets forth the components of expenses (in thousands):


	For the Three Months
	Ended March 31,
	2010		2009

Expense:
Net losses and loss adjustment expenses	$	87,480	$	74,895
Policy acquisition and other underwriting expenses		51,879		38,993
General selling & administrative expenses		5,906		8,166
General corporate expenses		1,977		1,922
Amortization expense		1,401		1,508
Interest expense		2,443		2,782

Total expenses	$	151.086	$	128,266

Net loss and loss adjustment expenses (“LAE”) increased $12.6 million, to $87.5 million for the three months ended March 31, 2010, from $74.9 million for the same period in 2009. Our loss and LAE ratio decreased 0.2 percentage points to 57.8% for the three months ended March 31, 2010, from 58.0% for the same period in 2009. The accident year loss and LAE ratio was 64.2% for the three months ended March 31, 2010 down from 64.5% in the comparable period in 2009. This decrease reflects the refinement of our costs allocation process between internal claims handling costs and policy administrative costs, offset by an increase in the 2010 accident year losses for the quarter, as a result of winter storm losses. Additional discussion of our reserve activity is described below within the Other Items — Reserves section.

Policy acquisition and other underwriting expenses increased $12.9 million, to $51.9 million for the three months ended March 31, 2010 from $39.0 million for the same period in 2009. Our expense ratio increased 4.1 percentage points to 34.3% for the three months ended March 31, 2010, from 30.2% for the same period in 2009. This increase reflects the above mentioned refinement in our internal costs allocation process between internal claims handling costs and policy administrative costs, as a well as the allocation between general administrative expenses and policy administrative costs. In addition, there was a slight increase in commission expense relating to new business added in the second half of 2009 where the agent performs certain policy issuance activities. Lastly, the 2009 expense ratio had been favorably impacted by lower insurance related assessments, primarily related to premium tax credits received from 2008 premium tax returns, which lowered the expense ratio by 1.3 percentage points for the quarter ended March 31, 2009.

General selling & administrative expenses decreased $2.3 million, to $5.9 million for the three months ended March 31, 2010 from $8.2 million for the same period in 2009. This decrease partially reflects the above mentioned refinement in our internal costs allocation process between policy acquisition costs and general administrative costs, as well as an overall decrease in costs such as technology, travel and related general costs.

Amortization expense decreased $0.1 million to $1.4 million for the three months ended March 31, 2010 from $1.5 million for the same period in 2009. This decrease reflects a decrease in the amortization relating to the USSU acquisition in 2007.

Interest expense for the three months ended March 31, 2010, decreased $0.3 million, to $2.5 million, from $2.8 million for the comparable period in 2009. Interest expense is primarily attributable to our debentures, which are described within the Liquidity and Capital Resources section of Management’s Discussion and Analysis, as well as our term loan. The overall decrease reflects the decline in the average outstanding balance on our term loan to $49.8 million for the period ended March 31, 2010 from $60.2 million for same period in 2009.

Federal income tax expense for the three months ended March 31, 2010 was $7.5 million or 32.5% of income before taxes compared to $7.5 million or 35.8% of income before taxes for the same period in 2009. Income tax expense on capital gains (losses) and the change in our valuation allowance for other than temporary impairments where there not any realized gains to offset the realized capital losses, was $253,000 and $518,000 for the three months ended March 31, 2010 and 2009, respectively. Excluding the impact of this deferred tax valuation, the effective income tax rate would have been 31.2% and 29.4% for the three months ended March 31, 2010 and 2009, respectively. This increase reflects a $477,000 adjustment to our current tax expense relating to a return to provision analysis completed on the closing tax return of ProCentury. Excluding this adjustment, the effective tax rate on net operating income, a non-GAAP measure, for the three months ended March 31, 2010 would have been 29.2% compared to 29.4% for the same period in 2009.

Other Items

Equity earnings of affiliated, net of tax;

In July 2009, our subsidiary, Star, purchased a 28.5% ownership interest in an insurance holding limited liability company for $14.8 million in cash. We are not required to consolidate this investment as we are not the primary beneficiary of the business. Our ownership interest is significant, but is less than a majority ownership and, therefore, we are accounting for this investment under the equity method of accounting. Star will recognize 28.5% of the profits and losses as a result of this equity interest ownership. For the three months ended March 31, 2010, we recorded pre-tax and after-tax equity earnings of $803,000 and $522,000, or $0.01 per share.

Reserves

At March 31, 2010, our best estimate for the ultimate liability for loss and LAE reserves, net of reinsurance recoverables, was $708.9 million. We established a reasonable range of reserves of approximately $645.0 million to $751.7 million. This range was established primarily by considering the various indications derived from standard actuarial techniques and other appropriate reserve considerations. The following table sets forth this range by line of business (in thousands):


	Minimum		Maximum
	Reserve		Reserve		Selected
Line of Business	Range		Range		Reserves

Workers’ Compensation(1)	$	212,756	$	235,446	$	226,899
Commercial Multiple Peril/General Liability		296,892		364,164		337,189
Commercial Automobile		100,995		113,195		107,854
Other		34,392		38,944		36,982

Total Net Reserves	$	645,035	$	751,749	$	708,924


(1)		Includes Residual Markets

Reserves are reviewed and established by our internal actuaries for adequacy and peer reviewed by our independent actuaries. When reviewing reserves, we analyze historical data and estimate the impact of numerous factors such as (1) per claim information; (2) industry and our historical loss experience; (3) legislative enactments, judicial decisions, legal developments in the imposition of damages, and changes in political attitudes; and (4) trends in general economic conditions, including the effects of inflation. This process assumes that past

experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of reserves, because the eventual deficiency or redundancy is affected by multiple factors.

The key assumptions used in our selection of ultimate reserves included the underlying actuarial methodologies, a review of current pricing and underwriting initiatives, an evaluation of reinsurance costs and retention levels, and a detailed claims analysis with an emphasis on how aggressive claims handling may be impacting the paid and incurred loss data trends embedded in the traditional actuarial methods. With respect to the ultimate estimates for losses and LAE, the key assumptions remained consistent for the three months ended March 31, 2010, and the year ended December 31, 2009.

For the three months ended March 31, 2010, we reported a decrease in net ultimate loss estimates for accident years 2009 and prior of $9.7 million, or 1.4% of $682.4 million of beginning net loss and LAE reserves at December 31, 2009. The change in net ultimate loss estimates reflected revisions in the estimated reserves as a result of actual claims activity in calendar year 2010 that differed from the projected activity. There were no significant changes in the key assumptions utilized in the analysis and calculations of our reserves during 2009 and for the three months ended March 31, 2010. The major components of this change in ultimates are as follows (in thousands):


	Reserves at		Incurred Losses								Paid Losses						Reserves at
	December 31,		Current		Prior			Total			Current		Prior		Total		March 31,
Line of Business	2009		Year		Years			Incurred			Year		Years		Paid		2010

Workers’ Compensation	$	185,729	$	36,525	$	1,476		$	38,001		$	1,080	$	16,665	$	17,745	$	205,985
Residual Markets		21,907		1,212		(1,274	)		(62	)		889		42		931	$	20,914
Commercial Multiple Peril/General Liability		333,688		26,144		(6,178	)		19,966			487		15,978		16,465	$	337,189
Commercial Automobile		105,468		18,804		(1,860	)		16,944			2,582		11,976		14,558	$	107,854
Other		35,584		14,502		(1,871	)		12,631			2,472		8,760		11,233	$	36,982

Net Reserves		682,376	$	97,187	$	(9,707	)	$	87,480		$	7,510	$	53,421	$	60,932		708,924

Reinsurance Recoverable		266,801																269,524

Consolidated	$	949,177															$	978,448


			Total
			Re-estimated		Development
			Reserves at		as a
	Reserves at		March 31,		Percentage of
	December 31,		2010 on		Prior Year
Line of Business	2009		Prior Years		Reserves

Workers’ Compensation	$	185,729	$	187,205		0.8	%
Commercial Multiple Peril/General Liability		333,688		327,510		−1.9	%
Commercial Automobile		105,468		103,608		−1.8	%
Other		35,584		33,713		−5.3	%

Sub-total		660,469		652,036		−1.3	%
Residual Markets		21,907		20,633		−5.8	%

Total Net Reserves	$	682,376	$	672,669		−1.4	%

Workers’ Compensation Excluding Residual Markets The projected net ultimate loss estimate for the workers’ compensation line of business excluding residual markets increased $1.5 million, or 0.8% of net workers’ compensation reserves. This net overall increase reflects increases of $1.7 million and $604,000 in the ultimate loss estimates for accident years 2009 and 2008, respectively. These increases were isolated to specific claim activity in certain specific programs. The change in ultimate loss estimates for all other accident years was insignificant.

Commercial Multiple Peril/General Liability The commercial multiple peril line and general liability line of business had a decrease in net ultimate loss estimates of $6.2 million, or 1.9% of net commercial multiple peril and

general liability reserves. The net decrease reflects decreases of $1.8 million, $2.7 million, and $678,000 in the ultimate loss estimates for accident years 2008, 2007, 2006, respectively. The decreases in the net ultimate loss estimates for these accident years were due to better than expected claim emergence in several general liability programs and an excess liability program.

Commercial Automobile The projected net ultimate loss estimate for the commercial automobile line of business decreased $1.9 million, or 1.8% of net commercial automobile reserves. This net overall decrease reflects decreases in the net ultimate loss estimate of $1.1 million and $853,000 for accident years 2009 and 2008, respectively. The decreases in the net ultimate loss estimates for these accident years were due to less than expected claim emergence in three west coast based programs. The decreases were offset by an increase of $498,000 in accident year 2005. This increase in the net ultimate loss estimates for this accident year was due to greater than expected claim emergence in an excess liability program. The change in ultimate loss estimates for all other accident years was insignificant.

Other The projected net ultimate loss estimate for the other lines of business decreased $1.9 million, or 5.3% of net reserves. This net decrease reflects a decrease of $1.9 million in accident year 2009. This decrease is primarily due to better than expected case reserve development during the calendar year in a professional liability program. This decrease was offset by an increase in net ultimate loss estimate of $475,000 in accident year 2008. This increase was due to greater than expected claim emergence in property lines of business. The change in ultimate loss estimates for all other accident years was insignificant.

Residual Markets The workers’ compensation residual market net reserves decreased by $1.3 million, or 5.8% of net reserves. This decrease reflects a reduction of $900,000 in accident year 2008. We record loss reserves as reported by the National Council on Compensation Insurance (“NCCI”), plus a provision for the reserves incurred but not yet analyzed and reported to us due to a two quarter lag in reporting. These changes reflect a difference between our estimate of the lag incurred but not reported and the amounts reported by the NCCI in the year. The change in ultimate loss estimates for all other accident years was insignificant.

Other Than Temporary Impairments

At March 31, 2010 and December 31, 2009, we had 107 and 127 securities that were in an unrealized loss position, respectively. Of the securities held at March 31, 2010, twenty seven securities had an aggregate $18.9 million and $1.8 million fair value and unrealized loss, respectively, and have been in an unrealized loss position for more than twelve months. Of the securities held at December 31, 2009, forty-one had an aggregate $30.0 million and $2.3 million fair value and unrealized loss, respectively, and have been in an unrealized loss position for more than twelve months.

During the quarter ended March 31, 2010, in accordance with to our OTTI policy, we recorded an OTTI credit loss of $305,000. For the three months ended March 31, 2009 we recorded an OTTI loss of $2.1 million.

Refer to Note 4 — Investments, for additional information specific to OTTI and their fair value and amount of unrealized losses segregated by the time period the investment has been in an unrealized loss position.

LIQUIDITY AND CAPITAL RESOURCES

Our principal sources of funds are insurance premiums, investment income, proceeds from the maturity and sale of invested assets from our Insurance Company Subsidiaries, and risk management fees and agency commissions from our non-regulated subsidiaries. Funds are primarily used for the payment of claims, commissions, salaries and employee benefits, other operating expenses, shareholder dividends, share repurchases, capital expenditures, and debt service.

A significant portion of our consolidated assets represents assets of our Insurance Company Subsidiaries that may not be transferable to the holding company in the form of dividends, loans or advances in accordance with state insurance laws.. These laws generally specify that dividends can be paid only from unassigned surplus and only to the extent that all dividends in the current twelve months do not exceed the greater of 10% of total statutory surplus as of the end of the prior fiscal year or 100% of the statutory net income for the prior year, less any dividends paid in the prior twelve months. Using these criteria, the available ordinary dividend available to be paid from the Insurance

Company Subsidiaries during 2010 is $47.9 million without prior regulatory approval. In addition to ordinary dividends, the Insurance Company Subsidiaries have the capacity to pay $51.5 million of extraordinary dividends in 2010, subject to prior regulatory approval. The Insurance Company Subsidiaries’ ability to pay future dividends without advance regulatory approval is dependent upon maintaining a positive level of unassigned surplus, which in turn, is dependent upon the Insurance Company Subsidiaries generating net income. Total ordinary dividends paid from our Insurance Company Subsidiaries to our holding company were $14.3 million and $8.3 million for the three months ended March 31, 2010 and 2009, respectively. We remain well within our targets as they relate to our premium leverage ratios, even taking into consideration the dividends paid by our Insurance Company Subsidiaries. Our targets for gross and net written premium to statutory surplus are 2.75 to 1.0 and 2.25 to 1.0, respectively. As of March 31, 2010, on a trailing twelve month statutory consolidated basis, the gross and net premium leverage ratios were 2.1 to 1.0 and 1.8 to 1.0, respectively. The ordinary dividends paid in 2010 and 2009 we funded from current financial earnings.

We also generate operating cash flow from non-regulated subsidiaries in the form of commission revenue, outside management fees, and intercompany management fees. These sources of income are used to meet debt service, shareholders’ dividends, and other operating expenses of the holding company and non-regulated subsidiaries. Earnings before interest, taxes, depreciation, and amortization from non-regulated subsidiaries were approximately $3.3 million for the three months ended March 31, 2010.

We have a line of credit totaling $35.0 million, which has no outstanding balance at March 31, 2010. The undrawn portion of the revolving credit facility is available to finance working capital and for general corporate purposes, including but not limited to, surplus contributions to our Insurance Company Subsidiaries to support premium growth or strategic acquisitions.

Cash flow provided by operations was $44.7 million and $23.3 million for the three months ended March 31, 2010 and 2009, respectively. The increase in cash flow from operations reflects growth in premiums written and the related underwriting profit. Our strong operating cash flows are also the result of our ability to match the duration of our invested assets and reserve duration as it relates to our incurred losses. We maintain a strong balance sheet with geographic spread of risks, high quality reinsurance, and a high quality investment portfolio.

Other Items

Interest Rate Swaps

We have entered into interest rate swap transactions to mitigate our interest rate risk on our existing debt obligations. These interest rate swap transactions have been designated as cash flow hedges and are deemed highly effective hedges. These interest rate swap transactions are recorded at fair value on the balance sheet and the effective portion of the changes in fair value are accounted for within other comprehensive income. The interest differential to be paid or received is accrued and recognized as an adjustment to interest expense. Refer to Note 6 — Derivative Instruments, for additional information specific to our interest rate swaps.

Credit Facilities

On July 31, 2008, we executed $100 million in senior credit facilities (the “Credit Facilities”). The Credit Facilities included a $65.0 million term loan facility, which was fully funded upon the closing of our Merger with ProCentury and a $35.0 million revolving credit facility, which was partially funded upon closing of the Merger. As of March 31, 2010, the outstanding balance on our term loan facility was $47.1 million. We did not have an outstanding balance on our revolving credit facility as of March 31, 2010. The undrawn portion of the revolving credit facility is available to finance working capital and for general corporate purposes, including but not limited to, surplus contributions to our Insurance Company Subsidiaries to support premium growth or strategic acquisitions. At December 31, 2009, we had an outstanding balance of $49.9 million on our term loan and did not have an outstanding balance on our revolving credit facility. Refer to Note 3 — Debt, for additional information specific to our credit facilities and debentures.

Investment Portfolio

As of March 31, 2010 and December 31, 2009, the recorded values of our investment portfolio, including cash and cash equivalents, were $1.2 billion.

In general, we believe our overall investment portfolio is conservatively invested. The effective duration of the investment portfolio at March 31, 2010 is 5.2 years, compared to 4.6 years at March 31, 2009. Our pre-tax book yield is 4.4%. The current after-tax yield is 3.3%, compared to 3.3% in 2009. Approximately 98.3% of our fixed income investment portfolio is investment grade.

Shareholders’ Equity

At March 31, 2010, shareholders’ equity was $511.5 million, or a book value of $9.43 per common share, compared to $502.9 million, or a book value of $9.06 per common share, at December 31, 2009.

At the Company’s regularly scheduled Board of Directors meeting on February 12, 2010, the Board authorized management to purchase up to 5.0 million shares of the Company’s common stock in market transactions for a period not to exceed twenty-four months. This share repurchase plan replaced the existing share repurchase plan authorized in July 2008. For the three months ended March 31, 2010, the Company purchased and retired 1.5 million shares of common stock for a total cost of approximately $11.0 million. There were no share repurchases in the three months ended March 31, 2009.

For the three months ended March 31, 2010 we had $1.6 million of cash dividends payable to our common shareholders on April 5, 2010. For the three months ended March 31, 2009 we paid cash dividends to our common shareholders totaled $1.1 million. On April 30, 2010, our Board of Directors declared a quarterly dividend of $0.03 per common share. The dividend is payable on June 1, 2010, to shareholders of record as of May 14, 2010.

When evaluating the declaration of a dividend, our Board of Directors considers a variety of factors, including but not limited to, cash flow, liquidity needs, results of operations, industry conditions, and our overall financial condition. As a holding company, the ability to pay cash dividends is partially dependent on dividends and other permitted payments from its Insurance Company Subsidiaries.

Contractual Obligations and Commitments

For the three months ended March 31, 2010, there were no material changes in relation to our contractual obligations and commitments, outside of the ordinary course of our business.

Recent Accounting Pronouncements

In June 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (“ASC”) 810, Consolidation (previously SFAS No. 167, Amendments to FASB Interpretation No. 46(R). ASC 810 contains consolidation guidance applicable to variable interest entities. The guidance further requires enhanced disclosures, including disclosure of significant judgments and assumptions as to whether a variable interest entity must be consolidated, and how involvement with the variable interest entity affects a company’s financial statements. The guidance is effective for annual periods beginning after November 15, 2009. The Company adopted ASC 810 in the first quarter of 2010. The adoption of ASC 810 did not have a material impact on its financial condition or results of operations.

In January 2010, the FASB issued Accounting Standards Update (“ASU”) 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. Effective for interim and annual reporting periods beginning after December 15, 2009, ASU 2010-06 requires additional disclosures for financial instrument transfers in and out of Levels 1 and 2; and clarifies existing disclosure requirements around the level of disaggregation and for the inputs and valuation techniques. These additional disclosures are provided in Note 5 — Fair Value Measurements.


ITEM 3.	*QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK*

Market risk is the risk of loss arising from adverse changes in market rates and prices, such as interest rates as well as other relevant market rate or price changes. The volatility and liquidity in the markets in which the underlying assets are traded directly influence market risk. The following is a discussion of our primary risk exposures and how those exposures are currently managed as of March 31, 2010. Our market risk sensitive instruments are primarily related to fixed income securities, which are available for sale and not held for trading purposes.

Interest rate risk is managed within the context of an asset and liability management strategy where the target duration for the fixed income portfolio is based on the estimate of the liability duration and takes into consideration our surplus. The investment policy guidelines provide for a fixed income portfolio duration of between three and a half and five and a half years. At March 31, 2010, our fixed income portfolio had a effective duration of 5.15, compared to 5.09 at December 31, 2009.

At March 31, 2010, the fair value of our investment portfolio, excluding cash and cash equivalents, was $1.2 billion. Our market risk to the investment portfolio is primarily interest rate risk associated with debt securities. Our exposure to equity price risk is related to our investments in relatively small positions of preferred stocks and mutual funds with an emphasis on dividend income. These investments comprise 2.50% of our investment portfolio.

Our investment philosophy is one of maximizing after-tax earnings and has historically included significant investments in tax-exempt bonds. We continue to increase our holdings of tax-exempt securities based on our desire to maximize after-tax investment income. For our investment portfolio, there were no significant changes in our primary market risk exposures or in how those exposures are managed compared to the year ended December 31, 2009. We do not anticipate significant changes in our primary market risk exposures or in how those exposures are managed in future reporting periods based upon what is known or expected to be in effect.

A sensitivity analysis is defined as the measurement of potential loss in future earnings, fair values, or cash flows of market sensitive instruments resulting from one or more selected hypothetical changes in interest rates and other market rates or prices over a selected period. In our sensitivity analysis model, a hypothetical change in market rates is selected that is expected to reflect reasonable possible near-term changes in those rates. “Near term” means a period of up to one year from the date of the consolidated financial statements. In our sensitivity model, we use fair values to measure our potential loss of debt securities assuming an upward parallel shift in interest rates to measure the hypothetical change in fair values. The table below presents our model’s estimate of changes in fair values given a change in interest rates. Dollar values are in thousands.


	Rates Down			Rates			Rates Up
	100bps			Unchanged			100bps

Fair Value	$	1,199,788		$	1,141,412		$	1,082,472
Yield to Maturity or Call		2.46	%		3.45	%		4.47	%
Effective Duration		4.77			5.15			5.29

The other financial instruments, which include cash and cash equivalents, equity securities, premium receivables, reinsurance recoverables, line of credit and other assets and liabilities, when included in the sensitivity model, do not produce a material change in fair values.

Our debentures are subject to variable interest rates. Thus, our interest expense on these debentures is directly correlated to market interest rates. At March 31, 2010 and December 31, 2009, we had debentures of $80.9 million. At this level, a 100 basis point (1%) change in market rates would change annual interest expense by $809,000.

Our term loan is subject to variable interest rates. Thus, our interest expense on our term loan is directly correlated to market interest rates. At March 31, 2010, we had an outstanding balance on our term loan of $47.1 million. At this level, a 100 basis point (1%) change in market rates would change annual interest expense by $471,000. At December 31, 2009, we had an outstanding balance on our term loan of $49.9 million. At this level, a 100 basis point (1%) change in market rates would change annual interest expense by $499,000.

effective hedges. These interest rate swap transactions are recorded at fair value on the balance sheet and the effective portion of the changes in fair value are accounted for within other comprehensive income. The interest differential to be paid or received is accrued and recognized as an adjustment to interest expense. Refer to Note 6 — Derivative Instruments for further detail relating to our interest rate swap transactions.

In addition, our revolving line of credit under which we can borrow up to $35.0 million is subject to variable interest rates. Thus, our interest expense on the revolving line of credit is directly correlated to market interest rates. At March 31, 2010 and December 31, 2009, we did not have an outstanding balance on our revolving line of credit.


ITEM 4.	*CONTROLS AND PROCEDURES*

Evaluation of Disclosure Controls and Procedures.

Our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, the “Exchange Act”), which we refer to as disclosure controls, are controls and procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act, such as this Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls are also designed with the objective of ensuring 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 disclosure. There are inherent limitations to the effectiveness of any control system. A control system, no matter how well conceived and operated, can provide only reasonable assurance that its objectives are met. No evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.

As of March 31, 2010, an evaluation was carried out under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of disclosure controls. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls were effective in recording, processing, summarizing, and reporting, on a timely basis, material information required to be disclosed in the reports we file under the Exchange Act and is accumulated and communicated, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no significant changes in our internal control over financial reporting during the three month period ended March 31, 2010, which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

EXHIBITS INDEX


Exhibit
No.			Description

	10	.1	Form of Restricted Stock Agreement in connection with restricted stock awards granted to Robert S. Cubbin, Karen M. Spaun, Michael G. Costello, Stephen A. Belden, and James M. Mahoney (incorporated by reference from Current Report on Form 8-K filed on March 1, 2010).
	31	.1	Certification of Robert S. Cubbin, Chief Executive Officer of the Corporation, pursuant to Securities Exchange Act Rule 13a-14(a).
	31	.2	Certification of Karen M. Spaun, Senior Vice President and Chief Financial Officer of the Corporation, pursuant to Securities Exchange Act Rule 13a-14(a).
	32	.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Robert S. Cubbin, Chief Executive Officer of the Corporation.
	32	.2	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Karen M. Spaun, Senior Vice President and Chief Financial Officer of the Corporation.


	2010			2009
	(Unaudited)
	(In thousands)

Net income	$	16,434		$	13,540
Other comprehensive income, net of tax:
Unrealized gains on securities		4,798			6,035
Unrealized gains in affiliates and unconsolidated subsidiaries		147			—
Depreciation on non-credit other-than-temporary impairments on securities		(607	)		—
Net deferred derivative gain (losses) — hedging activity		(178	)		329
Less reclassification adjustment for investment losses included in net income		156			2,014

Other comprehensive gains, net of tax		4,316			8,378

Comprehensive income	$	20,750		$	21,918


					Total Number		Maximum
					of Shares		Number of
					Purchased as		Shares that may
					Part of Publicly		yet be
	Total		Average		Announced		Repurchased
	Number of		Price Paid		Plans or		Under the Plans
Period	Shares		Per Share		Programs		or Programs

January 1 — January 31, 2010		—	$	—		—		272,098
February 1 — February 28, 2010		350,000	$	6.98		—		4,650,000
March 1 — March 31, 2010		1,106,000	$	7.67				3,544,000

Total		1,456,000	$	7.51		—

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

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

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

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

	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.

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

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

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

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

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PART I — FINANCIAL INFORMATION
ITEM 1	—	FINANCIAL STATEMENTS
		Consolidated Statements of Income (unaudited)	2
		Consolidated Statements of Comprehensive Income (unaudited)	3
		Consolidated Balance Sheets (unaudited)	4
		Consolidated Statement of Shareholders’ Equity (unaudited)	5
		Consolidated Statement of Cash Flows (unaudited)	6
		Notes to Consolidated Financial Statements (unaudited)	7-21
ITEM 2	—	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	22-30
ITEM 3	—	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	31-32
ITEM 4	—	CONTROLS AND PROCEDURES	32


PART II — OTHER INFORMATION
ITEM 1	—	LEGAL PROCEEDINGS	33
ITEM 1A — RISK FACTORS			33
ITEM 2	—	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	33
ITEM 6	—	EXHIBITS	33
SIGNATURES			34
EX-31.1
EX-31.2
EX-32.1
EX-32.2


ITEM 2.	*UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS*

	1.		I have reviewed this quarterly report on Form 10-Q of Meadowbrook Insurance 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 officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:



Date: May 10, 2010	/s/ Robert S. Cubbin
	Robert S. Cubbin
	Chief Executive Officer



Date: May 10, 2010	/s/ Karen M. Spaun
	Karen M. Spaun
	Senior Vice President and Chief Financial Officer