AMERISAFE - 10-Q quarterly report FY2012 Q3

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2012

Commission file number:

001-12251

AMERISAFE, INC.

(Exact Name of Registrant as Specified in Its Charter)

Registrant’s telephone number, including area code: (337) 463-9052

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

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

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

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

As of November 1, 2012, there were 18,187,226 shares of the Registrant’s common stock, par value $.01 per share, outstanding.

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FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and 21E of the Securities Exchange Act of 1934. You should not place undue reliance on these statements. These forward-looking statements include statements that reflect the current views of our senior management with respect to our financial performance and future events with respect to our business and the insurance industry in general. Statements that include the words “expect,” “intend,” “plan,” “believe,” “project,” “forecast,” “estimate,” “may,” “should,” “anticipate” and similar statements of a future or forward-looking nature identify forward-looking statements. Forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in these statements. We believe that these factors include, but are not limited to, the following:

The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this report and under Item 1A, “Risk Factors” of Part I to our Annual Report on Form 10-K for the year ended December 31, 2011. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate.

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PART I - FINANCIAL INFORMATION

AMERISAFE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

See accompanying notes.

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AMERISAFE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except share and per share data)

(unaudited)

See accompanying notes.

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AMERISAFE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

(unaudited)

See accompanying notes.

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AMERISAFE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(In thousands, except share data)

(unaudited)

See accompanying notes.

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AMERISAFE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

See accompanying notes.

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AMERISAFE, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Note 1. Basis of Presentation

AMERISAFE, Inc. (the “Company”) is an insurance holding company incorporated in the state of Texas. The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries: American Interstate Insurance Company (“AIIC”), Silver Oak Casualty, Inc. (“SOCI”), American Interstate Insurance Company of Texas (“AIICTX”), Amerisafe Risk Services, Inc. (“RISK”) and Amerisafe General Agency, Inc. (“AGAI”). AIIC and SOCI are property and casualty insurance companies organized under the laws of the state of Louisiana. AIICTX is a property and casualty insurance company organized under the laws of the state of Texas. RISK, a wholly owned subsidiary of the Company, is a claims and safety services company, currently servicing only affiliated insurance companies. AGAI, a wholly owned subsidiary of the Company, is a general agent for the Company. AGAI sells insurance, which is underwritten by AIIC, SOCI and AIICTX, as well as by nonaffiliated insurance carriers. The assets and operations of AGAI are not significant to that of the Company and its consolidated subsidiaries. The terms “AMERISAFE,” the “Company,” “we,” “us” or “our” refer to AMERISAFE, Inc. and its consolidated subsidiaries, as the context requires.

The Company provides workers’ compensation and general liability insurance for small to mid-sized employers engaged in hazardous industries, principally construction, trucking and agriculture. Assets and revenues of AIIC represent more than 99% of comparable consolidated amounts of the Company for each of 2012 and 2011.

In the opinion of management of the Company, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the financial position, the results of operations and cash flows for the periods presented. The unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q under the Securities Exchange Act of 1934 and therefore do not include all information and footnotes to be in conformity with accounting principles generally accepted in the United States (“GAAP”). The results for the interim periods are not necessarily indicative of the results of operations that may be expected for the year. The unaudited condensed consolidated financial statements contained herein should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2011.

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

Certain prior year amounts have been reclassified to conform with the current year presentation.

Note 2. Stock Options and Restricted Stock

The Company has three equity incentive plans: the AMERISAFE 2005 Equity Incentive Plan (the “2005 Incentive Plan”), the AMERISAFE 2010 Non-Employee Director Restricted Stock Plan (the “2010 Restricted Stock Plan”) and the AMERISAFE 2012 Equity and Incentive Compensation Plan (the “2012 Incentive Plan”). The 2012 Incentive Plan was approved by the Company’s shareholders at the annual shareholders’ meeting in June 2012. See Note 13 to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2011 for additional information regarding the Company’s 2005 and 2010 incentive plans.

Pursuant to the 2010 Restricted Stock Plan, 9,513 shares of restricted common stock granted to non-employee directors in June 2011 vested on June 15, 2012, the date of the annual shareholders’ meeting. On June 15, 2012, the Company granted 7,833 shares of restricted common stock to non-employee directors in accordance with the 2010 Restricted Stock Plan. The market value of the restricted shares granted was $0.2 million.

In March 2012, the compensation committee of our board of directors granted 2,331 shares of restricted common stock to two executive officers. The award was made pursuant to the Company’s 2012 Incentive Plan.

In May 2012, the Company granted 4,000 shares of restricted common stock in connection with the employment of a new officer. The award was made pursuant to the Company’s 2005 Incentive Plan.

During the nine months ended September 30, 2012, options to purchase 22,800 shares of common stock were exercised. During the nine months ended September 30, 2011, options to purchase 217,750 shares of common stock were exercised. In connection with these exercises, the Company received $0.2 million of stock option proceeds in the current year and $2.0 million of stock option proceeds in the same period in 2011.

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The Company recognized share-based compensation expense of $0.2 million in the quarters ended September 30, 2012 and $0.1 million in the same period in 2011. The Company recognized share-based compensation expense of $0.4 million in the nine months ended September 30, 2012, and 2011.

Note 3. Earnings Per Share

We compute earnings per share in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 260, “Earnings Per Share.” Diluted earnings per share includes potential common shares assumed issued under the “treasury stock method,” which reflects the potential dilution that would occur if any outstanding options are exercised. Diluted earnings per share also includes the “if converted” method for participating securities if the effect is dilutive.

Note 4. Investments

The gross unrealized gains and losses on, and the cost or amortized cost and fair value of, those investments classified as held-to-maturity at September 30, 2012 are summarized as follows:

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The gross unrealized gains and losses on, and the cost and fair value of, those investments classified as available-for-sale at September 30, 2012 are summarized as follows:

The gross unrealized gains and losses on, and the cost or amortized cost and fair value of, those investments classified as held-to-maturity at December 31, 2011 are summarized as follows:

The gross unrealized gains and losses on, and the cost and fair value of, those investments classified as available-for-sale at December 31, 2011 are summarized as follows:

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A summary of the cost or amortized cost and fair value of investments in fixed maturity securities, classified as held-to-maturity at September 30, 2012, by contractual maturity, is as follows:

A summary of the cost or amortized cost and fair value of investments in fixed maturity securities, classified as available-for-sale at September 30, 2012, by contractual maturity, is as follows:

The following table summarizes, as of September 30, 2012, gross unrealized losses on securities that were at a loss for either less than twelve months or twelve months or greater:

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The following table summarizes, as of December 31, 2011, gross unrealized losses on securities that were at a loss for either less than twelve months or twelve months or greater:

In the three months ended September 30, 2012, we sold equity and fixed maturity securities classified as available-for-sale. The carrying value of these securities at disposal was $11.1 million with realized gains on the sale of these securities of $0.9 million. In the three months ended September 30, 2011, we sold fixed maturity securities classified as available-for-sale. The carrying value of these securities at disposal was $9.6 million with realized gains on the sale of these securities of $0.5 million.

In the nine months ended September 30, 2012, we sold equity and fixed maturity securities classified as available-for-sale. The carrying value of these securities at disposal was $31.2 million with realized gains on the sale of these securities of $2.7 million for the nine months ended September 30, 2012, compared to a carrying value of $22.4 million and realized gains of $0.9 million for the same period in 2011.

We regularly review our investment portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of our investments. We consider various factors in determining if a decline in the fair value of an individual security is other-than-temporary. The key factors we consider are:

We reviewed all securities with unrealized losses in accordance with the impairment policy described above. We determined that the unrealized losses in the fixed maturity securities portfolios related primarily to changes in market interest rates since the date of purchase, current conditions in the capital markets and the impact of those conditions on market liquidity and prices generally and the transfer of investments from the available-for-sale classification to the held-to-maturity classification in January 2004. We expect to recover the carrying value of these securities since management does not intend to sell the securities and it is not more likely than not that we will be required to sell the security before the recovery of its amortized cost basis. In addition, none of the unrealized losses on debt securities are considered credit losses.

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Note 5. Income Taxes

In accordance with FASB ASC Topic 740, “Income Taxes,” we provide for the recognition and measurement of deferred income tax benefits based on the likelihood of their realization in future years. As of September 30, 2012, the Company had no material unrecognized tax benefits and no adjustments to liabilities or operations were required.

The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. There were no uncertain tax positions recognized for the periods ended September 30, 2012 and 2011.

The effective tax rate increased to 17.7% for the nine months ended September 30, 2012 from 9.7% for the nine months ended September 30, 2011. This increase is due to a lower level of tax-exempt investment income relative to our pre-tax income.

Tax years 2008 through 2011 are subject to examination by the federal and state taxing authorities. In April 2012, the Company was notified by the Internal Revenue Service that the examination for tax year 2009 had been completed. The Internal Revenue Service concluded that the Company properly computed the 2009 net long-term capital loss carryback of $8.1 million and the Company was entitled to a $2.9 million credit.

Note 6. Comprehensive Income

Comprehensive income was $9.0 million for the three months ended September 30, 2012, as compared to $6.2 million for the three months ended September 30, 2011. Comprehensive income was $22.0 million for the nine months ended September 30, 2012, as compared to $18.1 million for the same period in 2011. The difference between net income as reported and comprehensive income for the three months ended September 30, 2012 was due to changes in unrealized gains and losses, net of tax of $1.4 million compared to $0.8 million change in unrealized gains and losses, net of tax and a change in the deferred tax asset valuation allowance of $0.5 million for the same period in 2011. The difference between net income as reported and comprehensive income for the nine months ended September 30, 2012 was due to changes in unrealized gains and losses, net of tax of $1.9 million compared to $1.3 million change in unrealized gains and losses, net of tax and a change in the deferred tax asset valuation allowance of $0.7 million for the same period in 2011.

Note 7. Fair Value Measurements

We carry available-for-sale securities at fair value in our consolidated financial statements and determine fair value measurements and disclosure in accordance with FASB ASC Topic 820, “Fair Value Measurements and Disclosures.”

The Company determined the fair values of its financial instruments based on the fair value hierarchy established in ASC Topic 820, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard defines fair value, describes three levels of inputs that may be used to measure fair value, and expands disclosures about fair value measurements.

Fair value is defined in ASC Topic 820 as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is the price to sell an asset or transfer a liability and, therefore, represents an exit price, not an entry price. Fair value is the exit price in the principal market (or, if lacking a principal market, the most advantageous market) in which the reporting entity would transact. Fair value is a market-based measurement, not an entity-specific measurement, and, as such, is determined based on the assumptions that market participants would use in pricing the asset or liability. The exit price objective of a fair value measurement applies regardless of the reporting entity’s intent and/or ability to sell the asset or transfer the liability at the measurement date.

ASC Topic 820 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present value amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset, also known as current replacement cost. Valuation techniques used to measure fair value are consistently applied.

In ASC Topic 820, inputs refer broadly to the assumptions that market participants would use in pricing the asset or liability, including assumptions about risk, for example, the risk inherent in a particular valuation technique used to measure fair value (such as a pricing model) and/or the risk inherent in the inputs to the valuation technique. Inputs may be observable or unobservable:

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Valuation techniques used to measure fair value are intended to maximize the use of observable inputs and minimize the use of unobservable inputs. ASC Topic 820 establishes a fair value hierarchy that prioritizes the use of inputs used in valuation techniques into the following three levels:

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters.

The fair values of the Company’s investments are based upon prices provided by an independent pricing service. The Company has reviewed these prices for reasonableness and has not adjusted any prices received from the independent provider. Securities reported at fair value utilizing Level 1 inputs represent assets whose fair value is determined based upon observable unadjusted quoted market prices for identical assets in active markets. Level 2 securities represent assets whose fair value is determined using observable market information such as previous day trade prices, quotes from less active markets or quoted prices of securities with similar characteristics. There were no transfers between Level 1 and Level 2 during the nine months ended September 30, 2012.

At September 30, 2012, assets and liabilities measured at fair value on a recurring basis are summarized below:

At December 31, 2011, assets and liabilities measured at fair value on a recurring basis are summarized below:

In addition, the Company held no common securities in unconsolidated variable interest entities at September 30, 2012 compared to $0.8 million at December 31, 2011, which were carried at cost. These variable interest entities are further discussed below in Note 9.

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The Company determines fair value amounts for financial instruments using available third-party market information. When such information is not available, the Company determines the fair value amounts using appropriate valuation methodologies. Nonfinancial instruments such as real estate, property and equipment, deferred policy acquisition costs, deferred income taxes and loss and loss adjustment expense reserves are excluded from the fair value disclosure.

Cash and Cash Equivalents—The carrying amounts reported in the accompanying consolidated balance sheets for these financial instruments approximate their fair values, which are characterized as a Level 1 asset.

Investments—The fair values for fixed maturity and equity securities are based on prices obtained from an independent pricing service. Fixed maturity securities are characterized as a Level 2 asset, as their fair values are determined using observable market inputs. Equity securities are characterized as Level 1 assets, as their fair values are based on quoted prices in active markets.

Short Term Investments—The carrying amounts reported in the accompanying consolidated balance sheets for these financial instruments approximate their fair values. These securities are characterized as a Level 2 asset in the fair value hierarchy.

Subordinated Debt Securities—The carrying value of the Company’s subordinated debt securities approximates the estimated fair value of the obligations as the interest rates on these securities are comparable to rates that the Company believes it presently would incur on comparable borrowings. These liabilities are characterized as a Level 2.

The following table summarizes the carrying or reported values and corresponding fair values for financial instruments:

Note 8. Treasury Stock

The Board of Directors initially authorized the Company’s share repurchase program in February 2010. In October 2011, the Board reauthorized this program with a new limit of $25.0 million. In October 2012, the Board extended the share repurchase program through December 31, 2013. There were no shares purchased during the three or nine months ended September 30, 2012. During the three months ended September 30, 2011, 357,970 shares were purchased for $6.8 million, or an average price (including commissions) of $18.99 per share. During the nine months ended September 30, 2011, 517,032 shares were purchased for $9.7 million, or an average price (including commissions) of $18.67 per share.

Note 9. Variable Interest Entities

In 2003, the Company formed Amerisafe Capital Trust I (“ACT I”) for the sole purpose of issuing $10.0 million in trust preferred securities. ACT I used the proceeds from the sale of these securities and the Company’s initial capital contribution to purchase $10.3 million of subordinated debt securities from the Company. In July 2011, the Company redeemed all $10.3 million of subordinated debt securities from ACT I and the trust was canceled.

In 2004, the Company formed Amerisafe Capital Trust II (“ACT II”) for the sole purpose of issuing $25.0 million in trust preferred securities. ACT II used the proceeds from the sale of these securities and the Company’s initial capital contribution to purchase $25.8 million of subordinated debt securities from the Company. In May 2012, the Company redeemed $12.9 million of the $25.8 million aggregate principal amount of subordinated debt securities. In May 2012, the Company’s Board of Directors authorized the redemption of the remaining $12.9 million principal amount of subordinated debt securities. The Company redeemed the remaining shares from ACT II in August 2012 and the trust was canceled.

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Note 10. Recently Issued Accounting Pronouncements

In October 2010, the FASB issued Accounting Standards Update 2010-26, “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts” (previously referred to as Emerging Issues Task Force (“EITF”) Issue 09-G). This guidance changes the accounting for costs associated with acquiring or renewing insurance contracts in response to diversity in practice in the capitalization and amortization of those costs. Under the new guidance, deferrable costs will be limited to incremental direct costs of successful contract acquisition incurred with independent third parties and the portion of total employee compensation and payroll-related fringe benefits related to time spent performing specified acquisition activities (e.g., underwriting, policy issuance and processing) for successful acquisition efforts. Companies will have a choice between prospective and retrospective adoption. The new guidance is effective for fiscal years beginning after December 15, 2011. Pursuant to the new guidance, the Company adopted the standard on a retrospective basis. The Company’s adoption resulted in a $2.2 million reduction of deferred policy acquisition costs, a $0.8 million decrease in deferred income tax liabilities and a $1.4 million decrease to shareholders’ equity at December 31, 2011. The adjustment to shareholders’ equity resulted in a reduction in book value of $0.08 per share based on the number of shares outstanding at January 1, 2012. The impact on the Company’s results of operations at September 30, 2012 was not material.

In May 2011, the FASB issued Accounting Standards Update 2011-04 “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in GAAP and the International Financial Reporting Standards (“IFRS”).” ASU 2011-04 clarifies some existing concepts, eliminates wording differences between GAAP and IFRS, and in some limited cases, changes principles to achieve convergence between GAAP and IFRS. ASU 2011-04 results in a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between GAAP and IFRS. ASU 2011-04 also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. The new guidance is effective for interim and annual periods beginning after December 15, 2011. The adoption of this guidance did not have a material impact on our consolidated financial statements.

In June 2011, the FASB issued Accounting Standards Update 2011-05, “Presentation of Comprehensive Income.” This guidance requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present components of other comprehensive income as part of the statement of equity. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of this guidance did not have a material impact on our consolidated financial statements.

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The following discussion should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and the related notes included in Item 1of Part I of this Quarterly Report on Form 10-Q, together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2011.

We begin our discussion with an overview of our Company to give you an understanding of our business and the markets we serve. We then discuss our critical accounting policies. This is followed with a discussion of our results of operations for the three and nine months ended September 30, 2012 and 2011. This discussion includes an analysis of certain significant period-to-period variances in our consolidated statements of operations. Our cash flows and financial condition are discussed under the caption “Liquidity and Capital Resources.”

Business Overview

AMERISAFE is a holding company that markets and underwrites workers’ compensation insurance through its insurance subsidiaries. Workers’ compensation insurance covers statutorily prescribed benefits that employers are obligated to provide to their employees who are injured in the course and scope of their employment. Our business strategy is focused on providing this coverage to small to mid-sized employers engaged in hazardous industries, principally construction, trucking and agriculture. Employers engaged in hazardous industries pay substantially higher than average rates for workers’ compensation insurance compared to employers in other industries, as measured per payroll dollar. The higher premium rates are due to the nature of the work performed and the inherent workplace danger of our target employers. Hazardous industry employers also tend to have less frequent but more severe claims as compared to employers in other industries due to the nature of their businesses. We employ a proactive, disciplined approach to underwriting employers and providing comprehensive services intended to lessen the overall incidence and cost of workplace injuries. We provide safety services at employers’ workplaces as a vital component of our underwriting process and also to promote safer workplaces. We utilize intensive claims management practices that we believe permit us to reduce the overall cost of our claims. In addition, our audit services ensure that our policyholders pay the appropriate premiums required under the terms of their policies and enable us to monitor payroll patterns that cause underwriting, safety or fraud concerns. We believe that the higher premiums typically paid by our policyholders, together with our disciplined underwriting and safety, claims and audit services, provide us with the opportunity to earn attractive returns for our shareholders.

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We actively market our insurance in 35 states and the District of Columbia through independent agencies, as well as through our wholly owned insurance agency subsidiary. We are also licensed in an additional 12 states and the U.S. Virgin Islands.

Critical Accounting Policies

Understanding our accounting policies is key to understanding our financial statements. Management considers some of these policies to be very important to the presentation of our financial results because they require us to make significant estimates and assumptions. These estimates and assumptions affect the reported amounts of our assets, liabilities, revenues and expenses and related disclosures. Some of the estimates result from judgments that can be subjective and complex and, consequently, actual results in future periods might differ from these estimates.

Management believes that the most critical accounting policies relate to the reporting of reserves for loss and loss adjustment expenses, including losses that have occurred but have not been reported prior to the reporting date, amounts recoverable from reinsurers, premiums receivable, assessments, deferred policy acquisition costs, deferred income taxes, the impairment of investment securities and share-based compensation. These critical accounting policies are more fully described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of Part II to our Annual Report on Form 10-K for the year ended December 31, 2011.

Results of Operations

The following table summarizes our consolidated financial results for the three and nine months ended September 30, 2012 and 2011.

Consolidated Results of Operations for Three Months Ended September 30, 2012 Compared to September 30, 2011

Gross Premiums Written. Gross premiums written for the quarter ended September 30, 2012 were $77.3 million, compared to $65.7 million for the same period in 2011, an increase of 17.6%. The increase was attributable to a $10.2 million increase in annual premiums on voluntary policies written during the period, a $0.6 million increase in premiums resulting from payroll audits and related premium adjustments for policies written in previous quarters, a $0.6 million increase in assumed premium from mandatory pooling arrangements, and a $0.2 million increase in premium on direct assignment policies.

Net Premiums Written. Net premiums written for the quarter ended September 30, 2012 were $73.3 million, compared to $62.2 million for the same period in 2011, an increase of 17.8%. The increase was primarily attributable to the increase in gross premiums written. As a percentage of gross premiums earned, ceded premiums were 5.3% for the third quarter of 2012, compared to 5.2% for the third quarter of 2011. For additional information, see “Business—Reinsurance” in our Annual Report on Form 10-K for the year ended December 31, 2011.

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Net Premiums Earned. Net premiums earned for the third quarter of 2012 were $72.4 million, compared to $64.5 million for the same period in 2011, an increase of 12.4%. The increase was attributable to the increase in net premiums written in the quarter, offset by an increase in unearned premiums.

Net Investment Income. Net investment income for the quarter ended September 30, 2012 was $6.8 million compared to $6.5 million for the same period in 2011. Average invested assets, including cash and cash equivalents, were $880.8 million in the quarter ended September 30, 2012, compared to $830.5 million for the same period in 2011, an increase of 6.1%. The pre-tax investment yield on our investment portfolio was 3.1% per annum during the quarters ended September 30, 2012 and September 30, 2011. The tax-equivalent yield on our investment portfolio was 4.5% per annum for the quarter ended September 30, 2012 and 4.6% for the same period in 2011. The tax-equivalent yield is calculated using the effective interest rate and a 35% marginal tax rate.

Net Realized Gains (Losses) on Investments. Net realized gains on investments for the three months ended September 30, 2012 totaled $1.0 million, compared to $0.5 million for the same period in 2011. Net realized gains in the third quarter of 2012 were attributable to called fixed maturity securities and the sale of equity securities and fixed maturity securities from the available-for-sale portfolio. Net realized gains in the third quarter of 2011 were attributable to realized gains from the sale of equity securities and fixed maturity securities from the available for sale portfolio.

Loss and Loss Adjustment Expenses Incurred. Loss and loss adjustment expenses (LAE) incurred totaled $53.9 million for the three months ended September 30, 2012, compared to $49.3 million for the same period in 2011, an increase of $4.5 million, or 9.2%. The current accident year losses and LAE incurred were $55.4 million, or 76.5% of net premiums earned, compared to $50.4 million, or 78.2% of net premiums earned, for the same period in 2011. We recorded favorable prior accident year development of $1.6 million in the third quarter of 2012, compared to favorable development of $1.1 million in the same period of 2011, as further discussed below in “Prior Year Development.” Our net loss ratio was 74.4% in the third quarter of 2012, compared to 76.5% for the same period of 2011.

Underwriting and Certain Other Operating Costs, Commissions and Salaries and Benefits. Underwriting and certain other operating costs, commissions and salaries and benefits for the quarter ended September 30, 2012 were $16.5 million, compared to $16.3 million for the same period in 2011, an increase of 0.9%. This increase was primarily due to a $0.6 million increase in commission expense and a $0.2 million increase in mandatory pooling arrangement fees. Offsetting these increases was a $0.8 million increase in experience-rated commissions and a decrease in insurance related assessments of $0.2 million. Our expense ratio decreased to 22.8% in the third quarter of 2012 from 25.4% in the third quarter of 2011 mostly as a result of the increase in net premiums earned during the period of 12.4%.

Interest expense. Interest expense for the third quarter of 2012 was $0.1 million, compared to $0.3 million for the same period in 2011. Weighted average borrowings for the quarter ended September 30, 2012 were $6.4 million, compared to $26.4 million for the same period in 2011. The decrease was due to the redemption of $25.8 million of subordinated debt securities in 2012. The weighted average interest rate increased to 4.3% per annum for the third quarter of 2012 from 4.1% per annum for the third quarter of 2011.

Income tax expense. Income tax expense for the three months ended September 30, 2012 was $1.9 million, compared to $0.6 million for the same period in 2011. The increase was attributable to an increase in pre-tax income to $9.0 million in the quarter ended September 30, 2012 from $5.5 million in the same period in 2011. The effective tax rate increased to 20.9% in the third quarter of 2012 from 11.5% in the third quarter of 2011. The increase in the effective tax rate was attributable to a lower ratio of tax-exempt investment income to pre-tax income in the third quarter of 2012 compared to the third quarter of 2011.

Consolidated Results of Operations for Nine Months Ended September 30, 2012 Compared to September 30, 2011

Gross Premiums Written. Gross premiums written for the first nine months of 2012 were $247.7 million, compared to $210.0 million for the same period in 2011, an increase of 18.0%. The increase was attributable to a $24.6 million increase in annual premiums on voluntary policies written during the period, a $10.9 million increase in premiums resulting from payroll audits and related premium adjustments for policies written in previous quarters, a $1.9 million increase in assumed premium from mandatory pooling arrangements, and a $0.3 million increase in premium on direct assignment policies.

Net Premiums Written. Net premiums written for the nine months ended September 30, 2012 were $235.8 million, compared to $199.5 million for the same period in 2011, an increase of 18.2%. The increase was primarily attributable to the increase in gross premiums written. As a percentage of gross premiums earned, ceded premiums were 5.3% for the first nine months of 2012, compared to 5.4% for the first nine months of 2011. The decrease in ceded premiums as a percentage of gross premiums earned is a result of a change in our 2012 reinsurance treaties.

Net Premiums Earned. Net premiums earned for the first nine months of 2012 were $211.9 million, compared to $184.8 million for the same period in 2011, an increase of 14.7%. The increase was attributable to the increase in net premiums written, offset by an increase in unearned premiums.

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Net Investment Income. Net investment income for the first nine months of 2012 was $20.3 million, compared to $19.6 million for the same period in 2011. Average invested assets, including cash and cash equivalents, were $872.3 million in the nine months ended September 30, 2012, compared to $828.4 million for the same period in 2011, an increase of 5.3%. The pre-tax investment yield on our investment portfolio was 3.1% per annum during the nine months ended September 30, 2012 and 2011. The tax-equivalent yield on our investment portfolio was 4.5% per annum for the first nine months of 2012 compared to 4.6% for the same period in 2011. The tax-equivalent yield is calculated using the effective interest rate and a 35% marginal tax rate.

Net Realized Gains (Losses) on Investments. Net realized gains on investments for the nine months ended September 30, 2012 totaled $2.9 million, compared to $0.8 million for the same period in 2011. Net realized gains in the first nine months of 2012 were attributable to called fixed maturity securities and from the sale of equity securities and fixed maturity securities from the available-for-sale portfolio. Net realized gains in the first nine months of 2011 primarily resulted from $0.9 million in gains from called fixed maturity securities, the sale of equity securities and the sale of fixed maturity securities from the available-for-sale portfolio. The gains were offset by an other-than-temporary impairment of $0.2 million on one asset-backed security from our held-to-maturity portfolio in the 2011 period.

Loss and Loss Adjustment Expenses Incurred. Loss and loss adjustment expenses (LAE) incurred totaled $162.4 million for the nine months ended September 30, 2012, compared to $140.1 million for the same period in 2011, an increase of $22.3 million, or 15.9%. The current accident year losses and LAE incurred were $162.2 million, or 76.5% of net premiums earned, compared to $144.5 million, or 78.2% of net premiums earned, for the same period in 2011. We recorded unfavorable prior accident year development of $0.2 million in the first nine months of 2012, compared to favorable prior accident year development of $4.4 million in the same period of 2011, as further discussed below in “Prior Year Development.” Our net loss ratio was 76.6% in the first nine months of 2012, compared to 75.8% for the same period of 2011.

Underwriting and Certain Other Operating Costs, Commissions and Salaries and Benefits. Underwriting and certain other operating costs, commissions and salaries and benefits for the nine months ended September 30, 2012 were $46.6 million, compared to $45.8 million for the same period in 2011, an increase of 1.6%. This increase was primarily due to a $2.5 million increase in commission expense, a $0.7 million increase in accounts receivable write-offs, a $0.6 million increase in mandatory pooling arrangement fees and an increase in compensation of $0.3 million. Offsetting these increases was a $3.1 million increase in experience-rated commission, a decrease in premium taxes of $0.6 million and a decrease of $0.3 million in ceding commission related to our 2012 reinsurance agreement. Our expense ratio decreased to 22.0% in the first nine months of 2012 from 24.8% in the same period of 2011 mostly as a result of the increase in net premiums earned during the period of 14.7%.

Interest expense. Interest expense for the first nine months of 2012 was $0.6 million, compared to $1.0 million for the same period in 2011. Weighted average borrowings for the nine months ended September 30, 2012 were $17.1 million, compared to $33.0 for the same period of 2011. The decrease was due to the redemption of $25.8 million of subordinated debt securities in 2012. The weighted average interest rate increased to 4.3% per annum for the first nine months of 2012 from 4.2% for the same period of 2011.

Income tax expense. Income tax expense for the nine months ended September 30, 2012 was $4.3 million, compared to $1.7 million for the same period in 2011. The increase was attributable to an increase in pre-tax income to $24.5 million in the first nine months of 2012 from $17.8 million in the first nine months of 2011. The effective tax rate also increased to 17.7% for the nine months ended September 30, 2012 from 9.7% for the nine months ended September 30, 2011. This increase is due to a lower level of tax-exempt investment income relative to our pre-tax income.

Liquidity and Capital Resources

Our principal sources of operating funds are premiums, investment income and proceeds from sales and maturities of investments. Our primary uses of operating funds include payments of claims and operating expenses. Currently, we pay claims using cash flow from operations and invest our excess cash.

Net cash provided by operating activities was $59.0 million for the nine months ended September 30, 2012, which represented a $29.2 million increase from $29.8 million in net cash provided by operating activities for the nine months ended September 30, 2011. This increase in operating cash flow was attributable to a $22.7 million increase in premiums collected, a $4.8 million decrease in underwriting expenses paid, a $4.8 million increase in investment income and a $4.4 million increase in payable for securities sold. Offsetting these increases was a $5.4 million increase in federal income taxes paid.

Net cash used in investing activities was $9.8 million for the nine months ended September 30, 2012, compared to net cash used in investment activities of $4.5 million for the same period in 2011. Cash provided by sales and maturities of investments totaled $209.2 million for the nine months ended September 30, 2012, compared to $197.0 million for the same period in 2011. A total of $218.1 million in cash was used to purchase investments in the nine months ended September 30, 2012, compared to $200.9 million in purchases for the same period in 2011.

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Net cash used in financing activities in the nine months ended September 30, 2012 was $25.4 million, compared to $17.3 million for the same period in 2011. In the nine months ended September 30, 2012, $25.8 million of cash was used to redeem subordinated debt securities compared to $10.3 million for the same period in 2011. During the nine months ended September 30, 2012, there were no repurchases of outstanding shares of our common stock, compared to $9.7 million used for repurchases for the same period in 2011. Proceeds from stock option exercises totaled $0.2 million in the nine months ended September 30, 2012, compared to $2.0 million for the same period in 2011. During the nine months ended September 30, 2012, there was a tax benefit of share based payments in the amount of $0.1 million, compared to $0.7 for the same period in 2011.

The Board of Directors initially authorized the Company’s share repurchase program in February 2010. In October 2011, the Board reauthorized this program with a new limit of $25.0 million. In October 2012, the Board extended the share repurchase program through December 31, 2013. There were no shares purchased during the nine months ended September 30, 2012. During the nine months ended September 30, 2011, 517,032 shares were purchased for $9.7 million, or an average price (including commissions) of $18.67 per share.

In May 2012, the Company’s Board of Directors authorized the redemption of the remaining $12.9 million principal amount of outstanding subordinated debt securities. The redemption occurred in August of 2012.

Investment Portfolio

As of September 30, 2012, our investment portfolio, including cash and cash equivalents, totaled $882.6 million, an increase of 5.5% from September 30, 2011. Effective April 1, 2010, purchases of fixed maturity securities are classified as available-for-sale or held-to-maturity based on the individual security. Such classification is made at the time of purchase. The reported value of our fixed maturity securities classified as held-to-maturity, as defined by FASB ASC Topic 320, “Investments-Debt and Equity Securities,” was equal to their amortized cost, and thus was not impacted by changing interest rates. Our equity securities and fixed maturity securities classified as available-for-sale were reported at fair value.

The composition of our investment portfolio, including cash and cash equivalents, as of September 30, 2012, is shown in the following table: