Edgar Filing: BRISTOL WEST HOLDINGS INC

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

FORM 10-K

(Mark One)
x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2006

Or

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 001-31984

BRISTOL WEST HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

Delaware		13-3994449
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)

5701 Stirling Road Davie, Florida 33314 (954) 316-5200
(Address, of principal executive offices; zip code)
(Registrant’s telephone number, including area code)

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

Title of each class		Name of each exchange on which registered

Common Stock, $0.01 par value		New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

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

Yes o

No x

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

Yes o

No x

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 o

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

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

Large accelerated filer

Accelerated filer

Non-accelerated filer

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes o

No x

The aggregate market value of the registrant’s voting common stock held by non-affiliates, based on the closing market price, as reported on the New York Stock Exchange, on the last business day of the second quarter of 2006 was $317,522,288. As of February 28, 2007, the total number of shares outstanding of registrant’s common stock was 29,478,865.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement issued in connection with the 2007 annual meeting of stockholders filed with the Securities and Exchange Commission within 120 days after December 31, 2006 (Part III).

BRISTOL WEST HOLDINGS, INC. 2006 ANNUAL REPORT

Table of Contents

		Page

PART I
Item 1.	Business		1
Item 1A.	Risk Factors		19
Item 1B.	Unresolved Staff Comments		26
Item 2.	Properties		26
Item 3.	Legal Proceedings		26
Item 4.	Submission of Matters to a Vote of Security Holders		26

PART II
Item 5.	Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		27
Item 6.	Selected Financial Data		30
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		31
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk		60
Item 8.	Financial Statements and Supplementary Data		60
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		60
Item 9A.	Controls and Procedures		61
Item 9B.	Other Information		61

PART III
Item 10.	Directors and Executive Officers of the Registrant		62
Item 11.	Executive Compensation		62
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		62
Item 13.	Certain Relationships and Related Transactions		62
Item 14.	Principal Accountant Fees and Services		62

PART IV
Item 15.	Exhibits, Financial Statement Schedules		63

BRISTOL WEST HOLDINGS, INC. 2006 ANNUAL REPORT

PART I

Item 1. Business

Overview

Bristol West Holdings, Inc. (the “Company”), a Delaware corporation, is a provider of private passenger automobile insurance. When this report uses the words “we,” “us,” and “our,” these words refer to Bristol West Holdings, Inc. and its subsidiaries, unless the context otherwise requires. The Company was organized under the laws of the State of Delaware on February 17, 1998.

Most of the business we write is non-standard automobile insurance. Given the homogeneity of our product, the regulatory environments in which we operate, the type of customer we serve and our method of distribution, we report our operations as one segment. Non-standard automobile insurance provides coverage to drivers who find it difficult to purchase automobile insurance from standard carriers as a result of a number of factors, including their vehicle type, age, claims history, limited financial resources or driving record. Typically, these drivers purchase minimal levels of insurance coverage in order to comply with state-mandated financial responsibility laws. As of December 31, 2006, 82% of our policyholders had purchased minimum limits of liability coverage as required by the states in which they reside, although 71% of our policyholders had clean motor vehicle driving records. For comparable coverage, premiums for non-standard automobile insurance policies generally are higher than for standard or preferred automobile insurance policies.

The operating results of property and casualty insurance companies are subject to fluctuations from quarter-to-quarter and year-to-year due to a number of factors, including, but not limited to, general economic conditions, the regulatory climate in states where an insurer operates, state regulation of premium rates, changes in pricing and underwriting practices of the insurer and its competitors, the frequency and severity of losses, natural disasters and other factors. (See “Item 1A. Risk Factors” below.) Historically, results of property and casualty insurance companies have been cyclical, with periods of high premium rates and strong profitability followed by periods of price competition, falling premium rates and reduced profitability.

We offer insurance coverage exclusively through independent agents and brokers, which totaled 9,141 as of December 31, 2006. Because some of our agents and brokers operate from multiple locations, our products were offered at 12,391 locations. We are licensed to provide insurance in 38 states and the District of Columbia, although we focus our operations in 22 states that we believe provide significant opportunity for profitable growth over time. Our markets include California, Florida and Texas - the three largest non-standard automobile insurance markets in the United States. These states were our first, second, and fourth largest states by premium volume and accounted for approximately 64% of our gross written premium for the year ended December 31, 2006. We charge fees for policy issuance, installment payment processing and other items that, in total, are equivalent to approximately 9% of gross earned premium.

On March 1, 2007, we entered into a merger agreement (the “Merger Agreement”) with Farmers Group, Inc. (“Farmers”) pursuant to which BWH Acquisition Company, a wholly-owned subsidiary of Farmers (“Merger Sub”), will be merged with and into the Company, with the Company continuing as the surviving corporation and becoming a wholly-owned subsidiary of Farmers (the “Merger”). Pursuant to the Merger Agreement, at the effective time and as a result of the Merger, each then outstanding share (each a “Share”) of common stock of the Company, par value $0.01 per share (“Common Stock”), including restricted stock (which vests upon a change in control), will be cancelled and converted into the right to receive $22.50 in cash per Share, without interest (the “Merger Consideration”). Each share of Common Stock that is subject to a then outstanding option and warrant that is vested or vests upon a change in control will be converted into the right to receive the Merger Consideration less the exercise price per Share for the Option. Each hypothetical share of Common Stock then included in a non-employee director’s deferred compensation account (each a “Phantom Share”) under our Non-Employee Directors’ Deferred Compensation and Stock Award Plan (the “Non-Employee Directors’ Plan”) also will be converted into the right to receive the Merger Consideration. Consummation of the Merger is subject to various customary closing conditions, including, but not limited to, (1) the expiration or termination of applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, (2) all insurance antitrust approvals and regulatory approvals from certain insurance departments, (3) absence of certain orders preventing the Merger, and (4) the approval of the Merger Agreement by the Company’s stockholders. Further, both the Company and Farmers may terminate the Merger Agreement if the Merger is not consummated by December 1, 2007. We currently expect the Merger to close before the end of 2007.

Products and Services

Policies. We offer a wide range of coverage options to meet our policyholders’ needs. Our liability-only policies generally include:

	•	bodily injury liability coverage, which protects insureds if they are involved in accidents that cause bodily injuries to others, and also provides insureds with a legal defense if they are sued by others for covered damages; and

	•	property damage liability coverage, which protects insureds if they are involved in accidents that cause damage to another’s property, and also provides insureds with a legal defense if they are sued by others for covered damages.

Our liability-only policies include personal injury protection coverage in certain states, which provides coverage for our insureds’ injuries without regard to fault.

In addition to the coverages described above, our policies may include, at the option of the policyholder:

	•	collision coverage, which pays for damages to the insured’s vehicle when damaged by a collision with another vehicle or object, regardless of fault;

	•	comprehensive coverage, which pays for damages to the insured’s vehicle when damaged as a result of causes other than collision, such as vandalism, theft, wind, hail or water; and

	•	medical payments coverage, which pays for an insured’s medical or funeral expenses related to an automobile accident.

We offer insurance products and payment plans that we have tailored to the non-standard marketplace. For customers whose selection of an insurance policy is driven by their desire to minimize their initial cash outlay, we offer low down payments and monthly billing plans. Our experience has shown us that total policy cost, although a variable in the purchasing decision, is not as important to this segment of applicants as is an installment plan with a low down payment. Accordingly, we designed our payment plans to be attractive to these customers by minimizing the up-front cash outlay through low down payments and monthly billing. Our billing and collection processes facilitate these payment plans while preventing significant exposure to credit losses.

There is another large segment of drivers who do not qualify for standard products due to a driving record transgression, their age, or recent financial instability, but for whom total policy cost is the most important consideration. We also structured our products to appeal to these potential customers. We offer various discounts for better risks, including in some states where allowed, discounts for having maintained automobile insurance within a prescribed prior time period and/or for maintaining homeowners insurance. Conversely, we add surcharges for traffic violations and accidents.

In addition to the premiums we collect for the insurance coverage we provide, we collect policy origination fees and installment fees. We may also charge additional fees for late payment, policy cancellation, policy rewrite and reinstatement and for other reasons. These fees represented revenues equivalent to approximately 9% of gross earned premium.

Distribution and Marketing

We distributed our products through 9,141 independent producers as of December 31, 2006. Because some producers operate from multiple locations, our products were offered through 12,391 locations. Since we sell our products only through the independent producer channel, building and maintaining strong relationships with our independent agents and brokers is a key element to our long-term success. We strive to maintain these relationships by providing our agents and brokers with high-quality service, a stable presence in their markets and competitive compensation programs. We provide our producers with easy-to-use underwriting and policy administration software. We offer competitively priced products, convenient installment billing plans and superior service to our producers and insureds. We do not provide contingent commissions or incentives to our agents and brokers.

Geographic Distribution. We have licenses to write insurance in 38 states and the District of Columbia, but we focus on 22 states that we believe provide significant opportunity for profitable growth based upon historical results, current market conditions and each state’s legal and regulatory environment.

For the year ended December 31, 2006, our top three states represented 70.2% of our gross written premium. The following table sets forth the distribution of our gross written premium by state, excluding the change in the provision for expected cancellations, as a percent of total gross written premium for the years ended December 31, 2006, 2005 and 2004:

	Years Ended December 31,

	2006			2005			2004

California		40.4	%		46.3	%		56.1	%
Florida		17.9			15.2			14.3
Michigan		11.9			13.9			10.2
Texas		5.2			3.8			2.4
South Carolina		4.9			3.4			2.5
Pennsylvania		4.0			3.0			2.2
New Hampshire		2.3			2.6			1.8
Colorado		2.0			1.2			0.7
Maine		2.0			2.4			1.9
Virginia		1.8			1.5			1.6
All other states		7.7			6.7			6.3

		100.0%			100.0	%		100.0	%

Major Producers. Our top 10 producers, as measured by premium volume, accounted for 20.1%, 22.4%, and 25.5% of our gross written premium for the years ended December 31, 2006, 2005 and 2004, respectively. In 2006, no single producer accounted for 10% or more of our gross written premium. The concentration of our business with our top producers has declined as we have increased our producer base, entered new markets, and encountered increased competition in California, resulting in a decline in production from both large and small producers. We do not have any long-term producer contracts. Eight of our 10 largest producers produce the majority of their business in California.

Relationships with Agents and Brokers. We offer our policies through 9,141 agents and brokers with 12,391 locations as of December 31, 2006. We devote considerable time and resources to developing and maintaining relationships with these producers, and we endeavor to provide them with responsive service, a stable presence, and competitive compensation programs.

Our marketing department regularly visits and works closely with our agents and brokers in order to keep them up to date on our products and to gather information on industry trends.

We provide proprietary software to agents and brokers that permits them to access centralized information about their customers. In addition, we have deployed point-of-sale underwriting and policy issuance software at most of our producers’ locations. Point-of-sale underwriting technology uses Internet connectivity to obtain and verify an applicant’s underwriting and rating information as part of the application process. The producer enters the applicant’s underwriting data into a Company-provided software application, OneStep® or OneStep Raptor®. Concurrently, these software applications automatically and electronically obtain key underwriting and rating information, such as driving record and claim history, and reconcile it to the application information. In this manner, the producer can provide a final price quote to the applicant at the point of sale. If the applicant chooses to purchase the policy, producers can complete the transaction immediately. The producer can collect the payment and provide the insured with their policy and insurance identification card, and in some cases, with their policy declaration page and a copy of their first invoice.

We employ daily, weekly, monthly and quarterly data analysis to monitor various aspects of a producer’s business conduct including adherence to our underwriting policies and procedures and the profitability of the producer’s business with us. We evaluate each producer on numerous key factors, including the following:

	•	loss experience;

	•	violations of our underwriting guidelines;

	•	claim timing: we terminate relationships with producers we find backdating policies to make them effective prior to the occurrence of a loss; and

	•	business activity: we measure our producers’ business activity to identify and actively manage our relationship with producers that are not consistently selling our products.

Producer Compensation. We have designed our producer compensation programs to be competitive in each market in which we operate. At policy inception or renewal, we pay commissions at a percentage of the full term policy premium. Our producers highly value receiving the full term commission up front. If a policy cancels before its expiration date, the producer is bound contractually to return the unearned commission to us.

For 2006 and 2005, the only forms of compensation we paid to our producers were new and renewal commissions. In previous years and on a case-by-case basis, we had negotiated profit sharing agreements with some of our larger producers. Such agreements awarded additional compensation to producers which maintained or outperformed specified loss ratio targets and maintained an agreed amount of in-force business. Effective January 1, 2005, we discontinued these profit sharing arrangements and implemented various fixed commission tiers into which producers are placed depending upon our assessment of economies of scale, the producer’s level of expertise in placing automobile insurance and the geographic scope of the producer’s operations. Within each state, we revised the commission structure to produce a commission ratio consistent with the previous structure.

The ratio of commission expense to gross earned premium, including all profit sharing compensation, of which there was none in 2006 and 2005, was 14.8%, 14.7%, and 15.3% for the years ended December 31, 2006, 2005 and 2004, respectively. The ratio of profit sharing commission expense to gross earned premium was 0.0%, 0.0%, and 0.6% for the years ended December 31, 2006, 2005 and 2004, respectively.

Point-of-Sale Underwriting and Policy Issuance. We have made significant strides in point-of-sale underwriting. In the aggregate, we utilized point-of-sale underwriting to process over 99% of our new business applications in 2006. We have fully deployed OneStep, our browser-based point-of-sale underwriting system, in 12 states.

By utilizing point-of-sale underwriting, policy issuance is now immediate in the states in which we have deployed it compared to an average of five days prior to our implementation of point-of-sale underwriting. In addition to reducing uprates (increases in premiums after issuance), the efficiency gains have helped us to improve policyholder service.

Underwriting and Pricing

We establish policy rates utilizing a variety of factors, including, but not limited to, vehicle type, driver age, driving record, type of coverage, miles driven, financial responsibility, prior insurance coverage and policy limits. We continuously evaluate and modify our rates in order to maintain an acceptable level of underwriting profitability.

We have product managers for each state in which we operate or that we are considering entering. Each product manager is responsible for monitoring our competitive position and profitability. They work closely with our pricing actuaries, marketing department and senior staff to develop or alter our product and pricing strategies.

Claims Handling

Our Claims Department currently has over 500 claims employees and managers located in 14 offices around the country. Each claims office has an assigned geographic service area, but has the flexibility to handle claims from other areas as necessitated by workloads and available staff.

We respond quickly to reported claims. A toll-free access number allows policyholders to report claims 24 hours a day, seven days a week. Claims representatives endeavor to contact all parties involved in an accident within 24 hours of receipt of loss notification and inspect any damaged property within 72 hours of contact with the owner. Claims managers review all new claims within 24 hours of receipt of notification to provide input and direction, and maintain involvement throughout the life of the claim.

We focus on prompt, accurate claims handling. Our claims staff investigates all claims and handles most vehicle damage appraisals, with a small percentage of inspection appraisals completed by independent appraisers when warranted by the location or when our appraisers are not available. Twenty-two in-house attorneys in seven offices defend most of the lawsuits brought against our insureds. We maintain a Special Investigation Unit with 37 employees deployed nationwide who control costs through fraud mitigation, form effective relationships with law enforcement agencies and ensure our compliance with applicable anti-fraud regulations. The Special Investigation Unit uses anti-fraud databases and real time intelligence from law enforcement agencies to identify suspicious losses. We have a Claim Quality and Employee Development (QED) group responsible for auditing and training. The Audit Department conducts comprehensive internal audits of claim handling, focusing on procedures, financial controls, data integrity and regulatory compliance. The Training Department provides both new hire training and advanced training to experienced claims representatives.

Technology

We have substantially upgraded our information technology capabilities in recent years, including the following:

Data Warehouse. We maintain an extensive proprietary database, which contains statistical records with respect to our insureds, including, among other data, the insured’s rating classification, motor vehicle records, years licensed, and loss experience by each rating variable. Analysis of this data enables us to identify trends emerging in our business and to respond with changes to prices, product or underwriting guidelines.

Claims Administration. Our in-house claims administration system maintains all notes, diaries and related party information on each claim and provides automated on-line management reports on the number of outstanding claims and service levels. It provides a financial control and automatically generates and maintains loss and loss adjustment expense reserves. The system interfaces with a standardized estimating service and retains pictures of each appraised vehicle.

Point-of-Sale Underwriting. We have online point-of-sale application systems, OneStep and OneStep Raptor; and as of December 31, 2006, we were producing more than 99% of our business through these systems. We have an exclusive license to use OneStep in the non-standard automobile insurance industry through December 2009. OneStep and OneStep Raptor use technology to provide fast and accurate quotes by accessing third-party information at the point of sale, including an applicant’s driving record, accident history and, where permitted by law, credit reports. This process reduces the frequency of uprates, which may occur when an application is incomplete or inaccurate. Our point-of-sale application systems permit the producer to print the policy, the identification cards and the policy declaration page as soon as the verifications are complete, usually within minutes.

BWProducers.com. This website provides our producers with complete access to all information about their Bristol West policyholders, including billing information, policy status, cancellations and installments. This access to timely and centralized information gives our producers the ability to better manage their business and increase their retention rates. The system allows online payments from our producers.

Policyholder Tools. We provide automated phone and web payment functionality for our policyholders that is available 24 hours per day, seven days per week.

Loss and Loss Adjustment Expense Reserve Development

Automobile accidents generally result in insurance companies paying settlements resulting from physical damage to one or more automobiles or other property and injuries to one or more persons. Because our insureds typically notify us immediately after an accident has occurred, our ultimate liability on our policies generally becomes fairly apparent in a relatively short period of time. However, months and sometimes years may elapse between the occurrence of an accident, reporting of the accident to us and payment of the claim. We record a liability for estimates of losses and loss adjustment expenses (“LAE”) that we expect to pay on accidents reported to us and we estimate and record a liability for accidents that have occurred but have not been reported to us, which we refer to as incurred but not reported loss and LAE reserves. For a discussion of our methodologies for establishing loss and LAE reserves as well as our estimates of loss and LAE reserves as of December 31, 2006, 2005 and 2004, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies - Estimation of Unpaid Losses and Loss Adjustment Expenses.”

Quarterly, for each financial reporting date, we record our best estimate, which is a point estimate, of our overall loss and LAE reserves for both current and prior accident years. As our experience develops and we learn new information, our quarterly reserving process may produce revisions to our previously reported loss and LAE reserves. We refer to such revisions as “development” and such development may be material. We recognize favorable development when we decrease our previously reported loss and LAE reserves, which results in an increase to net income in the period recognized. We recognize adverse development when we increase our previously reported loss and LAE reserves, which results in a decrease to net income in the period recognized.

The following table presents the development of our loss and LAE reserves, net of reinsurance, for the calendar years 1996 through 2006 (in thousands of dollars).

	1996			1997			1998			1999			2000			2001			2002			2003			2004			2005			2006

As Originally Estimated:		21,013			26,593			59,472			44,174			51,349			39,089			82,280			89,010			105,420			197,403			204,654
As Re-estimated as of December 31, 2006:		25,946			39,237			57,656			54,484			84,810			79,942			107,492			105,695			113,121			202,696
Liability Re-estimated as of:
One Year Later		24,630			44,295			55,640			50,502			68,002			67,274			91,594			91,523			105,429			202,696
Two Years Later		28,169			38,239			55,977			51,667			80,655			75,203			102,382			101,373			113,121
Three Years Later		25,520			38,368			56,602			52,928			83,277			78,113			106,627			105,695
Four Years Later		25,662			38,943			56,950			53,805			84,260			79,863			107,492
Five Years Later		26,089			39,029			57,161			54,438			84,934			79,942
Six Years Later		26,005			39,051			57,634			54,622			84,810
Seven Years Later		25,923			39,183			57,753			54,484
Eight Years Later		25,971			39,290			57,656
Nine Years Later		25,983			39,237
Ten Years Later		25,946

Cumulative Deficiency (Redundancy)		4,933			12,644			(1,816	)		10,310			33,461			40,853			25,212			16,685			7,701			5,293

Cumulative Amounts Paid as of :
One Year Later		18,069			27,371			51,201			43,231			61,891			50,870			75,489			67,411			42,736			139,079
Two Years Later		23,520			36,674			56,448			50,016			75,642			71,619			94,793			85,226			93,293
Three Years Later		25,189			38,320			57,101			51,839			81,953			75,777			103,431			100,625
Four Years Later		25,653			38,808			57,046			52,693			83,591			78,725			106,468
Five Years Later		25,850			38,945			57,185			54,344			84,369			79,119
Six Years Later		25,872			38,969			57,610			54,556			84,492
Seven Years Later		25,866			39,190			57,719			54,520
Eight Years Later		25,970			39,290			57,652
Nine Years Later		25,983			39,239
Ten Years Later		25,946

Net Loss and Loss Adjustment Expense Liability as a Percentage of Initially Estimated Liability
	1996			1997			1998			1999			2000			2001			2002			2003			2004			2005			2006

Liability Re-estimated as of:
One Year Later		117	%		167	%		94	%		114	%		132	%		172	%		111	%		103	%		100	%		103	%
Two Years Later		134	%		144	%		94	%		117	%		157	%		192	%		124	%		114	%		107	%
Three Years Later		121	%		144	%		95	%		120	%		162	%		200	%		130	%		119	%
Four Years Later		122	%		146	%		96	%		122	%		164	%		204	%		131	%
Five Years Later		124	%		147	%		96	%		123	%		165	%		205	%
Six Years Later		124	%		147	%		97	%		124	%		165	%
Seven Years Later		123	%		147	%		97	%		123	%
Eight Years Later		124	%		148	%		97	%
Nine Years Later		124	%		148	%
Ten Years Later		123	%

Cumulative Deficiency (Redundancy)		23	%		48	%		-3	%		23	%		65	%		105	%		31	%		19	%		7	%		3	%

Net Loss and Loss Adjustment Cumulative Paid as a Percentage of Initially Estimated Liability

Cumulative Amounts Paid as of:

One Year Later		86	%		103	%		86	%		98	%		121	%		130	%		92	%		76	%		41	%		70	%
Two Years Later		112	%		138	%		95	%		113	%		147	%		183	%		115	%		96	%		88	%
Three Years Later		120	%		144	%		96	%		117	%		160	%		194	%		126	%		113	%
Four Years Later		122	%		146	%		96	%		119	%		163	%		201	%		129	%
Five Years Later		123	%		146	%		96	%		123	%		164	%		202	%
Six Years Later		123	%		147	%		97	%		124	%		165	%
Seven Years Later		123	%		147	%		97	%		123	%
Eight Years Later		124	%		148	%		97	%
Nine Years Later		124	%		148	%
Ten Years Later		123	%

In 2006, we experienced $5.3 million of adverse development on loss and LAE reserves established at December 31, 2005. The increase in our reserves for prior accident years was driven by a variety of factors, including higher than expected claim severity (dollars of loss per claim) in Michigan Personal Injury Protection claims, greater than expected litigation costs in Florida, and higher than expected claim severity in California, which includes a California extra-contractual claim verdict of $0.4 million.

The adverse development in our reserves for losses and LAE for the 1999 to 2002 years is due to a number of factors. A reorganization of our claims department in 2000 resulted in an unanticipated increase in the average cost per closed claim and the number of claims primarily in California and Florida in 2000, 2001 and 2002. In addition, rate reductions in California between June 1998 and July 1999 and a poorly structured and priced product in Texas that we began offering in the first quarter of 1999 and discontinued in August 2002 also led to adverse development in reserves for unpaid losses and LAE.

In April 2003, our actuarial staff started tracking the emergence of all loss data by state, program, coverage group and accident quarter on a daily basis. We analyze this data using a browser-based reporting tool that compares the actual emergence of losses and LAE relative to the expected emergence over time. We use detailed mathematical models, which we continuously refine to reduce the variability of our estimates of loss and LAE reserves. Additionally, in August 2003, we deployed an Oracle-based data warehouse, which improves our actuarial staff’s ability to evaluate loss and LAE emergence relative to our expectations regarding loss and LAE reserves for the prior quarter. In addition to the sophistication with which we price our products, this data warehouse also improves the ability of our actuaries to analyze loss emergence relative to initial pricing and product design assumptions. For a discussion of our methodologies for establishing loss and LAE reserves, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies - Estimation of Unpaid Losses and Loss Adjustment Expenses.”

We believe the liabilities that we have currently recorded for losses and LAE are adequate to cover the ultimate cost of losses and LAE that we have incurred to date.

The following table is a reconciliation of our net liability to our gross liability for losses and LAE (in thousands).

	1996			1997			1998			1999			2000			2001			2002			2003			2004			2005			2006

As Originally Estimated:

Net Liability		21,013			26,593			59,472			44,174			51,349			39,089			82,280			89,010			105,420			197,403			204,654
Add Reinsurance Recoverables		20,541			33,762			12,795			20,827			30,132			66,904			75,136			113,286			116,906			24,042			34,523

Gross Liability		41,554			60,355			72,267			65,001			81,481			105,993			157,416			202,296			222,326			221,445			239,177

As Re-estimated as of December 31, 2006:

Net Liability		25,946			39,237			57,656			54,484			84,810			79,942			107,492			105,695			113,121			202,696
Add Reinsurance Recoverables		23,279			22,764			10,174			21,812			39,128			66,018			83,299			113,679			118,365			28,275

Gross Liability		49,225			62,001			67,830			76,296			123,938			145,960			190,791			219,374			231,486			230,971

Gross Cumulative Deficiency (Redundancy)		7,671			1,646			(4,437	)		11,295			42,457			39,967			33,375			17,078			9,160			9,526

Gross Cumulative Deficiency (Redundancy) as a Percent of Originally Estimated Gross Liability		18	%		3	%		-6	%		17	%		52	%		38	%		21	%		8	%		4	%		4	%

Investments

We had total cash, cash equivalents and invested assets of $545.0 million at December 31, 2006, which represents an increase of $57.7 million, compared to $487.3 million at December 31, 2005. The following table summarizes our cash, cash equivalents and invested assets as of the dates indicated.

	Amortized Cost		Fair Value		% of Total at Fair Value

	(dollars in millions)
December 31, 2006
Debt securities, available for sale	$	496.8	$	493.7		90.6	%
Equity securities, available for sale		2.0		2.0		0.4	%
Cash and cash equivalents		49.3		49.3		9.0	%

Total	$	548.1	$	545.0		100.0	%

	Amortized Cost		Fair Value		% of Total at Fair Value

	(dollars in millions)
December 31, 2005
Debt securities, available for sale	$	458.2	$	452.9		92.9	%
Equity securities, available for sale		2.0		2.0		0.4	%
Cash and cash equivalents		32.4		32.4		6.7	%

Total	$	492.6	$	487.3		100.0	%

Investment Strategy. Our fixed income investment portfolio is highly marketable and consists of publicly traded, high quality investment-grade debt securities. We hold no equity securities, other than an investment in OneShield, Inc. (see Note 8 to the Consolidated Financial Statements included herein). We have no foreign currency risk. Hyperion Brookfield Asset Management, Inc. manages our investment portfolio and provides all related accounting and statutory investment reporting.

We have formal investment guidelines with our outside managers, which have been in place for seven years, and allow the following maximum allocations by sector subject to investment regulations in effect in the state of domicile of each of our insurance companies:

U.S. Treasury Notes	100	%
U.S. Government Agencies	50	%
Mortgage Backed Securities	50	%
Commercial Mortgage Backed Securities	10	%
Corporate Bonds	60	%
Canadian Provinces	10	%
Yankee bonds (excluding Canada)	10	%
Asset Backed Securities	25	%

We vary our allocation to tax-exempt securities based upon our tax position. We are in regular communication with our investment advisor to discuss our tax position and other matters. We base the maximum allocation to any one issuer on the ratings of the issuer’s securities.

Investment Portfolio. Our investment portfolio consists primarily of debt securities, all of which we classify as available for sale and carry at fair value. We report unrealized gains and losses in our financial statements as a separate component of stockholders’ equity on an after-tax basis. As of December 31, 2006, the fair value of our investment portfolio of $495.7 million included $3.1 million in pre-tax net unrealized losses. As of December 31, 2005, the fair value of our investment portfolio of $454.9 million included $5.3 million in pre-tax net unrealized losses. The tax equivalent book yield of the portfolio was 4.96% at December 31, 2006 compared to 4.52% at December 31, 2005.

Our investment objectives are to maximize after-tax investment income, while maintaining a highly marketable investment grade portfolio. As of December 31, 2006, our portfolio had an average Standard & Poor’s rating of “AAA”, a tax equivalent book yield of 4.96% and an effective duration of 3.30 years. The following table presents the composition of our investment portfolio by type of investment as of the dates indicated:

	At December 31,

	2006					2005

	(dollars in millions)
Cash and cash equivalents	$	49.3		9.0	%	$	32.4		6.6	%
U.S. Government securities		2.8		0.5	%		3.3		0.7	%
Mortgage backed bonds		120.4		22.1	%		73.1		15.0	%
Tax-exempt bonds		222.2		40.8	%		211.2		43.3	%
Collateralized mortgage obligations		12.1		2.2	%		13.0		2.7	%
Corporate and other		139.3		25.6	%		157.6		32.4	%
Preferred stock		2.0		0.4	%		2.0		0.4	%
Net unrealized losses on fixed maturities		(3.1	)	-0.6	%		(5.3	)	-1.1	%

Total investments at market value	$	545.0		100.0	%	$	487.3		100.0	%

The following table presents the composition by type of security, including the amortized cost, gross unrealized gains, gross unrealized losses and fair value of debt securities available for sale in our investment portfolio as of the dates indicated:

	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value

	(in millions)
December 31, 2006
Fixed maturities:
U.S. Government securities	$	2.8	$	—	$	—	$	2.8
Mortgage backed bonds		120.4		0.8		1.0		120.2
Tax-exempt bonds		222.2		0.7		2.3		220.6
Collateralized mortgage obligations		12.1		—		0.2		11.9
Corporate and other		139.3		0.4		1.5		138.2

Total fixed maturities		496.8		1.9		5.0		493.7
Preferred stock		2.0		—		—		2.0

Total	$	498.8	$	1.9	$	5.0	$	495.7


	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value

	(in millions)
December 31, 2005
Fixed maturities:
U.S. Government securities	$	3.3	$	—	$	—	$	3.3
Mortgage backed bonds		73.1		0.1		1.4		71.8
Tax-exempt bonds		211.2		0.6		2.3		209.5
Collateralized mortgage obligations		13.0		—		0.2		12.8
Corporate and other		157.6		0.4		2.5		155.5

Total fixed maturities		458.2		1.1		6.4		452.9
Preferred stock		2.0		—		—		2.0

Total	$	460.2	$	1.1	$	6.4	$	454.9

The following table reflects the amortized cost and fair value of debt securities in our investment portfolio as of December 31, 2006, by contractual maturity. Actual repayments may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.

	Amortized Cost		Fair Value

	(in millions)
Years to maturity
One year or less	$	32.9	$	32.6
After one year through five years		155.8		153.9
After five years through ten years		120.6		120.1
After ten years		55.0		55.0
Mortgage backed bonds		120.4		120.2
Collateralized mortgage obligations		12.1		11.9

Total	$	496.8	$	493.7

The Securities Valuation Office of the National Association of Insurance Commissions (“NAIC”) evaluates the bond investments of insurers for regulatory reporting purposes and assigns securities to one of six investment categories called “NAIC designations.” The NAIC designations generally parallel the credit ratings of the nationally recognized statistical rating organizations for marketable bonds. NAIC designations 1 and 2 include bonds considered to be investment grade, which are those rated “BBB-” or higher by Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. NAIC designations 3 through 6 include bonds considered to be below investment grade, rated “BB+” or lower by Standard & Poor’s. All of the debt securities in our portfolio were rated investment grade by the NAIC and Standard & Poor’s as of December 31, 2006. Investment grade securities generally bear lower yields and lower degrees of credit risk than those that are unrated or are rated non-investment grade.

The following table reflects the quality distribution of our fixed maturity portfolio as of December 31, 2006:

	NAIC Rating		Amortized Cost		Fair Value		% of Total at Fair Value

	(dollars in millions)
Standard & Poor’s Rating
AAA		1	$	402.3	$	399.9		81.0	%
AAA		2		1.1		1.1		0.2	%
AA		1		56.3		55.8		11.3	%
A		1		33.3		33.1		6.7	%
A		2		1.0		1.0		0.2	%
U.S. Treasuries agencies		1		2.8		2.8		0.6	%

Total fixed maturity investments			$	496.8	$	493.7		100.0	%

We evaluate the risk against reward tradeoffs of investment opportunities, measuring their effects on the stability, diversity, overall quality and liquidity of our investment portfolio.

The primary market risk exposure to our debt securities portfolio is interest rate risk, which we strive to limit by managing duration to a range of three to four years. Interest rate risk includes the risk from movements in market rates and changes in the credit spread of the respective sectors of the debt securities held in our portfolio.

An additional exposure to our debt securities portfolio is credit risk. We attempt to manage our credit risk through issuer and industry diversification. We regularly monitor our overall investment results and review compliance with our investment objectives and guidelines. Our investment guidelines include limitations on the minimum rating of debt securities in our investment portfolio, as well as restrictions on the maximum amount of investments in debt securities of a single issuer.

On a quarterly basis, we examine our investment portfolio for evidence of impairment. Our assessment of whether impairment has occurred is based on our evaluation, on an individual security basis, of the underlying reasons for the decline in fair value, which we discuss with our investment advisor. Together, we determine the extent to which such changes are attributable to interest rates, market-related factors other than interest rates, as well as financial condition, business prospects and other fundamental factors specific to the issuer. We review declines attributable to issuer fundamentals in further detail. If we were to determine that one or more of the securities in our investment portfolio had suffered a decline in fair value that is other than temporary, we would reduce the carrying value of the security to its current fair value as required by accounting principles generally accepted in the United States of America (“GAAP”).

Based upon our analysis, we believe that we will recover all contractual principal and interest payments related to those securities that currently reflect unrealized losses. We also have the ability and intent to hold these securities until they mature or recover in value. In the last three years, we have not incurred any impairment charges. We believe that it is not likely that future impairment charges will have a significant effect on our portfolio value or liquidity.

As of December 31, 2006, we had deposited investments carried at a fair value of $12.3 million and cash of approximately $0.3 million with state insurance regulatory authorities.

Short-Term Investments. Our short-term investments primarily consist of investments in money market funds and commercial paper with original maturities of three months or less.

Competition

The non-standard automobile insurance industry is highly competitive and, except for regulatory considerations, there are relatively few barriers to entry. We compete with both large national insurance providers and smaller regional companies on the basis of price, coverages offered, claims handling, customer service, producer commission, geographic coverage and financial strength ratings. Some of our competitors have more capital, higher ratings and greater resources than we have, and may offer a broader range of products, lower prices and lower down payments than we do. Some of our competitors sell insurance policies directly to customers, rather than through agents or brokers as we do, and may have certain competitive advantages, including increased name recognition among customers, direct relationships with policyholders and potentially lower cost structures. In addition, it is possible that new competitors will enter the non-standard automobile insurance market. Further, increased competition has resulted and may continue to result in some companies offering lower premium rates and policy terms and conditions that are more favorable to insureds than those we offer. Such actions by competitors could reduce our ability to increase or maintain our level of premium writings or underwriting margins.

Based upon data compiled from statutory filings of companies in the non-standard market (as determined by A.M. Best Company, Inc. (“A.M. Best”)), we believe that, as of December 31, 2005, the date of the most recent available report, the top ten insurance groups accounted for approximately 74% of the approximately $36.8 billion non-standard market segment. We believe that our primary insurance company competition comes not only from national companies or their subsidiaries, such as The Progressive Corporation, American International Group, Inc. (AIG), The Allstate Corporation, State Farm Mutual Automobile Insurance Company, Safeco Corp., GEICO, and Farmers Insurance Group, but also from non-standard insurers such as Mercury General Corporation, Infinity Property & Casualty Corporation, Affirmative Insurance Holdings, Inc., and Direct General Corporation.

Reinsurance

We have utilized reinsurance to increase our underwriting capacity and to reduce our exposure to losses. Reinsurance is an arrangement in which a reinsurer contracts to indemnify an insurance company (the “ceding company”) for all or a portion of the ceding company’s losses arising under specified classes of insurance policies. We have used reinsurance to limit our risk, to support our growth and to manage our capital more efficiently. In the past, we have relied on quota share and excess of loss reinsurance agreements to limit our exposure to loss to a level that is within the capacity of our capital resources. Pursuant to our quota share reinsurance arrangements, our reinsurers agreed to assume a specified percentage of our losses and loss adjustment expenses in exchange for a corresponding percentage of our premium written. In our excess of loss reinsurance arrangements, our reinsurers agreed to assume all or a portion of our losses and allocated loss adjustment expenses in excess of a specified amount.

Quota Share Agreements. We elected to terminate and commute our 2002 to 2004 quota share reinsurance agreement on a cut-off basis effective January 1, 2005 (see Note 6 to the Consolidated Financial Statements included herein). The termination and commutation resulted in the reinsurers’ release from all future liability and settlement of all balances due to us of $196.6 million, which we received on January 21, 2005. The termination and commutation of this quota share reinsurance agreement had no impact upon reported net income. Earned premium ceded under this agreement from inception through December 31, 2004 was $791.2 million. National Union Fire Insurance Company of Pittsburgh, PA, Alea London Ltd., and Federal Insurance Company provided the reinsurance under this agreement.

We entered into a quota share reinsurance agreement effective January 1, 2005 with National Union Fire Insurance Company of Pittsburgh, PA (“National Union”), a subsidiary of American International Group, Inc. (AIG). We elected to cede 10% of business written during 2005. For the twelve months ended December 31, 2005, we ceded $42.5 million of earned premium to National Union with a net pre-tax cost to us, excluding lost investment income, of $1.3 million. We agreed with the reinsurer to terminate and commute the 2005 quota share reinsurance agreement on a cut-off basis effective January 1, 2006 (see Note 6 to the Consolidated Financial Statements). The termination and commutation resulted in the reinsurer’s release from all future liability and settlement of all balances due to us of $11.0 million, which we received on January 31, 2006. The termination and commutation of this quota share reinsurance agreement had no impact upon reported net income.

Aggregate Excess of Loss (Stop Loss Agreement). Effective March 18, 2004, we elected to terminate and commute our aggregate excess of loss reinsurance agreement covering the 2001 through 2003 underwriting years. The termination and commutation resulted in the reinsurer being released from all future liability and settlement of the contract’s experience account balance of $10.6 million, which we received on March 18, 2004. The termination and commutation had no impact upon reported net income in 2004 as the experience account balance was equal to the liability released. Inter-Ocean Reinsurance (Ireland) Limited provided the reinsurance under this agreement, and they collateralized their obligations to us with a letter of credit. American Re-Insurance Company was the retrocessionaire.

Prior to entering into this aggregate excess of loss agreement, we concluded that the agreement was properly treated as reinsurance in our financial statements because it met the risk transfer tests of Statement of Financial Accounting Standards No. 113, Accounting and Reporting for Reinsurance of Short Duration and Long Duration Contracts (“SFAS No. 113”). We determined in 2005 that, as a result of a modification to the aggregate excess of loss agreement, as of the second quarter of 2002, the agreement no longer satisfied the risk transfer test of SFAS No. 113. We concluded that this determination had no impact on our current and prior year financial statements. We also concluded that the financial statement impact of not accounting for this agreement as reinsurance starting in the second quarter of 2002 was not material, and therefore we made no accounting adjustments to our financial statements for 2004 and prior years.

As of January 2006, all of the material reinsurance agreements to which we had been a party had been terminated and commuted, and the reinsurers had been released from all future liabilities under the agreements.

As previously disclosed, there are ongoing governmental investigations regarding reinsurance, and the various regulatory authorities could reach conclusions different from our conclusions concerning the accounting treatment of our historical reinsurance agreements. (See “Item 3. Legal Proceedings.”) In addition, we ceded premium to the Michigan Catastrophic Claims Association (the “MCCA”), a mandatory facility in that state. Earned premium that we ceded to the MCCA was $9.6 million, $9.4 million, and $6.2 million for the twelve months ended December 31, 2006, 2005, and 2004, respectively.

Ratings

Financial strength ratings are an important factor in establishing the competitive position of insurance companies and are important to our ability to market and sell our products. Rating organizations periodically review the financial positions of insurers. In May 2006, A.M. Best raised the financial strength rating of our then existing insurance subsidiaries to A- (Excellent) with a stable outlook. Bristol West Preferred Insurance Company, which received a certificate of authority from Michigan in October 2006, has not yet been rated by A.M. Best. The A- rating is the 4^th highest of 15 rating levels, and, according to A.M. Best, it assigns A- ratings to insurers that have “… an excellent ability to meet their ongoing obligations to policyholders.” A.M. Best maintains a letter scale rating system ranging from “A++” (Superior) to “F” (in liquidation). This rating is subject to periodic review and revision by A.M. Best. A.M. Best placed the existing financial strength rating of A- (Excellent) of our insurance subsidiaries under review with positive implications pending stockholder and regulatory approval of the Merger and further discussions with management regarding our integration into Farmers.

Regulatory Matters

We are subject to comprehensive regulation by government agencies in the states where our insurance subsidiaries are domiciled and licensed to transact business. State insurance laws and regulations are complex, and each jurisdiction’s requirements are different. Certain states impose restrictions or require prior regulatory approval of certain corporate actions.

Required Licensing. We operate under licenses issued by various state insurance authorities. These licenses govern, among other things, the types of insurance coverage and agency and claim services that we may offer consumers in these states. We are issued such licenses typically only after we file an appropriate application and satisfy prescribed criteria. We must apply for and obtain the appropriate new licenses before we can implement any plan to expand into a new state or offer a new line of insurance or other new product that requires separate licensing.

Transactions Between Insurance Companies and Their Affiliates. We are a holding company and are subject to regulation in the jurisdictions in which our insurance subsidiaries conduct business. Our insurance subsidiaries are organized and domiciled or commercially domiciled under the insurance statutes of a number of states. The insurance laws in most of those states provide that all transactions among members of an insurance holding company system must be fair and reasonable. Transactions between our subsidiaries and affiliates generally must be disclosed to the state regulators, and prior approval by the applicable regulator generally is required before any material or extraordinary transaction may be consummated or any services agreement or expense sharing arrangement is entered into. State regulators may refuse to approve or delay approval of such a transaction, which may impact our ability to innovate or operate efficiently.

Regulation of Insurance Rates and Approval of Policy Forms. The insurance laws of most states in which our insurance subsidiaries operate require insurance companies to file insurance rate schedules and insurance policy forms for review and approval. State insurance regulators have broad discretion in judging whether our rates are adequate, not excessive and not unfairly discriminatory and whether our policy forms comply with law. The speed at which we can change our rates depends, in part, on the method by which the applicable state’s rating laws are administered. Generally, state insurance regulators have the authority to disapprove our rates or request changes in our rates.

Investment Restrictions. We are subject to state laws and regulations that require diversification of our investment portfolios and that limit the amount of investments in certain categories. Failure to comply with these laws and regulations would cause non-conforming investments to be treated as non-admitted assets for purposes of measuring statutory surplus and, in some instances, would require divestiture.

Restrictions on Cancellation, Non-Renewal or Withdrawal. Many states have laws and regulations that limit an insurer’s ability to exit a market. For example, certain states limit an automobile insurer’s ability to cancel or not renew policies. Some states prohibit an insurer from withdrawing from one or more lines of business in the state, except pursuant to a plan approved by the state insurance department. In some states, this applies to significant reductions in the amount of insurance written, not just to a complete withdrawal. A state’s insurance department may disapprove a plan that may lead to market disruption. Laws and regulations that limit the cancellation or non-renewal of policies and that subject program withdrawals to prior approval requirements may restrict an insurer’s ability to exit unprofitable markets.

Capital Requirements. The laws of the states of domicile of our insurance subsidiaries impose risk-based capital standards and other minimum capital and surplus requirements. Moreover, in connection with the acquisition of our California insurance subsidiary in 1998, the California Department of Insurance requires us to maintain a net written premium to surplus ratio for that subsidiary of not greater than three to one. This requirement will remain in effect for so long as there are borrowings outstanding under our credit facility. The risk-based capital standards, based upon the Risk-Based Capital Model Act, adopted by the NAIC, require our insurance subsidiaries to report their results of risk-based capital calculations to the state departments of insurance and the NAIC. Failure to meet applicable risk-based capital requirements or minimum statutory capital requirements could subject us to further examination or corrective action imposed by state regulators, including limitations on our writing of additional business, state supervision or even liquidation. Any changes in existing risk-based capital requirements or minimum statutory capital requirements may require us to increase our statutory capital levels.

We must also comply with regulations involving, among other things, the following:

	•	the use of non-public consumer information and related privacy issues;

	•	the use of credit history in underwriting and rating;

	•	the payment of dividends;

	•	the acquisition or disposition of an insurance company or of any company controlling an insurance company;

	•	the approval or filing of policy forms;

	•	the involuntary assignments of high-risk policies, participation in reinsurance facilities and underwriting associations, assessments and other governmental charges; and

	•	reporting with respect to financial condition.

In addition, from time to time, the United States Congress and certain federal agencies investigate the current condition of the insurance industry to determine whether federal regulation is necessary.

Regulation of Dividends. We are a holding company with no business operations of our own. Consequently, our ability to pay dividends to stockholders and meet our debt payment obligations is largely dependent on dividends or other distributions from our insurance subsidiaries and commission and fees earned by non-insurance subsidiaries. State insurance laws restrict the ability of our insurance subsidiaries to pay stockholder dividends. These subsidiaries may not make an “extraordinary dividend” until 30 days after the applicable commissioner of insurance has received notice of the intended dividend and has not objected in such time or the commissioner has approved the payment of the extraordinary dividend within the 30-day period.

In California, Ohio and Michigan, three of our domiciliary states, an extraordinary dividend is generally defined as any dividend or distribution that, together with other dividends or distributions made within the preceding 12 months, exceeds the greater of 10% of the insurer’s surplus as of the preceding December 31, or the insurer’s net income for the 12-month period ending the preceding December 31, in each case determined in accordance with statutory accounting practices. In addition, an insurer’s remaining surplus after payment of a cash dividend or other distribution to stockholder affiliates must be both reasonable in relation to its outstanding liabilities and adequate to its financial needs. Finally, dividends may only be paid out of statutory earned surplus, which is similar in concept to retained earnings under GAAP.

Under Florida law, another of our domiciliary states, dividend payments to stockholders, without prior regulatory approval, may not exceed the larger of the following: (a) the lesser of 10% of surplus or net income, not including realized capital gains, plus a 2-year carry forward; (b) 10% of surplus, with dividends payable constrained to unassigned funds minus 25% of unrealized capital gains; and (c) the lesser of 10% of surplus or net investment income plus a 3-year carry forward with dividends payable constrained to unassigned funds minus 25% of unrealized capital gains. Alternatively, an insurer may pay a dividend or make a distribution without prior written regulatory approval when the following conditions are met: (i) the dividend is equal to or less than the greater of (x) 10% of the insurer’s surplus as to policyholders derived from realized net operating profits on its business and net realized capital gains or (y) the insurer’s entire net operating profits and realized net capital gains derived during the immediately preceding calendar year; (ii) the insurer will have surplus as to policyholders equal to or exceeding 115% of the minimum required statutory surplus as to policyholders after the dividend is made; and (iii) the insurer has filed a notice at least 10 business days prior to the dividend payment attesting that after payment of the dividend or distribution the insurer will have at least 115% of required statutory surplus.

Generally, the net admitted assets of insurance companies that, subject to other applicable insurance laws and regulations, are available for transfer to the parent company cannot include the net admitted assets required to meet the minimum statutory surplus requirements of the states where the companies are licensed. As of December 31, 2006, our insurance subsidiaries could pay dividends of $32.9 million without seeking regulatory approval. Such dividends, if paid, would be subject to regulatory dividend reporting requirements.

Acquisitions of Control. The acquisition of control of an insurance company requires the prior approval of the insurance regulator in the states where it is domiciled. Generally, any person who directly or indirectly through one or more affiliates acquires 10% or more of the outstanding voting securities of the insurer or its parent company (5% or more in Florida) is presumed to have acquired control of the domestic insurer. These requirements apply to the Merger.

Shared or Residual Markets. Like other insurers, we are required to participate in mandatory shared market mechanisms or state pooling arrangements as a condition for maintaining our automobile insurance licenses to do business in various states. The purpose of these state-mandated arrangements is to provide insurance coverage to individuals who, because of poor driving records or other underwriting reasons, are unable to purchase such coverage voluntarily provided by private insurers. The states can assign these risks to all insurers licensed in the state. The maximum volume of such risks that the state can assign to any one insurer typically is based on that insurer’s annual premium volume in that state. While this mandated business typically is not profitable for us, our underwriting results related to these states’ organizations have not been material to our overall results of operations and financial condition.

Guaranty Funds. Under state insurance guaranty fund laws, the state can assess insurers doing business in a state for certain obligations of insolvent insurance companies to policyholders and claimants. Maximum contributions permitted by laws in any one year vary between 1% and 2% of annual written premiums in the states in which we operate, but it is possible that individual states could raise caps on such contributions if there are numerous or large insolvencies. In most states, insurance companies can recover guaranty fund assessments either through future policy surcharges or offsets to state premium tax liability.

Trade Practices. The manner in which we conduct the business of insurance is regulated by state statutes in an effort to prohibit practices that constitute unfair methods of competition or unfair or deceptive acts or practices. Prohibited practices include, but are not limited to:

	•	disseminating false information or advertising;

	•	defamation;

	•	false statements or entries;

	•	unfair discrimination;

	•	rebating;

	•	improper tie-ins with lenders and the extension of credit;

	•	failure to maintain proper records;

	•	failure to maintain proper complaint handling procedures; and

	•	making false statements in connection with insurance applications for the purpose of obtaining a fee, commission or other benefit.

We set business conduct policies for our employees and we require them to conduct their activities in compliance with these statutes.

Unfair Claims Practices. Generally, state statutes prohibit insurance companies, adjusting companies and individual claims adjusters from engaging in unfair claims practices on a flagrant basis or with such frequency to indicate a general business practice. Unfair claims practices include:

	•	misrepresenting pertinent facts or insurance policy provisions relating to coverages at issue;

	•	failing to acknowledge and act reasonably promptly upon communications with respect to claims arising under insurance policies;

	•	failing to adopt and implement reasonable standards for the prompt investigation and settlement of claims arising under its policies;

	•	failing to affirm or deny coverage of claims within a reasonable time after proof of loss statements have been completed;

	•	attempting to settle a claim for less than the amount to which a reasonable person would have believed such person was entitled;

	•	attempting to settle claims on the basis of an application that was altered without notice to or knowledge or consent of the insured;

	•	compelling insureds to institute suits to recover amounts due under policies by offering substantially less than the amounts ultimately recovered in suits brought by them;

	•	refusing to pay claims without conducting a reasonable investigation;

	•	making claim payments to an insured without indicating the coverage under which each payment is being made;

	•	delaying the investigation or payment of claims by requiring an insured, claimant or the physician of either to submit a preliminary claim report and then requiring the subsequent submission of formal proof of loss forms, both of which submissions contains substantially the same information;

	•	failing, in the case of claim denials or offers of compromise or settlement, to promptly provide a reasonable and accurate explanation of the basis for such actions; and

	•	not attempting in good faith to effectuate prompt, fair and equitable settlements of claims in which liability has become reasonably clear.

We set business conduct policies and conduct training to make our employee-adjusters and other claims personnel aware of these prohibitions and we require them to conduct their activities in compliance with these statutes.

Periodic Financial and Market Conduct Examinations. The state insurance departments that have jurisdiction over our insurance subsidiaries may conduct on-site visits and examinations of our insurers’ affairs, including their financial condition, ability to fulfill their obligations to policyholders, market conduct, claims practices and compliance with other laws and applicable regulations. Typically, these examinations are conducted every three to five years. In addition, if circumstances dictate, regulators are authorized to conduct special or target examinations of insurers to address particular concerns or issues. The results of these examinations can give rise to regulatory orders requiring remedial, injunctive or other corrective action on the part of the company that is the subject of the examination or assessing fines or other penalties against that company. Currently, there are four such examinations and related proceedings in progress with respect to our insurance subsidiaries. The outcomes of these examinations and related proceedings are uncertain. While it is not possible to know with certainty the ultimate outcome of such examinations, based on the facts currently available to it, the Company believes that such examinations will not have a material adverse effect on the Company, including, without limitation, on its future financial condition, results of operations or cash flows. In view of the uncertainties regarding the outcome of these examinations, as well as the tax-deductibility of any related payments, it is possible that the ultimate cost to the Company of these examinations could have a material adverse effect on the Company, including, without limitation, on its future results of operations, financial condition, and cash flows in a particular quarter or year.

Utilization of Credit Information as Part of Rating Process. Our insurance subsidiaries generally use financial responsibility or credit information (which we refer to as “credit”) as part of the rating process in states that permit its use. Both our data and industry data have shown that credit is an effective predictor of insurance risk. Use of credit in underwriting and rating is the subject of significant regulatory and legislative activity. Some legislators and regulators have expressed concerns related to the use of credit, including perceptions that the use of credit may have a disparate impact on the poor and certain minority groups, questions regarding the accuracy of credit reports, the perceived lack of a demonstrated causal relationship between credit and insurance risk, the treatment of persons with limited or no credit, the impact on credit of extraordinary life events (e.g., catastrophic injury or death of a spouse), and the credit attributes applied in the credit scoring models used by insurers. A number of state insurance departments have issued bulletins, directives or regulations to regulate the use of credit by insurers. In addition, a number of states are considering or have passed legislation to regulate insurers’ use of credit. Congress also has mandated that the federal government conduct a disparate impact study of the use of credit. There may be future legislative and regulatory actions that further prohibit or restrict the use of credit by insurers. At this time, we cannot determine the outcome of such actions and their impact on the insurance industry and on our business.

Recent Regulatory Developments.

California. The California Department of Insurance has adopted regulations that require a rate filing and change the weighting of rating factors for private passenger auto insurance. These regulations effectively reduce the influence of territory on premium rates. Specifically, the influence of territory is now required to be less than any of the three mandatory factors (which are driving safety record, annual mileage and years of driving experience) on an individual basis. The new regulations require that all private passenger automobile insurance companies in California submit annual class plan filings to achieve full compliance at any time before mid-July 2008. The regulations require an initial class plan filing, which was due during the third quarter of 2006, to correct at least 15% of the rating factor weight non-compliance.

Attempts to block the implementation of these regulations by the insurance industry have not been successful. A lawsuit was filed challenging the legality of these regulations and seeking a preliminary injunction to prevent their implementation. The trial court denied the request for a preliminary injunction, and therefore the regulations became operative during the third quarter of 2006. In February 2007, the trial court in that lawsuit granted the Department of Insurance’s motion for summary judgment and determined that, as a matter of law, the regulations are consistent with the California Insurance Code. At this time, no appeal from that order has been filed.

We and other automobile insurance companies in California submitted the required rate and class plan filings by the end of September or early October 2006. We filed for a 2.6% rate decrease in our Basic program, and a 0.1% rate decrease in our Prima program. All of our significant competitors have rate and class plan filings that are of public record and available on the Department of Insurance’s website. Because some companies filed for increases while others filed for decreases, the weighted average filed rate change for companies that sell through independent agents and brokers resulted in no overall change. If the filings are approved, we expect to see our competitive position improve in terms of rates and expect to suffer a modest amount of margin compression.

Florida. In February 2005, the Florida Office of Insurance Regulation (the “FOIR”) proposed a rule that would make it more difficult for insurers to use credit as a rating variable. The proposed rule would require insurers to demonstrate that their use of credit reports and credit scores does not unfairly discriminate against insureds because of their race, color, religion, marital status, age, gender, income, national origin, or place of residence. The proposed rule was challenged in an administrative proceeding and, on December 29, 2006, an Administrative Law Judge issued an order declaring that the proposed rule was an invalid exercise of delegated legislative authority. The FOIR has filed an appeal from that order.

Michigan. In March 2005, the Michigan Office of Financial and Insurance Services (“Michigan OFIS”) adopted rules eliminating the use of credit as a rating variable and requiring insurers to reduce their base rates by the amount of the rate attributable to credit as a rating variable. In April 2005, a Michigan Circuit Court judge ruled that these Michigan OFIS rules were unenforceable. The Michigan OFIS appealed the ruling and the case was argued in October 2006 in the Michigan Court of Appeals. That Court has not yet issued a decision.

General. At this time, we cannot determine the outcome of the regulatory developments described above and their impact on the insurance industry and on our business.

Employees

As of December 31, 2006, we had 1,154 employees, none of whom were covered by collective bargaining agreements.

Trademarks

We own various registered trademarks and have various trademarks currently pending with the U.S. Trademark office. Our trademarks are not essential to our operations as a whole.

Available Information

Our Internet address is www.bristolwest.com. Please note that our Internet address is included in this Annual Report on Form 10-K as an inactive textual reference only. The information contained on our website is not incorporated by reference into this Annual Report on Form 10-K and should not be considered part of this report. We file and furnish annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”) pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and we make available free of charge most of our SEC filings through our Internet website as soon as reasonably practicable after we electronically file these materials with the SEC. You may access these SEC filings via the hyperlink that we provide on our website to a third-party SEC filings website. We also make available on our website the charters of our Audit Committee, our Compensation Committee, and our Corporate Governance and Nominating Committee, as well as the Corporate Governance Guidelines adopted by our Board of Directors, our Code of Conduct and Business Ethics, and our Code of Conduct and Business Ethics Policy for Chief Executive Officer and Senior Financial Officers. We will also provide copies of these documents, without charge, at the written request of any stockholder of record. Requests for copies should be mailed to: Bristol West Holdings, Inc., 5701 Stirling Road, Davie, FL 33314, Attention: Corporate Secretary.

Cautionary Statements for Purposes of Forward-Looking Statements/Information

Investors are cautioned that certain statements contained in this report, as well as some statements by us in periodic press releases and some oral statements by Company officials to securities analysts and stockholders during presentations about us that are not historical facts are “forward-looking statements,” within the meaning of the federal securities laws, including the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements that are predictive in nature, depend upon or refer to future events or conditions, or include words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” “hopes” and similar expressions. Forward-looking statements also include any statements concerning future financial performance (including future revenues, earnings, cash flow or growth rates), ongoing business strategies or prospects, and possible future Company actions, which may be provided by management. Forward-looking statements are based on our current expectations and beliefs concerning future events and involve risks, uncertainties and assumptions, among other things, about us, economic and market factors and the automobile insurance industry. A number of important factors could cause actual results to differ materially from those contained in any forward-looking statement. Such factors include those factors that are more particularly described below under the heading “Item 1A. Risk Factors.” We believe that our forward-looking statements are reasonable; however, undue reliance should not be placed on any forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise.

Item 1A. Risk Factors

An investment in Company common stock involves a number of risks. Investors should carefully consider the following information, together with the other information contained in this Annual Report on Form 10-K, before investing in Company common stock. Further, such factors could cause actual results to differ materially from those contained in any forward-looking statement contained in this report, statements by us in periodic press releases and oral statements by Company officials to securities analysts and stockholders during presentations about us. See “Item 1. Business - Cautionary Statements for Purposes of Forward-Looking Statements/Information” above.

The pending Merger with a subsidiary of Farmers Group, Inc. may not occur.

On March 1, 2007, we entered into a Merger Agreement with Farmers Group, Inc. pursuant to which a wholly owned subsidiary of Farmers will be merged with and into the Company, with the Company continuing as the surviving corporation and becoming a wholly-owned subsidiary of Farmers. Consummation of the Merger is subject to various customary closing conditions, including, but not limited to, (1) the expiration or termination of applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, (2) all insurance antitrust approvals and regulatory approvals from certain insurance departments, (3) absence of certain orders preventing the Merger, and (4) the approval of the Merger Agreement by the Company’s stockholders. Further, both the Company and Farmers may terminate the Merger Agreement if the Merger is not consummated by December 1, 2007. We currently expect the Merger to close before the end of 2007. However, it is possible that factors outside of our control could require the parties to complete the Merger at a later time or not to complete it at all.

We face intense competition from other automobile insurance providers.

The non-standard automobile insurance business is highly competitive and, except for regulatory considerations, there are relatively few barriers to entry. We compete with both large national insurance providers and smaller regional companies. The largest automobile insurance companies include The Progressive Corporation, The Allstate Corporation, State Farm Mutual Automobile Insurance Company, GEICO, Farmers Insurance Group, Safeco Corp., and American International Group (AIG). Our chief competitors include some of these companies as well as Mercury General Corporation, Infinity Property & Casualty Corporation, Affirmative Insurance Holdings, Inc., and Direct General Corporation. Some of our competitors have more capital, higher ratings and greater resources than we have, and may offer a broader range of products and lower prices and down payments than we offer. Some of our competitors that sell insurance policies directly to customers, rather than through agencies or brokerages as we do, may have certain competitive advantages, including increased name recognition among customers, direct relationships with policyholders and potentially lower cost structures. In addition, it is possible that new competitors will enter the non-standard automobile insurance market. Our loss of business to competitors could have a material impact on our growth and profitability. Further, competition could result in lower premium rates and less favorable policy terms and conditions, which could reduce our underwriting margins.

Our concentration on non-standard automobile insurance could make us more susceptible to unfavorable market conditions.

We underwrite primarily non-standard automobile insurance. Given this focus, negative developments in the economic, competitive or regulatory conditions affecting the non-standard automobile insurance industry could have a material adverse effect on our results of operations, financial condition and cash flows. In addition, these developments could have a greater effect on us, compared to more diversified insurers that also sell other types of automobile insurance products. Our profitability can be affected by cyclicality in the non-standard automobile insurance industry caused by price competition and fluctuations in underwriting capacity in the market, as well as changes in the regulatory environment.

Our success depends on our ability to price the risks we underwrite accurately.

Our results of operations and financial condition depend on our ability to underwrite and set rates accurately for a full spectrum of risks. Rate adequacy is necessary to generate sufficient premiums to pay losses, loss adjustment expenses and underwriting expenses and to earn a profit. If we fail to assess accurately the risks that we assume, we may fail to establish adequate premium rates, which could reduce our income and have a material adverse effect on our results of operations, financial condition or cash flows.

In order to price our products accurately, we must collect and properly analyze a substantial volume of data; develop, test and apply appropriate rating formulas; closely monitor and timely recognize changes in trends; and project both severity and frequency of losses with reasonable accuracy. Our ability to undertake these efforts successfully, and as a result price our products accurately, is subject to a number of risks and uncertainties, including, without limitation:

	•	availability of sufficient reliable data;
	•	incorrect or incomplete analysis of available data;
	•	uncertainties inherent in estimates and assumptions, generally;
	•	selection and application of appropriate rating formulas or other pricing methodologies;
	•	unanticipated or inconsistent court decisions, legislation or regulatory action;
	•	ongoing changes in our claim settlement practices, which can influence the amounts paid on claims;
	•	changing driving patterns, which could adversely affect both frequency and severity of claims;
	•	unexpected inflation in the medical sector of the economy, resulting in increased bodily injury and personal injury protection claim severity; and
	•	unanticipated inflation in automobile repair costs, automobile parts prices and used automobile prices, adversely affecting automobile physical damage claim severity.

Such risks may result in our pricing being based on inadequate or inaccurate data or inappropriate analyses, assumptions or methodologies, and may cause us to estimate incorrectly future increases in the frequency or severity of claims. As a result, we could underprice our products, which would negatively affect our profit margins, or we could overprice our products, which could reduce our volume and competitiveness. In either event, our results of operations, financial condition and cash flows could be materially and adversely affected.

Our losses and loss adjustment expenses may exceed our loss and loss adjustment expense reserves, which could adversely impact our results of operation, financial condition and cash flows.

Our financial statements include loss and loss adjustment expense reserves, which represent our best estimate of the amounts that we will ultimately pay on claims and the related costs of adjusting those claims as of the date of the financial statements. We rely heavily on our historical loss and loss adjustment expense experience in determining these loss and loss adjustment expense reserves. The historic development of reserves for losses and loss adjustment expenses may not necessarily reflect future trends in the development of these amounts. In addition, factors such as inflation, claims settlement patterns and legislative activities, regulatory activities, and litigation trends may also affect loss and loss adjustment expense reserves. As a result of these and other risks and uncertainties, ultimate losses and loss adjustment expenses may deviate, perhaps substantially, from our estimates of losses and loss adjustment expenses included in the loss and loss adjustment expense reserves in our financial statements. If actual losses and loss adjustment expenses exceed our expectations, our net income and our capital would decrease. Actual paid losses and loss adjustment expenses may be in excess of the loss and loss adjustment expense reserve estimates reflected in our financial statements. For additional information regarding our loss reserves, see “Item 1. Business - Loss and Loss Adjustment Expense Reserve Development” above and “Management’s Diuscussion and Analysis of Fianncial Condition and Results of Operations –Critical Accounting Policies – Estimation of Unpaid Losses and Loss Adjustment Expenses” below.

We are subject to comprehensive regulation, and our ability to earn profits may be adversely affected by these regulations.

We are subject to comprehensive regulation by government agencies in the states where our insurance subsidiaries are domiciled and where these subsidiaries issue policies and handle claims. Certain states impose restrictions or require prior regulatory approval of certain corporate actions, which may adversely affect our ability to operate, innovate, obtain necessary rate adjustments in a timely manner or grow our business profitably. In addition, certain federal laws impose additional requirements on insurers. Our ability to comply with these laws and regulations, and to obtain necessary regulatory action in a timely manner, is and will continue to be critical to our success.

Required Licensing. We operate under licenses issued by various state insurance authorities. If a regulatory authority denies or delays granting a new license, our ability to enter that market quickly can be substantially impaired.

Transactions Between Insurance Companies and Their Affiliates. Transactions between our subsidiaries and their affiliates (including us) generally must be disclosed to the state regulators, and prior approval of the applicable regulator generally is required before any material or extraordinary transaction may be consummated. State regulators may refuse to approve or delay approval of such a transaction, which may impact our ability to innovate or operate efficiently.

Regulation of Insurance Rates and Approval of Policy Forms. The insurance laws of the states in which our insurance subsidiaries operate require insurance companies to file insurance rate schedules and insurance policy forms for review and/or approval. If, as permitted in some states, we begin using new rates before they are approved, we may be required to issue refunds or credits to our policyholders if the new rates are ultimately deemed excessive or unfair and disapproved by the applicable state regulator. Accordingly, our ability to respond to market developments or increased costs in that state can be adversely affected.

Restrictions on Cancellation, Non-Renewal or Withdrawal. Many states have laws and regulations that limit an insurer’s ability to exit a market. For example, certain states limit an automobile insurer’s ability to cancel or not renew policies. Some states prohibit an insurer from withdrawing from one or more lines of business in the state, except pursuant to a plan approved by the state insurance department. In some states, this restriction applies to significant reductions in the amount of insurance written, not just to a complete withdrawal. These laws and regulations could limit our ability to exit or reduce our writings in unprofitable markets or discontinue unprofitable products in the future.

Other Regulations. We must also comply with regulations involving, among other things:

	•	the use of non-public consumer information and related privacy issues;
	•	investment restrictions;
	•	the use of credit history in underwriting and rating;
	•	the payment of dividends;
	•	the acquisition or disposition of an insurance company or of any company controlling an insurance company;
	•	the involuntary assignments of high-risk policies, participation in reinsurance facilities and underwriting associations, assessments and other governmental charges; and
	•	reporting with respect to financial condition.

Compliance with laws and regulations addressing these and other issues often will result in increased administrative costs. In addition, these laws and regulations may limit our ability to underwrite and price risks accurately, prevent us from obtaining timely rate increases necessary to cover increased costs and may restrict our ability to discontinue unprofitable relationships or exit unprofitable markets. These results, in turn, may adversely affect our results of operation or our ability or desire to grow our business in certain jurisdictions. The failure to comply with these laws and regulations may also result in actions by regulators, fines and penalties, and in extreme cases, revocation of our ability to do business in that jurisdiction. In addition, we may face individual and class action lawsuits by our insureds and other parties for alleged violations of certain of these laws or regulations.

Our insurance subsidiaries are subject to minimum capital and surplus requirements. Our failure to meet these requirements could subject us to regulatory action.

The laws of the states of domicile of our insurance subsidiaries impose risk-based capital standards and other minimum capital and surplus requirements. Failure to meet applicable risk-based capital requirements or minimum statutory capital requirements could subject us to further examination or corrective action imposed by state regulators, including limitations on our writing of additional business, state supervision or liquidation. Any changes in existing risk-based capital requirements or minimum statutory capital requirements may require us to increase our statutory capital levels, which we may be unable to do.

Regulation may become more extensive in the future, which may adversely affect our business.

States may make existing insurance laws and regulations more restrictive in the future or enact new restrictive laws. In such events, we may seek to reduce our premium writings in, or to withdraw entirely from, these states. In addition, from time to time, the United States Congress and certain federal agencies investigate the current condition of the insurance industry to determine whether federal regulation is necessary. We are unable to predict whether and to what extent new laws and regulations that would affect our business will be adopted in the future, the timing of any such adoption and what effects, if any, they may have on our financial condition, results of operations, and cash flows.

Our failure to pay claims accurately could adversely affect our business, financial condition, results of operations and cash flows.

We must accurately evaluate and pay claims that are made under our policies. Many factors affect our ability to pay claims accurately, including the training and experience of our claims representatives, our claims organization’s culture and the effectiveness of our management, our ability to develop or select and implement appropriate procedures and systems to support our claims functions and other factors. Our failure to pay claims accurately could lead to material litigation, undermine our reputation in the marketplace, impair our image and materially adversely affect our financial condition, results of operations and cash flows.

In addition, if we do not train new claims employees effectively or lose a significant number of experienced claims employees our claims department’s ability to handle an increasing workload could be adversely affected. In addition to potentially requiring that growth be slowed in the affected markets, we could suffer in decreased quality of claims work, which in turn could lower our operating margins.

As a holding company, we are dependent on the results of operations of our subsidiaries and their ability to transfer funds to us to meet our obligations.

We are a holding company without significant operations of our own. Dividends from our subsidiaries are our principal source of funds to meet our cash needs, including debt service payments and other expenses, and to pay dividends to our stockholders. Insurance laws limit the ability of our insurance subsidiaries to pay dividends to us. In addition, for competitive reasons, our insurance subsidiaries maintain financial strength ratings that require us to sustain certain capital levels in those subsidiaries. The need to maintain these required capital levels may affect the ability of our insurance subsidiaries to pay dividends to us. As of December 31, 2006, our insurance subsidiaries could pay dividends of $32.9 million without seeking regulatory approval. Such dividends, if paid, would be subject to regulatory dividend reporting requirements. Our non-insurance subsidiaries’ ability to pay dividends to us is not limited by insurance law. Nevertheless, these non-insurance subsidiaries’ earnings are dependent on commissions collected from our insurance subsidiaries for services provided under general agency agreements, which are subject to insurance regulation. Under the Merger Agreement with Farmers, without Farmer’s prior written consent, the Company is only permitted to pay a regular quarterly dividend with respect to our Common Stock not to exceed $0.08 per share and our subsidiaries are not permitted to pay dividends. See also “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.”

The policy service fee revenues could be adversely affected by insurance regulation.

Policy service fee revenues have provided additional revenues equivalent to approximately 9% of gross earned premium. These fees include policy origination fees and installment fees to compensate us for the costs of providing installment payment plans, as well as late payment, policy cancellation, policy rewrite and reinstatement fees. Our revenues could be reduced by changes in insurance regulation that restrict our ability to charge these fees. Those arrangements are subject to insurance holding company act regulation in the states where our insurance subsidiaries are domiciled. Continued payment of these fees could be affected if insurance regulators in these states determined that these arrangements are not permissible under the insurance holding company acts.

New pricing, claim and coverage issues and class action litigation are continually emerging in the automobile insurance industry, and these new issues could adversely impact our results of operations and financial condition.

As automobile insurance industry practices and regulatory, judicial and consumer conditions change, unexpected and unintended issues related to claims, coverage and business practices may emerge. These issues can have an adverse effect on our business by changing the way we price our products, including limiting the factors we may consider when we underwrite risks, by extending coverage beyond our underwriting intent, by increasing the size or frequency of claims or by requiring us to change our claims handling practices and procedures or our practices for charging fees. The effects of these unforeseen emerging issues could negatively affect our results of operations, financial condition and cash flows.

We may be unable to attract and retain independent agents and brokers.

We distribute our products exclusively through independent agents and brokers. We compete with other insurance carriers to attract producers and maintain commercial relationships with them. Some of our competitors offer a larger variety of products, lower prices for insurance coverage or higher commissions. We may not be able to continue to attract and retain independent agents and brokers to sell our products. Our inability to continue to recruit and retain productive independent agents and brokers would have an adverse effect on our financial condition and results of operations and could impact our cash flows.

Our failure to maintain a commercially acceptable financial strength rating of our insurance subsidiaries could significantly and negatively affect our ability to implement our business strategy successfully.

Financial strength ratings are an important factor in establishing the competitive position of insurance companies and have an effect on an insurance company’s sales. A.M. Best maintains a letter scale financial strength rating system ranging from “A++ (Superior)” to “F” (in liquidation). In May 2006, A.M. Best assigned our insurance subsidiaries a rating of “A-” (Excellent), which is the 4th highest of 15 rating levels. According to A.M. Best, “A-” ratings are assigned to insurers that have “… an excellent ability to meet their ongoing obligations to policyholders.” See “Item 1. Business - Ratings.” The rating of our insurance subsidiaries is subject to at least annual review by, and may be revised downward or revoked at the sole discretion of, A.M. Best. Many of our competitors have ratings higher than those of our insurance subsidiaries. A downgrade in the financial strength rating of our insurance subsidiaries would have an adverse impact on our ability to effectively compete with other insurers with higher ratings or our attractiveness to policyholders and agents and brokers.

A.M. Best bases its ratings on factors that concern policyholders and not upon factors concerning investor protection. Such ratings are subject to change and are not recommendations to buy, sell or hold securities.

We rely on information technology and telecommunication systems, and the failure of these systems could materially and adversely affect our business.

Our business is highly dependent upon the successful and uninterrupted functioning of our information technology and telecommunications systems. We rely on these systems to process new and renewal business, provide customer service, make claims payments and facilitate collections and cancellations. These systems also enable us to perform actuarial and other modeling functions necessary for underwriting and rate development. The failure of these systems could interrupt our operations or materially impact our ability to evaluate and write new business. Because our information technology and telecommunication systems interface with and depend on third-party systems, we could experience service denials if demand for such service exceeds capacity or such third-party systems fail or experience interruptions. If sustained or repeated, a system failure or service denial could result in a deterioration of our ability to write and process new and renewal business and provide customer service or compromise our ability to pay claims in a timely manner. This outcome could result in a material adverse effect on our business and our results of operations, financial condition and cash flows.

We are parties to multiple lawsuits, which, if decided adversely against us, could have a negative impact on our financial results.

The Company is named as a defendant in a number of class action and individual lawsuits arising in the ordinary course of business, the outcomes of which are uncertain at this time. These cases include those plaintiffs who challenge various aspects of the Company’s claims and marketing practices and business operations and seek restitution, damages and other remedies. We may be subject to further litigation in the future. Litigation, by its very nature, is unpredictable and the outcome of any case is uncertain. We are unable to predict the precise nature of the relief that may be sought or granted in any lawsuits or the effect that pending or future cases may have on our future results of operations, financial condition and cash flows. For additional information regarding such lawsuits, see “Item 3. Legal Proceedings” below.

Our ability to operate our company effectively could be impaired if we lose key personnel.

We manage our business with a number of key personnel, including our executive officers, the loss of whom could have a material adverse effect on our business and our results of operations, financial condition and cash flows. Only our Executive Chairman, James R. Fisher, has an employment agreement with us, which has a current term that expires on June 30, 2007. Effective July 1, 2006, Mr. Fisher relinquished his position as Chief Executive Officer and continues to serve as Executive Chairman of the Board. In addition, as our business develops and expands, we believe that our future success will depend greatly on our continued ability to attract and retain highly skilled and qualified personnel. We may not be able to continue to employ key personnel and may not be able to attract and retain qualified personnel in the future. Failure to retain or attract key personnel could have a material adverse effect on our business and our results of operations, financial condition and cash flows. We do not have “key person” life insurance to cover our executive officers.

Our debt service obligations could impede our operations, flexibility and financial performance.

Our level of debt could affect our financial performance. As of December 31, 2006, we had consolidated indebtedness (other than trade payables and certain other short term debt) of approximately $100.0 million and additional availability under our credit facility of $25.0 million. In addition, borrowings under our credit agreement bear interest at rates that may fluctuate. Therefore, increases in interest rates on the obligations under our credit agreement would adversely affect our income and cash flow that would be available for the payment of interest and principal on the loans under our credit agreement. Our interest expense for the year ended December 31, 2006 was $5.7 million.

Our level of debt could have important consequences, including the following:

	•	we will need to use a portion of the money we earn to pay principal and interest on outstanding amounts due under our credit facility, which will reduce the amount of money available to us for financing our operations and other business activities;
	•	we may have a much higher level of debt than certain of our competitors, which may put us at a competitive disadvantage;
	•	we may have difficulty borrowing money in the future; and
	•	we could be more vulnerable to economic downturns and adverse developments in our business.

We continue to expect to obtain the money to pay dividends to our stockholders, to pay our expenses and to pay the principal and interest on our outstanding debt from our operations. Our ability to meet our expenses and debt service obligations thus depends on our future performance, which will be affected by financial, business, economic, demographic and other factors, including competition.

If we do not have enough money to pay our debt service obligations, we may be required to refinance all or part of our existing debt, sell assets, borrow more money or raise equity. In that event, we may not be able to refinance our debt, sell assets, borrow more money or raise equity on terms acceptable to us or at all.

We are subject to restrictive covenants, which may restrict our operational flexibility.

Our credit facility and the Merger Agreement with Farmers contains various operating covenants, including among other things, restrictions on our ability to incur additional indebtedness, pay dividends on and redeem capital stock, make other restricted payments, including investments, sell our assets and enter into consolidations, mergers and transfers of all or substantially all of our assets. These restrictions could limit our ability to take actions that require funds in excess of those available to us.

Our credit facility also requires us to maintain specified financial ratios and satisfy financial condition tests. Our ability to meet those financial ratios and tests can be affected by events beyond our control and we cannot assure that we will meet those ratios and tests. A breach of any of these covenants, ratios, tests or restrictions could result in an event of default under the credit facility. If an event of default exists under the credit facility, the lenders could elect to declare all outstanding amounts immediately due and payable. If the lenders under our credit facility accelerate the payment of the indebtedness, we cannot assure that our assets would be sufficient to repay in full that indebtedness and our other indebtedness that would become due as a result of any acceleration.

Adverse securities market conditions can have significant and negative effects on our investment portfolio.

Our results of operations depend in part on the performance of our invested assets. As of December 31, 2006, 99.6% of our investment portfolio was invested in fixed maturity securities with the remainder in one private equity investment. Certain risks are inherent in connection with fixed maturity securities, including loss upon default and price volatility in reaction to changes in interest rates, credit spreads, deterioration in the financial condition of the issuers and general market conditions. An increase in interest rates lowers prices on fixed maturity securities, and any sales we make during a period of increasing interest rates may result in losses. Also, investment income earned from future investments in fixed maturity securities will decrease if interest rates decrease.

In addition, our investment portfolio is subject to risks inherent in the capital markets. The functioning of those markets, the values of our investments and our ability to liquidate investments on short notice may be adversely affected if those markets are disrupted by national or international events including, without limitation, wars, terrorist attacks, recessions or depressions, high inflation or a deflationary environment, the collapse of governments or financial markets, and other factors or events.

If our investment portfolio were impaired by market or issuer-specific conditions to a substantial degree, our financial condition, results of operations and cash flows could be materially adversely affected. Further, our income from these investments could be materially reduced, and write-downs of the value of certain securities could further reduce our profitability. In addition, a decrease in value of our investment portfolio could put us at risk of failing to satisfy regulatory capital requirements. If we were not able to supplement our subsidiaries’ capital by issuing debt or equity securities on acceptable terms, our ability to continue growing could be adversely affected.

Our operations could be adversely affected if conditions in the states where our business is concentrated were to deteriorate.

For the year ended December 31, 2006, we generated approximately 70% of our gross written premium in our top three states, California, Florida and Michigan. California, our largest market, represented approximately 40% of our gross written premium in 2006. Our revenues and profitability are therefore subject to prevailing regulatory, legal, economic, demographic, competitive and other conditions in those states. Changes in any of those conditions could have an adverse effect on our results of operations, financial condition and cash flows. Adverse regulatory developments in any of those states, which could include, among others, reductions in the rates permitted to be charged, inadequate rate increases, restrictions on our ability to reject applications for coverage or on how we handle claims, or more fundamental changes in the design or implementation of the automobile insurance regulatory framework, could have a material adverse effect on our results of operations, financial condition and cash flows.

Severe weather conditions and other catastrophes may result in an increase in the number and amount of claims filed against us.

Our business is also exposed to the risk of severe weather conditions and other catastrophes in the states in which we operate. Catastrophes include severe winter weather, hurricanes, tornadoes, hail storms, floods, windstorms, earthquakes, fires and other events such as terrorist attacks and riots, each of which tends to be unpredictable. Such conditions generally result in higher incidence of automobile accidents and increase the number of claims. Because many of our insureds live near the coastlines, we have potential exposure to hurricanes and major coastal storms. In addition, our business could be impaired if a significant portion of our business or systems were shut down by, or if we were unable to gain access to certain of our facilities as a result of such an event. If such events were to occur with enough severity, our results of operations, financial condition and cash flows could be materially adversely affected.

The loss of, or significant reduction in, business from our largest producers could adversely affect our financial condition and results of operations.

Some of our producers are material to our business. For the year ended December 31, 2006, our top 10 producers, as measured by premium value, accounted for 20.1% of our gross written premium. Although we believe that our relationships with our major producers are good, we do not have long-term contracts with any of them, which is typical of our industry. If any of these producers were to reduce their business with us, or if we were unable to continue to do business with them on terms as favorable to us as our current terms or at all, our financial condition, results of operations and cash flows could suffer materially.

We have terminated and commuted our significant reinsurance agreements; therefore, we will retain more risk, which could result in losses.

Effective January 2006, all of the material reinsurance agreements to which we had been a party had been terminated and commuted, and the reinsurers have been released from all future liabilities under the agreements. Thus, we will retain more gross written premium over time, but will also retain more of the related losses. The termination and commutation of our significant reinsurance agreements will increase our risk and exposure to losses, which could have a material adverse effect on our financial condition, results of operations and cash flows.

Our financial condition may be adversely affected if one or more parties with which we enter into significant contracts becomes insolvent or experiences other financial hardship.

Our business is dependent on the performance by third parties of their responsibilities under various contractual relationships, including without limitation, contracts for the acquisitions of goods and services (such as telecommunications and information technology software, equipment and support and other services that are integral to our operations) and arrangements for transferring certain of our risks (including our corporate insurance policies). If one or more of these parties were to default on the performance of their obligations under their respective contracts or determine to abandon or terminate support for a system, product or service that is significant to our business, we could suffer significant financial losses and operational problems, which could in turn adversely affect our financial condition, results of operations and cash flows.

Item 1B. Unresolved Staff Comments

Not applicable – there are no unresolved staff comments.

Item 2. Properties

We lease an aggregate of approximately 317,000 square feet of office space in numerous cities throughout the United States. Our most significant leased office spaces are located in Davie, Florida with approximately 100,000 square feet; Independence, Ohio with approximately 60,000 square feet; Orange, California with approximately 39,000 square feet; Phoenix, Arizona with approximately 24,000 square feet; and Centennial, Colorado with approximately 29,000 square feet. During 2006, we terminated the lease for a storage facility in Dania, Florida with approximately 10,000 square feet. We also opened an office in Southfield, Michigan with square footage of approximately 1,700 and expanded the existing office in North Charleston, South Carolina by approximately 1,500 square feet.

Item 3. Legal Proceedings

On April 21, 2005, we received a subpoena from the Florida Office of Insurance Regulation (the “FOIR”) requesting documents related to all reinsurance agreements to which we have been a party since January 1, 1998. On May 2, 2005, we received a subpoena from the SEC seeking documents relating to “certain loss mitigation insurance products.” On June 14, 2005, we received a grand jury subpoena from the United States Attorney for the Southern District of New York (the “USAO”) seeking information related to our finite reinsurance activities. We have been informed that other insurance industry participants have received similar subpoenas.

We have cooperated with the FOIR, the SEC and the USAO. All of the material reinsurance agreements to which we have been a party have been terminated and settled, and the reinsurers have been released from all future liabilities under the agreements. Inasmuch as the governmental investigations are ongoing and the various regulatory authorities could reach conclusions different from our conclusions concerning the treatment of these transactions that are reflected in our financial statements, it would be premature to reach any conclusions as to the likely outcome of these matters or their potential impact upon us.

We are named as a defendant in a number of class action and individual lawsuits arising in the ordinary course of business, the outcomes of which are uncertain at this time. These cases include those plaintiffs who challenge various aspects of our claims and marketing practices and business operations and seek restitution, damages and other remedies. We plan to contest the outstanding lawsuits vigorously. We believe the current assumptions and other considerations we use to estimate our potential liability for such litigation are appropriate. While it is not possible to know with certainty the ultimate outcome of such lawsuits, based on the facts currently available to us, we believe we have adequately reserved for our existing known litigation and that such litigation will not have a material adverse effect the Company, including, without limitation, on its future results of operations, financial condition or cash flows. In view of the uncertainties regarding the outcome of these lawsuits, as well as the tax-deductibility of any related payments, it is possible that the ultimate cost to us of these lawsuits could exceed the reserves we establish by amounts that would have a material adverse effect on the Company, incuding, without limitation, on its future results of operations, financial condition and cash flows in a particular quarter or year.

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

No matters were submitted to a vote of our stockholders during the quarter ended December 31, 2006.

PART II

Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock, $0.01 par value per share (“Common Stock”), is listed on the New York Stock Exchange (“NYSE”) under the symbol “BRW”. The following table sets forth the high, low, and closing market prices of our Common Stock during each of the four calendar quarters of 2006 and 2005. The high, low and closing prices set forth below are as reported on the NYSE’s consolidated transaction reporting system.

For the quarter ended:	High		Low		Close		Dividends per Share

March 31, 2006	$	20.49	$	17.72	$	19.25	$	0.07
June 30, 2006		19.35		14.75		16.00		0.07
September 30, 2006		16.04		13.68		14.55		0.07
December 31, 2006		16.70		13.53		15.83		0.08

For the quarter ended:	High		Low		Close		Dividends per Share

March 31, 2005	$	21.80	$	14.91	$	15.50	$	0.05
June 30, 2005		18.49		14.76		18.30		0.07
September 30, 2005		19.64		15.80		18.25		0.07
December 31, 2005		19.75		17.12		19.03		0.07

As of February 28, 2007, there were 1,195 registered holders of record of our Common Stock. A significant number of outstanding shares of Common Stock are registered in the name of only one holder, which is a nominee of The Depository Trust Company, a securities depository for banks and brokerage firms.

The table above reflects the frequency and amount of cash dividends that we paid on our Common Stock during 2006 and 2005. We paid $0.29 per common share for a total dividend payout of $8.5 million with respect to our Common Stock during the year ended December 31, 2006 and $0.26 per common share for a total dividend payout of $8.0 million during the year ended December 31, 2005. The declaration and payment of dividends is subject to the discretion of our Board of Directors, and will depend on, among other things, our financial condition, results of operations, capital and cash requirements, future prospects, regulatory and contractual restrictions on the payment of dividends by our subsidiaries, restrictions under our credit facility on our ability to pay dividends to our stockholders and other factors deemed relevant by the Board of Directors. Under the Merger Agreement with Farmers, without Farmer’s prior written consent, the Company is only permitted to pay a regular quarterly dividend with respect to our Common Stock not to exceed $0.08 per share. For a discussion of our cash resources and needs, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.”

We are a holding company without significant operations of our own. Dividends from our subsidiaries are our principal source of funds. Insurance laws limit the ability of our insurance subsidiaries to pay dividends to us. Our non-insurance subsidiaries’ earnings are generally unrestricted as to their availability for the payment of dividends subject to customary state corporate laws regarding solvency. See “Item 1. Regulatory Matters – Regulation of Dividends.” Our subsidiaries also are not permitted to pay dividends without Farmer’s prior written consent. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.”

Securities Authorized for Issuance Under Equity Compensation Plans

The table below shows information with respect to our equity compensation plans and individual compensation arrangements as of December 31, 2006:

Plan Category	Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights		Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights		Number of Securities Remaining Available For Future Issuance (A)

Equity compensation plans approved by security holders:		—		—		—
Equity compensation plans not approved by security holders: ⁽¹⁾		3,011,984	$	4.13		2,378,981


^(A)	Amounts reflected in this column exclude securities reflected in the column entitled “Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights.” The amounts reflected in this column include 2,212,084 shares of Common Stock available for issuance under our 2004 Stock Incentive Plan (the “2004 Plan”) in the form of restricted stock as well as options and other derivative securities convertible into Common Stock that are issuable under the 2004 Plan and Phantom Shares that are issuable under our Non-Employee Directors’ Plan and the 2004 Plan. See Note 10 to the Consolidated Financial Statements included herein.

⁽¹⁾	All outstanding options, warrants and other rights were issued as follows and were not subject to stockholder approval because the Company was privately held until an initial public offering on February 12, 2004:

	^•	Options issued under our 1998 Stock Option Plan for Management and Key Employees (the “1998 Plan”). See Note 10 to the Consolidated Financial Statements included herein.
	^•	Options issued under the 2004 Plan. See Note 10 to the Consolidated Financial Statements included herein.
	^•	Phantom Shares issued under our Non-Employee Directors’ Plan
	^•	Options originally issued to Firemark Partners, LLC, on July 23, 2002, to purchase 521,520 shares of Common Stock at an exercise price of $3.83 per share pursuant to a Services Agreement, dated July 24, 2002. See Notes 8 and 10 to the Consolidated Financial Statements included herein.
	^•	Warrants issued to Inter-Ocean Reinsurance (Ireland) Limited, on July 1, 2001, to purchase 782,280 shares of Common Stock at an exercise price of $3.83 per share. See Note 10 to the Consolidated Financial Statements included herein.
	^•	Options issued to Fisher Capital LLC, from July 9, 1998 to October 1, 2003, to purchase 873,546 shares of Common Stock at an exercise price of $3.83 per share. These options are fully vested. See Note 8 to the Consolidated Financial Statements included herein.
	^•	Options issued to George O’Brien, currently our Senior Vice President-Chief Legal Officer, on April 1, 2003, while he was outside counsel, to purchase 19,557 shares of Common Stock at an exercise price of $3.83 per share. These options are fully vested. See Note 10 to the Consolidated Financial Statements included herein.

Recent Sales of Unregistered Securities

There were no sales of unregistered securities during the year ended December 31, 2006.

Purchases of Equity Securities by the Registrant

The following table contains information about our purchases of our equity securities during the fourth quarter of 2006.

Issuer Purchases of Equity Securities

Period	Total Number of Shares Purchased⁽¹⁾		Average Price Paid per Share		Total Number of Shares Purchased as Part of a Publicly Announced Plan		Approximate Dollar Value that May Yet Be Purchased Under the Plan

December 1 - 31, 2006		916	$	15.96		—		—

Total		916	$	15.96		—		—


⁽¹⁾	The amounts in this column constitute shares of restricted stock withheld to reimburse us for withholding taxes that we paid upon the vesting of restricted stock awarded to employees, at an average price of $15.96 per share, based on the last reported closing price per share of our Common Stock, as reported by the NYSE on the vesting date.

For additional information concerning our capitalization, please see Note 10 to the Consolidated Financial Statements included herein.

Item 6. Selected Financial Data

The following table presents our historical financial and operating data as of the dates or for the periods indicated. We derived the data as of and for each of the five years ended December 31, 2006 from our audited consolidated financial statements. The results of operations for past accounting periods are not necessarily indicative of the results to be expected for any future accounting periods. You should read this summary in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K.

	As of or For the Twelve Months Ended December 31,

	2006			2005			2004			2003			2002

	(dollars in millions, except per share data)
Statement of Operations Data:
Revenues:
Net earned premium	$	581.0		$	595.1		$	325.3		$	274.0		$	241.0
Net investment income		21.4			17.2			9.0			6.7			6.4
Realized gain (loss) on investments, net		0.1			(0.1	)		—			1.2			0.3
Policy service fee revenue		54.7			62.5			74.1			69.2			47.3
Outsourcing servicing fees (a)		—			—			—			0.1			0.9
Other income		3.8			2.9			2.5			1.6			2.0

Total revenues		661.0			677.6			410.9			352.8			297.9

Costs and Expenses:
Losses and loss adjustment expenses incurred		394.1			394.6			219.4			199.7			200.5
Commissions and other underwriting expenses		152.8			154.1			58.4			51.8			42.1
Other operating and general expenses		42.9			40.3			32.6			26.7			19.6
Litigation expense (b)		—			—			—			17.4			14.3
Interest expense		5.7			4.2			3.0			3.1			4.6
Extinguishment of debt		1.3			—			1.6			—			—

Total costs and expenses		596.8			593.2			315.0			298.7			281.1

Income before income taxes		64.2			84.4			95.9			54.1			16.8
Income tax expense		22.1			29.7			34.8			20.6			5.3

Net Income	$	42.1		$	54.7		$	61.1		$	33.5		$	11.5

Balance Sheet Data:
Cash and investments	$	545.0		$	487.3		$	295.1		$	150.5		$	139.9
Total assets		944.6			893.4			1,040.9			777.9			633.1
Reserve for losses and loss adjustment expenses		239.2			221.4			222.3			202.3			157.4
Long-term debt, including current portion		100.0			69.9			73.4			71.5			71.5
Total liabilities		587.8			556.4			718.6			639.1			530.3
Stockholders’ equity		356.8			337.0			322.3			138.7			102.8

Operating Data:
Gross written premium	$	595.0		$	617.9		$	752.9		$	648.2		$	481.8
Net written premium		604.0			653.1			369.0			263.0			236.3

Per Share Data:
Earnings per share - basic	$	1.44		$	1.78		$	1.99		$	1.41		$	0.48
Earnings per share - diluted		1.37			1.70			1.89			1.32			0.48
Book value per share		12.09			11.13			10.11			5.82			4.32

Ratios:
Loss ratio		67.8	%		66.3	%		67.4	%		72.9	%		83.2	%
Expense ratio		23.6	%		21.7	%		4.5	%		2.8	%		4.7	%

Combined ratio		91.4	%		88.0	%		71.9	%		75.7	%		87.9	%


a)	Outsourcing service fees represent fees earned under a contract with Reliance Insurance Company for servicing policies and claims on the run-off of their non-standard automobile insurance business. We entered into this contract in connection with our acquisition of the non-standard automobile operations of Reliance Group Holdings in April 2001. These fees do not represent a recurring source of income.

b)	Litigation expense represents expense associated with the settlements of certain class action lawsuits.

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

We have derived the following discussion and analysis of the results of operations for the three years ended December 31, 2006, and our financial condition as of each year-end, from the consolidated financial statements included elsewhere in this document. You should read this discussion and analysis in conjunction with such financial statements.

Overview

We derive our revenues principally from the following:

	•	net premiums earned, which comprises the premiums we earn from sales of automobile insurance policies less those premiums that we cede to reinsurers;

	•	net investment income we earn on our invested assets;

	•	policy service fee revenues, which are composed primarily of policy origination fees and installment fees billed to our policyholders; and

	•	other income, which primarily represents commission income we earn for producing insurance policies written by an unrelated policy issuing county mutual insurance company in Texas, which policies we reinsure through a quota share reinsurance agreement.

	Our expenses consist predominately of the following:

	•	losses and LAE, including estimates for losses and LAE incurred during the period and changes in estimates from prior periods, less the portion of those insurance losses and LAE that we ceded to reinsurers;

	•	commissions and other underwriting expenses, which consist of commissions we pay to agents and brokers, premium taxes and Company expenses related to the production and underwriting of insurance policies, less ceding commissions that we receive under our reinsurance contracts;

	•	other operating and general expenses, which include general and administrative expenses, depreciation and other expenses; and

	•	interest expense on debt.

The Merger Agreement with Farmers

On March 1, 2007, we entered into a Merger Agreement with Farmers Group, Inc. pursuant to which BWH Acquisition Company, a wholly owned subsidiary of Farmers (“Merger Sub”), will be merged with and into the Company, with the Company continuing as the surviving corporation and becoming a wholly-owned subsidiary of Farmers. Pursuant to the Merger Agreement, at the effective time and as a result of the Merger, each then outstanding share (each a “Share”) of Common Stock, including restricted stock (which vests upon a change in control), will be cancelled and converted into the right to receive $22.50 in cash per Share, without interest (the “Merger Consideration”). Each share of Common Stock that is subject to a then outstanding option and warrant that is vested or vests upon a change in control will be converted into the right to receive the Merger Consideration less the exercise price per Share for the option and warrant. Each Phantom Share under our Non-Employee Directors’ Plan also will be converted into the right to receive the Merger Consideration. Consummation of the Merger is subject to various customary closing conditions, including, but not limited to, (1) the expiration or termination of applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, (2) all insurance antitrust approvals and regulatory approvals from certain insurance departments, (3) absence of certain orders preventing the Merger, and (4) the approval of the Merger Agreement by our stockholders. We currently expect the Merger to close before the end of 2007.

Products and Services

We continuously monitor the profitability of our business at a highly detailed level. We seek rate changes based on indicated profitability related to our targets. We believe we can continue to improve our product structure by filing class plan changes that lower rates for certain market segments that produce favorable results relative to our average in a given state and raise rates for other poorer performing segments. We modified rates 64 times in 2006. Eighteen of such modifications were increases, 19 were revenue neutral, 14 were decreases, and 13 were new product introductions. The overall effect of these modifications was an increase to our overall rate level by 1.1%.

In the aggregate, we utilized point-of-sale underwriting to process over 99% of our new business applications in 2006. We have fully deployed OneStep, our browser-based point-of-sale underwriting system, in 12 states for both new business and endorsements.

We have an exclusive license to use OneStep in the non-standard automobile insurance industry through December 2009. OneStep and OneStep Raptor use technology to provide fast and accurate quotes by accessing third-party information at the point of sale, including an applicant’s driving record, accident history and, where permitted by law, credit reports. This process reduces the frequency of uprates (increases in premiums after issuance) which may occur when an application is incomplete or inaccurate. Our point-of-sale application systems permit the producer to print the policy, the identification cards and, in certain cases, the policy declaration page, once the verifications are complete, usually within minutes.

We are in the process of deploying a new more segmented point-of-sale product called Select 2.0. We designed this product to be broadly competitive. We have used advanced statistical techniques, most significantly Generalized Linear Models (“GLMs”), to create a new rating algorithm. GLMs are a family of regressions in which different distributions can be examined to determine which is most predictive. Additionally, we are employing our own proprietary credit model and vehicle symbol set in the rating process. During 2006, we launched the Select 2.0 product in 12 states, including six states during the fourth quarter. Preliminary results indicate that the product has been well received. In the 12 states in which we deployed the product, our aggregate written premium in 2006 increased 13% to $307.8 million compared to $273.0 million in 2005. By mid-2007, we expect to have introduced Select 2.0 in 20 of the 22 states in which we operate. We cannot deploy Select 2.0 in California because of regulatory constraints, and in Georgia, we believe that it will take longer to obtain regulatory approval. We are satisfied with this product’s performance to date.

Distribution and Marketing

Increasing the number of producers with which we do business is one important aspect of our growth strategy. We attempt to target producers in geographic areas where we are under-represented and where we believe we can write profitable business. During 2006, we increased our total number of producers to 9,141 and our total number of producer locations to 12,391. This compares to 8,701 producers and 11,674 producer locations as of September 30, 2006, and 7,720 producers and 10,361 producer locations as of December 31, 2005. The following table displays our producer representation in our top five states and in all of our other states collectively as of December 31, 2006 and December 31, 2005.

	Producers				Producer Locations

State	December 31, 2006		December 31, 2005		December 31, 2006		December 31, 2005

California		1,612		1,099		2,426		1,896
Florida		1,572		1,289		2,045		1,582
Michigan		630		601		911		813
Texas		937		841		1,499		1,318
South Carolina		399		372		449		416
All Other		3,991		3,518		5,061		4,336

Totals		9,141		7,720		12,391		10,361

Policies-in-Force

The number of policies in force is a significant driver of our gross earned premium. The table below shows our average number of policies in force and gross earned premium for the years ended December 31, 2006, 2005 and 2004.

	Twelve Months Ended December 31,						% Change 2006			% Change 2005

	2006		2005		2004

	(in thousands)
Average number of policies in force		406.5		446.1		487.7		-8.9	%		-8.5	%
Gross earned premium	$	590,719	$	646,944	$	695,605		-8.7	%		-7.0	%

The average number of policies in force for 2006 decreased by 8.9% compared to 2005 consistent with a decline in gross earned premium of 8.7% over the same period. Similarly, the average number of policies in force for 2005 declined by 8.5% compared to 2004, while gross earned premium declined by 7.0% over the same period. At December 31, 2006, we had approximately 414,000 policies in force compared to approximately 406,000 at December 31, 2005, an increase of 2.0%, and approximately 481,000 at December 31, 2004, a decrease of 15.6%.

Overall, average daily new business production in 2006 was stable compared to 2005 with less than 1% growth. However, average daily new business production began to improve significantly in the fourth quarter of 2006 with 23% growth compared to the fourth quarter of 2005. For the month of January 2007, we continued to see growth in average daily new business production, which increased 33% compared to January 2006 and 17% compared to the quarter ended December 31, 2006. Growth in new business is one component of gross written premium. Other components include renewal premium, rewrite premium, and positive endorsement premium, which increase our written premium, as well as cancellations, negative endorsement premium, and non-renewals, which reduce our written premium. The performance of these other components relative to prior periods, known as persistency, has a significant impact on our written and earned premium. In addition, new business production is a policy count metric. Average premium per policy also plays a large role in determining gross written premium. As an example, in California, we write predominantly twelve-month policies, which have twice the average premium of a six-month policy. An increase in twelve-month policies, or any higher average premium policy, would increase gross written premium, and a move to six-month polices, which we predominantly write in states other than California, would depress gross written premium, all other factors being equal.

We continue to emphasize productivity and efficiency by closely managing our staffing levels in relation to transaction volume in our claims and policy service divisions. At December 31, 2006, our staff count was 1,154 compared to 1,164 at September 30, 2006 and 1,213 at December 31, 2005. We employ various metrics to evaluate service performance so that we may ensure that service levels are meeting or exceeding our benchmarks.

Operating Results – Key States

Market conditions in the states in which we operate are competitive to varying degrees. We monitor the rate and underwriting activity of the other market participants in each state in which we do business. During the fourth quarter of 2006, we tracked 322 rate revisions by companies we monitor as detailed in the table below.

	Three months ended December 31, 2006

State	Increases		Decreases		Revenue-neutral		Total

California		4		9		99		112
Florida		17		7		22		46
Michigan		—		—		1		1
Texas		2		6		5		13
South Carolina		—		—		1		1
All Other		29		30		90		149

Total Rate Changes		52		52		218		322

Some companies with which we compete, primarily in California, do not verify certain underwriting information, which has the effect of lowering the premium they charge, and thus attracting more business. In addition, in California and in other states, some companies with which we compete pay incentives to agents and brokers, such as contingent commissions. Also, some competitors spend significant sums on national and local advertising. In all of our markets, we have not relaxed our underwriting standards, we do not pay incentives to agents and brokers, and we do not spend significantly on consumer advertising. In the fourth quarter of 2006, we began to observe a reversal of some of these trends and, as a result, our gross written premium for the quarter ended December 31, 2006 declined by only 4.5% compared to the same quarter of 2005, our best performance of the year.

One of our objectives is to increase our geographic diversification over time. Although California continues to be our largest state, our mix of premium writings has become more geographically diverse. For the year ended December 31, 2006, we derived 40% of our gross written premium from California compared to 46% for the year ended December 31, 2005. California, Florida and Michigan collectively accounted for 70% of our gross written premium for the year ended December 31, 2006, down from 75% for the year ended December 31, 2005. We also look to enter new large non-standard markets with favorable regulatory environments.

Gross written premium by state and in the aggregate before and after the change in the provision for cancellations for the years ended December 31, 2006, 2005, and 2004 are presented below.

	Twelve Months Ended December 31,						% Change 2006			% Change 2005

State	2006		2005		2004

	(dollars in millions)
California	$	239.5	$	277.4	$	396.2		-13.7	%		-30.0	%
Florida		106.0		91.2		100.8		16.2	%		-9.5	%
Michigan		70.3		83.5		71.9		-15.8	%		16.1	%
Texas		31.0		22.5		16.7		37.8	%		34.7	%
South Carolina		28.8		20.2		17.4		42.6	%		16.1	%
Pennsylvania		23.9		18.0		15.2		32.8	%		18.4	%
New Hampshire		13.5		15.7		12.9		-14.0	%		21.7	%
Colorado		12.0		7.4		4.7		62.2	%		57.4	%
Maine		11.8		14.1		13.2		-16.3	%		6.8	%
Virginia		10.9		9.1		11.4		19.8	%		-20.2	%
All other (includes 12 states)		45.4		39.9		46.1		13.8	%		-13.4	%

Gross written premium, before change in expected policy cancellation provision	$	593.1	$	599.0	$	706.5		-1.0	%		-15.2	%
Change in expected policy cancellation provision		1.9		18.9		46.3		n/m			n/m

Gross written premium	$	595.0	$	617.9	$	752.8		-3.7	%		-17.9	%

Changes in gross written premium, as detailed above, vary significantly by state and are influenced by a variety of factors, including competitive conditions and regulatory environments within each state, our strategies with respect to product pricing, and changes in the number and location of producers. In the aggregate, our gross written premium decreased by 4% in 2006 compared to 2005. Included in these figures is a change in the provision for expected policy cancellations that increased gross written premium by less than 1% in 2006, by 3% in 2005, and by 6% in 2004. We provide for expected policy cancellations in order to adjust written premium to amounts we expect to ultimately collect and earn. Because the cancellation provision adjusts our unearned premium for amounts we expect will not be collected, the changes in the provision are impacted by changes to both the rate of cancellations and the unearned premium reserve. Our cancellation experience has steadily improved in the last three years. The rate of expected cancellation declined to 20.7% as of December 31, 2006 compared to 21.7% as of December 31, 2005 and 24.7% as of December 31, 2004. Decreases to the provision added $1.9 million, $18.9 million and $46.3 million to gross written premium during 2006, 2005 and 2004.

In California, gross written premium declined by 14% in 2006 and by 30% in 2005 due to continued competitive market conditions in this state. In our other states, in the aggregate, our gross written premium grew by 10% in 2006 and by 4% in 2005. While our competitors’ rates, as filed, remain stable, some have relaxed underwriting standards by not verifying miles driven, driving experience, or other underwriting information, which can significantly affect policy premiums. This practice has resulted in lower policy premiums for some drivers, making it more difficult for companies not engaging in such practices to attract new customers and retain those that seek alternative quotes at renewal. We have not relaxed our underwriting standards and do not intend to do so in the future. Recent California regulations require auto insurers to implement procedures to verify annual mileage.

In Florida, our second largest state, gross written premium grew by 16% in 2006, following a decline of 10% in 2005. On August 1, 2006, we deployed our Select 2.0 product in Florida. (See “Overview – Products and Services” above.) We attribute much of the premium growth in Florida during 2006 to the introduction of this new product. Most agents in Florida use third party software that compares rates and, as a result, our new program became available very broadly and very quickly. We continue to observe signs that the rates in the Florida market are firming. As detailed in the table above, these revisions continue the trend of rate increases outnumbering rate decreases among competitors’ rate filings that we first noted during the fourth quarter of 2005.

In Michigan, our third largest state, gross written premium declined by 16% in 2006 and grew by 16% in 2005. We attribute the decline in volume in 2006 principally to rate increases that we implemented in January and April 2006 in response to increasing severity of personal injury protection (“PIP”) claims in Michigan. On October 30, 2006, we introduced our Select 2.0 product in Michigan. (See “Overview – Products and Services” above.) Most agents in Michigan do not use third party software that compares rates, resulting in a slower roll-out of the product in this state. Nevertheless, we have begun to see early indications that the product is making inroads into the marketplace, as processed written premium grew slightly in December 2006 to $5.9 million compared to $5.8 million in December 2005.

In Texas, gross written premium grew by 38% in 2006 and by 35% in 2005. In June 2006, we introduced our Select 2.0 product in Texas. (See “Overview – Products and Services” above.) The new product has been well received, as much of the premium growth in 2006 came in the latter half of the year.

In South Carolina, gross written premium grew by 43% in 2006 and by 16% in 2005. We introduced our Select 2.0 product in South Carolina in September 2006. (See “Overview – Products and Services” above.) Since we introduced this product, we have seen an increase in the growth rate of our premium writings in this state.

The table below shows our gross written premium by state and quarter for the twelve months ended December 31, 2006:

	Three Months Ended								Twelve Months Ended December 31, 2006

State	March 31, 2006		June 30, 2006		September 30, 2006		December 31, 2006

	(dollars in millions)
California	$	68.7	$	60.2	$	55.7	$	54.9	$	239.5
Florida		25.3		22.7		26.9		31.1		106.0
Michigan		19.5		17.6		17.1		16.1		70.3
Texas		6.1		5.9		10.0		9.0		31.0
South Carolina		6.6		5.4		6.7		10.1		28.8
Pennsylvania		5.9		7.2		6.0		4.8		23.9
New Hampshire		3.9		3.5		3.3		2.8		13.5
Colorado		2.1		2.7		3.4		3.8		12.0
Maine		3.3		3.0		3.1		2.4		11.8
Virginia		3.0		3.0		2.6		2.3		10.9
All other (includes 12 states)		12.1		10.9		11.2		11.2		45.4

Gross written premium, before change in expected policy cancellation provision	$	156.5	$	142.1	$	146.0	$	148.5	$	593.1
Change in expected policy cancellation provision		0.7		1.1		0.1		—		1.9

Gross written premium	$	157.2	$	143.2	$	146.1	$	148.5	$	595.0

Results of Operations

Twelve Months Ended December 31, 2006 compared to Twelve Months Ended December 31, 2005

Revenues

The following table shows the gross and ceded written and earned premium for the twelve months ended December 31, 2006 and 2005.

	Twelve Months Ended December 31,

	2006			2005

	(dollars in thousands)
Gross written premium	$	594,964		$	617,873
Ceded written premium:
Other reinsurance		9,205			71,052
Effect of reinsurance commutation		(18,287	)(1)		(106,310	)(2)

Total ceded written premium		(9,082	)		(35,258	)

Net Written Premium	$	604,046		$	653,131

% Ceded, excluding effect of reinsurance commutation		1.5	%		11.5	%

Gross Earned Premium	$	590,719		$	646,944
Ceded Earned Premium		9,657			51,872

Net Earned Premium	$	581,062		$	595,072

% Ceded		1.6	%		8.0	%

(1) Amount represents the unearned premium previously ceded under our 2005 quota share resinsurance agreement, which we received as a result of the termination and commutation of this agreement.

(2) Amount represents the unearned premium previously ceded under our 2002-2004 quota share reinsurance agreement, which we received as a result of the termination and commutation of this agreement.

Gross Written Premium. Gross written premium declined to $595.0 million for the twelve months ended December 31, 2006, or by 4%, compared to $617.9 million for 2005. The decline in gross written premium emanated primarily from California where written premium fell by $37.9 million, or 14%, for the twelve months ended December 31, 2006 compared to 2005. Our gross written premium in the other states in which we do business was higher in the aggregate by 10% for the twelve months ended December 31, 2006 compared to 2005. We provide for expected policy cancellations in order to adjust written premium to amounts we expect to ultimately collect and earn. (See “Operating Results – Key States” above.) We reduced the provision by $1.9 million in 2006, which added less than 1% to our reported gross written premium, and by $18.9 million in 2005, which added 3% to our reported gross written premium.

Net Written Premium. Net written premium declined by 8% to $604.0 million for the twelve months ended December 31, 2006 from $653.1 million for 2005. The decrease resulted primarily from the termination of quota share reinsurance agreements during the first quarters of both 2006 and 2005. Upon termination of the quota share reinsurance agreements, we “recaptured” the previously ceded unearned premium, which added to our net written premium. We recaptured $18.3 million in the first quarter of 2006 compared to $106.3 million in the first quarter of 2005, a decrease of $88.0 million. In addition, net written premium for the twelve months ended December 31, 2005 was reduced by $60.8 million ceded premium pursuant to a 10% quota share reinsurance agreement in place during that time. We had no quota share reinsurance agreement in effect during 2006.

Net Earned Premium. Net earned premium declined by 2% to $581.1 million for the twelve months ended December 31, 2006 from $595.1 million for 2005. Net earned premium for the twelve months ended December 31, 2005 included a reduction of $42.5 million for premium ceded pursuant to a 10% quota share reinsurance agreement. We had no quota share reinsurance agreement in effect during 2006. Net earned premium, excluding the effect of the 2005 quota share reinsurance, decreased by $56.5 million, or 9%, for the twelve months ended December 31, 2006 compared to 2005, which is consistent with the decline in gross earned premium of 9% for the same period.

Net Investment Income and Realized Gains and Losses on Investments. Net investment income increased by 25% to $21.5 million for the twelve months ended December 31, 2006 compared to $17.2 million for 2005. The tax equivalent book yield of our fixed maturity portfolio increased to 4.96% at December 31, 2006 from 4.52% at December 31, 2005. For the twelve-month period, approximately $2.4 million of the increase in net investment income was due to the larger size of the investment portfolio, and approximately $1.9 million related to a higher investment portfolio yield.

Net realized gains and losses on securities sales were insignificant for the twelve months ended December 31, 2006 and 2005.

Policy Service Fee Revenue. Policy service fee revenue declined by 12% to $54.7 million for the twelve months ended December 31, 2006 compared to $62.5 million for 2005. Policy fee income generally correlates with gross earned premium. Gross earned premium was lower by 9% for the twelve months ended December 31, 2006. Our fee income as a percentage of gross earned premium declined to 9.3% for the twelve months ended December 31, 2006 from 9.7% for the twelve months ended December 31, 2005. The decline is mostly attributable to a 14% decline in 2006 gross written premium in California, where our fees are higher than for the rest of our business on average, and decreases in our installment fees. A greater percentage of our customers are signing up for electronic funds transfer (“EFT”) payment plans, on which we charge lower installment fees. The EFT business is more persistent, produces lower losses and is less expensive to administer. The portion of our policyholders who utilize EFT increased to 16% for 2006 compared to 7% for 2005.

Costs and Expenses

Losses and LAE Incurred. Losses and LAE incurred declined to $394.1 million for the twelve months ended December 31, 2006 compared to $394.6 million for 2005. Our loss ratio increased by 1.5 points to 67.8% for 2006 from 66.3% for 2005.

The following table displays our incurred losses and LAE related to the current accident year (losses and LAE occurring in the current fiscal year) and prior accident years (losses and LAE recognized in the current fiscal year related to accidents which took place in a prior fiscal year).

	Twelve Months Ended December 31,

	2006			2005

	(dollars in thousands)
Losses and LAE incurred - current accident year	$	388,781		$	394,597
Losses and LAE incurred - prior accident years		5,293			9

Total losses and LAE incurred	$	394,074		$	394,606

Loss ratio - current accident year		66.9	%		66.3	%
Loss ratio - prior accident years		0.9	%		0.0	%

Total loss ratio		67.8	%		66.3	%

The increase in the loss ratio was primarily attributable to an increase in adverse development on loss and LAE reserves for prior years, which was $5.3 million in 2006 compared to an insignificant amount in 2005, or 0.9 points of the increase. Adverse development occurs when loss and LAE reserves established for accidents that took place in years prior to the current year prove to be inadequate and management increases those reserves to reflect the revised estimate of the ultimate losses related to such accidents. Such increases result in a charge to loss and LAE incurred in the current year. The remainder of the increase in the loss ratio is attributed to a 0.6 point increase in the current accident year loss ratio, which is principally due to an increase in our LAE ratio. The LAE ratio has increased as premium volume has declined because a portion of our claims department’s costs are fixed or semi-fixed and cannot be adjusted immediately in response to changes in volume.

Commissions and Other Underwriting Expenses. Commissions and other underwriting expenses declined to $152.8 million for the twelve months ended December 31, 2006 compared to $154.0 million for 2005. This category of expenses includes producers’ commissions, premium taxes and Company expenses that relate to the production of and vary with premium, reduced by ceding commission income.

The following table provides detail of our commissions and other underwriting expenses before and after reinsurance.

	Twelve Months Ended December 31,

	2006			2005

	(dollars in thousands)
Gross commissions	$	87,700		$	95,371
Premium tax expense		12,272			14,564
Other underwriting expenses		52,751			56,400

Gross expenses		152,723			166,335

Ceding commissions		(102	)		12,295

Commissions and other underwriting expenses	$	152,825		$	154,040

Gross expense ratio		23.2	%		21.8	%
Net expense ratio		23.6	%		21.7	%

Commissions and other underwriting expenses for the twelve months ended December 31, 2005 were reduced by ceding commission income of $12.3 million pursuant to a 10% quota share reinsurance agreement. We had no quota share reinsurance agreement in effect during 2006. Commissions and other underwriting expenses, excluding the effect of reinsurance, declined by 8% to $152.7 million from $166.3 million for the twelve months ended December 31, 2006 compared to 2005, which is consistent with the decline in gross earned premium of 9% for the same period.

Other Operating and General Expenses. Other operating and general (“G&A”) expenses were $42.9 million for the twelve months ended December 31, 2006 compared to $40.3 million for 2005, an increase of $2.6 million. Costs associated with governmental investigations concerning our reinsurance agreements added $2.7 million before taxes during the twelve months ended December 31, 2005, while we incurred an insignificant amount of such expenses in 2006. G&A expenses, excluding the expenses related to such regulatory inquiries in 2005, increased by $5.3 million for the twelve months ended December 31, 2006, compared to 2005. The most significant factor contributing to this growth was a change in the allocation of total Company expenses between commissions and other underwriting (“Underwriting”) expenses and G&A expenses. We conduct a periodic review of the allocation of total Company expenses between such categories based upon the mix of activities performed by our various departments. Based on our latest study, we allocated a higher proportion of total Company expenses to G&A expenses and a smaller proportion to Underwriting expenses than we did for the same periods of 2005. Total Company expenses, excluding the expenses related to such regulatory inquiries in 2005, changed insignificantly for the twelve months ended December 31, 2006 compared to 2005.

Interest Expense. Interest expense was $5.7 million for the twelve months ended December 31, 2006 compared to $4.2 million for 2005, an increase of $1.5 million. The increase in interest expense is primarily attributable to the refinancing of our credit facility on July 31, 2006, which increased the amount of our term loan to $100.0 million. In addition, increasing interest rates also contributed to the increase in interest expense. The interest on our credit facility debt is variable and is tied to the London Interbank Offered Rate (“LIBOR”). The average LIBOR rate was higher during the twelve months ended December 31, 2006 than in 2005. The aggregate weighted average interest rate we incurred was 6.5% during the twelve months ended December 31, 2006 compared to 5.0% during 2005. As of December 31, 2006, we had $100.0 million of outstanding credit facility debt as compared to $69.9 million as of December 31, 2005.

Extinguishment of Debt. We refinanced our credit facility, repaid the pre-existing term loan, and increased the amount of our term loan on July 31, 2006. We incurred a non-recurring non-cash pre-tax charge of $1.3 million during the twelve months ended December 31, 2006, resulting from the write-off of the unamortized portion of the deferred financing costs associated with the debt that was repaid.

Income Taxes. Income taxes for the twelve months ended December 31, 2006 were $22.1 million, or 34.4% of income before income taxes. This effective tax rate of 34.4% comprises 31.78% federal income taxes and 2.62% state income taxes. Income taxes for the twelve months ended December 31, 2005 were $29.7 million, or 35.17% of income before income taxes. This effective tax rate of 35.17% comprises 33.55% federal income taxes and 1.62% state income taxes.

Ratios. The table below displays the key components of the combined ratio:

	Twelve months ended December 31,

	2006			2005

Loss ratio		67.8	%		66.3	%

Direct commission ratio		15.1	%		16.1	%
Ceding commission (income) ratio		0.0	%		-2.1	%
Underwriting expense ratio		11.2	%		11.9	%
Other operating and general expense ratio		7.4	%		6.8	%
Fee and other (income) ratio		-10.1	%		-11.0	%

Net expense ratio		23.6	%		21.7	%

Combined ratio		91.4	%		88.0	%

Our combined ratio was 91.4% for the twelve months ended December 31, 2006 compared to 88.0% for 2005, an increase of 3.4 points. For the twelve-month period, the loss ratio increased 1.5 points (see “Losses and LAE Incurred” above) and the expense ratio increased 1.9 points. Approximately 2.1 points of the increase in the expense ratio was attributed to the absence of ceding commission income for the twelve months ended December 31, 2006 compared to 2005. In addition, 0.9 points of the increase in the expense ratio was due to lower fee and other income during the twelve months ended December 31, 2006 compared to 2005. These increases in the expense ratio were mitigated by a decrease in the direct commission ratio of 1.0 points.

The table below displays our gross, ceded, and net underwriting results, as well as the related gross, ceded and net loss, expense and combined ratios:

	Twelve Months Ended December 31,

	2006			2005

Underwriting Results Before Reinsurance
Revenues
Gross earned premium	$	590,719		$	646,944

Expenses
Losses and loss adjustment expenses incurred		420,369			431,791
Commissions		87,700			95,371
Other underwriting expenses		65,023			70,964
Other operating and general expenses		42,908			40,297

Total underwriting expenses		616,000			638,423

Gross underwriting result		(25,281	)		8,521
Policy service fee revenue and other income		58,480			65,395

Pretax underwriting income	$	33,199		$	73,916

Gross loss ratio		71.2	%		66.7	%
Gross expense ratio		23.2	%		21.8	%

Gross combined ratio		94.4	%		88.5	%

Reinsurance Ceded Results
Revenues
Ceded earned premium	$	9,657		$	51,872

Expenses
Ceded losses and loss adjustment expenses incurred		26,295			37,185
Ceding commissions		(102	)		12,295

Total underwriting expenses		26,193			49,480

Ceded underwriting (loss) income	$	(16,536	)	$	2,392

Ceded loss ratio		272.3	%		71.7	%
Ceded expense ratio		-1.1	%		23.7	%

Ceded combined ratio		271.2	%		95.4	%

Net Underwriting Results
Revenues
Net earned premium	$	581,062		$	595,072

Expenses
Net losses and loss adjustment expenses incurred		394,074			394,606
Commissions - net of reinsurance		87,802			83,076
Other underwriting expenses		65,023			70,964
Other operating and general expenses		42,908			40,297

Total underwriting expenses		589,807			588,943

Net underwriting result		(8,745	)		6,129
Policy service fee revenue and other income		58,480			65,395

Pretax underwriting income	$	49,735		$	71,524

Net loss ratio		67.8	%		66.3	%
Net expense ratio		23.6	%		21.7	%

Net combined ratio		91.4	%		88.0	%

Twelve Months Ended December 31, 2005 compared to Twelve Months Ended December 31, 2004

Revenues

The following table shows the gross and ceded written and earned premium for the twelve months ended December 31, 2005 and 2004.

	Twelve Months Ended December 31,

	2005			2004

	(dollars in thousands)
Gross written premium	$	617,873		$	752,859

Ceded written premium:
Quota share reinsurance and other		71,052			383,848
Effect of reinsurance commutation		(106,310	)*		—

Total ceded written premium		(35,258	)		383,848

% Ceded, excluding effect of reinsurance commutation		11.5	%		51.0	%

Gross earned premium	$	646,944		$	695,605
Ceded earned premium		51,872			370,284
% Ceded		8.0	%		53.2	%

* Amount represents the unearned premium previously ceded under our 2002-2004 quota share reinsurance agreement, which we received as a result of the termination and commutation of this agreement.

Gross Written Premium. Gross written premium decreased to $617.9 million for the twelve months ended December 31, 2005, or by 18%, compared to $752.9 million for 2004. The decline in gross written premium emanated primarily from California where written premium declined by 30% for the year. Generally, we observed increasingly competitive conditions during 2005 in the states where we did business. Because we exercised underwriting and pricing discipline, we saw our volume of business decline in several states, most notably, California and Florida, and grow more slowly in many other states compared to 2004. We provide for expected policy cancellations in order to adjust written premium to amounts we expect to ultimately collect and earn. (See “Operating Results – Key States” above.) During 2005, we reduced the provision by $18.9 million, which added 3% to our reported gross written premium for the year.

Net Written Premium. Net written premium increased by 77% to $653.1 million for the twelve months ended December 31, 2005 from $369.0 million for the comparable period of 2004. Of the increase in net written premium, $313.2 million was due to the reduction in the cession percentage to 10% for 2005 business from 50% for 2004 business and $106.3 million was due to the termination and commutation of our 2002-2004 quota share reinsurance agreement effective January 1, 2005. As of January 2006, all of the material reinsurance agreements to which we had been a party had been terminated and commuted, and the reinsurers had been released from all future liabilities under the agreements. See “Business – Reinsurance” above.

Net Earned Premium. Net earned premium increased by 83% to $595.1 million for the twelve months ended December 31, 2005 from $325.3 million for the comparable period of 2004. Gross earned premium was down by 7% and our premium retention increased to 92% from 47% as a result of the reduction in the ceding percentage under our quota share reinsurance agreement. We had a quota share reinsurance agreement in 2004 under which we ceded 50% of 2004 policy premium; for 2005, we had a quota share reinsurance agreement under which we ceded 10% of 2005 policy premium.

Net Investment Income and Realized Losses and Gains on Investments. Net investment income was $17.2 million for the twelve months ended 2005 compared to $9.0 million for the same period of 2004. Most of the increase was attributable to a larger invested asset base on average during 2005 compared to 2004. Our initial public offering, which we completed in February 2004, provided $113.4 million of net proceeds and the termination and commutation of our 2002-2004 quota share reinsurance agreement resulted in our receipt of $196.6 million in January 2005. Excluding the proceeds from the reinsurance termination, cash flow from operations aggregated $56.3 million for the twelve months ended December 31, 2005 compared to $45.9 million for the twelve months ended December 31, 2004. The increased cash flow also contributed to the growth in invested assets and increased net investment income. The average pre-tax equivalent investment yield on our investment portfolio increased to 4.52% as of December 31, 2005 from 4.30% as of December 31, 2004.

Net realized gains and losses on securities sales were insignificant for the twelve months ended December 31, 2005 and 2004.

Policy Service Fee Revenue. Policy service fee revenue for the twelve months ended December 31, 2005 was $62.5 million, equivalent to 10% of gross earned premium, compared to $74.1 million, equivalent to 11% of gross earned premium, for the same period of 2004. The most prominent factor affecting our level of fee income was the decline in our average policies in force. As noted above, the ratio of fees to gross earned premium declined by 1 point, indicating that on a per policy basis, we are collecting lower fees on average than in the prior year. Approximately 40%, or 0.4 points, of the decline was due to a 30% decline in 2005 gross written premium in California where the level of fees charged has been greater related to premiums than in the other states in which we operate. While approximately 20% of new business was written on electronic funds transfer (“EFT”) payment plans in the last quarter of 2005, and we charged approximately 50% lower installment fees on installments paid by EFT, this was not a significant factor in the lower fee ratio for the full year, accounting for less than 25%, or 0.25 points, of the decline.

Costs and Expenses

Losses and LAE Incurred. Losses and LAE incurred increased to $394.6 million for the twelve months ended December 31, 2005 compared to $219.4 million for the same period of 2004. Our loss ratio improved 1.1 points to 66.3% for 2005 from 67.4% for 2004.

	Twelve Months Ended December 31,

	2005			2004

	(dollars in thousands)
Losses and LAE incurred - current accident year	$	394,597		$	216,845
Losses and LAE incurred - prior accident years		9			2,513

Total losses and LAE incurred	$	394,606		$	219,358

Loss ratio - current accident year		66.3	%		66.6	%
Loss ratio - prior accident years		0.0	%		0.8	%

Total loss ratio		66.3	%		67.4	%

The decline in the loss ratio was primarily attributable to a reduction in adverse development on loss and LAE reserves for prior years, which was an insignificant amount in 2005 down from $2.5 million in 2004, or 0.8 points of the improvement. The remainder of the decrease in the loss ratio was due to a 0.3 point improvement in our claims experience for accident year 2005 compared to 2004. This improvement occurred despite $2.5 million of pre-tax losses related to Hurricanes Katrina, Rita and Wilma during the twelve months ended December 31, 2005 compared to $1.0 million of pre-tax losses related to Hurricanes Charley, Frances, Ivan and Jeanne during the twelve months ended December 31, 2004.

Commissions and Other Underwriting Expenses. Commissions and other underwriting expenses increased to $154.0 million for the twelve months ended December 31, 2005 compared to $58.4 million for the twelve months ended December 31, 2004, an increase of $95.6 million, or 164%. This category of expenses includes producers’ commissions, premium taxes and company expenses that relate to the production of and vary with premium, reduced by ceding commission income. Most of the increase was the result of the large decrease in the ceding percentage under our quota share agreements, which, in turn, reduced ceding commission income. During the twelve months ended December 31, 2005, we ceded 8% of our gross earned premium compared to 53% for the comparable period of 2004.

The following table provides detail of our commissions and other underwriting expenses before and after reinsurance.

	Twelve Months Ended December 31,

	2005			2004

	(dollars in thousands)
Gross commissions	$	95,371		$	106,695
Premium tax expense		14,564			15,681
Other underwriting expenses		56,400			48,527

Gross expenses		166,335			170,903

Ceding commissions		12,295			112,475

Commissions and other underwriting expenses	$	154,040		$	58,428

Gross expense ratio		21.5	%		18.1	%
Net expense ratio		21.3	%		4.1	%

The decrease in premium taxes from 2004 to 2005 was the result of the decline in gross earned premiums. The premium tax rate was little changed between years.

The change in deferred acquisition costs related to Company expenses contributed $4.8 million of the increase in other underwriting expenses. Net amortization was $3.8 million during the twelve months ended December 31, 2005 compared to net capitalization of $1.0 million during the twelve months ended December 31, 2004.