As filed with the Securities and Exchange Commission on February 5, 2010

Registration No. 333-150864

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Amendment No. 12

Form S-1

REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

Patriot Risk Management, Inc.

(Exact name of registrant as specified in its charter)


Delaware	6331	73-1665495
(State or other jurisdiction of incorporation or organization)	(Primary Standard Industrial Classification Code Number)	(I.R.S. Employer Identification No.)

401 East Las Olas Boulevard, Suite 1540

Fort Lauderdale, Florida 33301

(954) 670-2900

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

Steven M. Mariano

Chairman, President and Chief Executive Officer

401 East Las Olas Boulevard, Suite 1540

Fort Lauderdale, Florida 33301

(954) 670-2900

(Name, address, including zip code, and telephone number, including area code, of agent for service)

Copies to:


J. Brett Pritchard Christopher A. Pesch Locke Lord Bissell & Liddell LLP 111 South Wacker Drive Chicago, Illinois 60606 (312) 443-0700		John J. Sabl Beth Flaming Sidley Austin LLP One South Dearborn Street Chicago, Illinois 60603 (312) 853-7000

Approximate date of commencement of proposed sale to the public: As soon as practicable after the Registration Statement becomes effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. o

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o

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


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

(Do not check if a smaller reporting company)

CALCULATION OF REGISTRATION FEE

Proposed Maximum

Amount of

Title of Each Class of

Amounts to be

Aggregate Offering

Aggregate

Registration

Securities to be Registered

Registered(1)

Price per Share

Offering Price(1)(2)

Fee(3)

Common Stock, par value $0.001 per share

24,380,000

$8.00

$195,040,000

$16,726.98


(1)		Includes amount attributable to shares of common stock issuable upon the exercise of the underwriters’ over-allotment option.

(2)		Estimated solely for the purpose of calculating the amount of the registration fee in accordance with Rule 457(o) under the Securities Act of 1933, as amended.

(3)		Previously paid.

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

The information in this prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

SUBJECT TO COMPLETION, DATED FEBRUARY 5, 2010

PRELIMINARY PROSPECTUS

21,200,000 Shares

Common Stock

We are offering 21,200,000 shares of our common stock in this firm commitment underwritten public offering. This is our initial public offering. We anticipate that the initial public offering price of our common stock will be $8.00 per share.

Prior to this offering, there has been no public market for our common stock, and our common stock is not currently listed on any national exchange or market system. Our common stock has been approved for listing on the New York Stock Exchange under the symbol “PMG.”

Investing in our common stock involves risks. See “Risk Factors” beginning on page 14 of this prospectus to read about the risks you should consider before buying our common stock.


	Per Share	Total

Price to public	$	$
Discounts and commissions to underwriters(1)	$	$
Net proceeds (before expenses) to us	$	$


(1)		Concurrent with the closing of this offering, an affiliate of FBR Capital Markets & Co. will purchase 672,043 shares of our common stock at a price equal to the public offering price in this offering, less an amount equal to the underwriting discounts and commissions. The shares of the concurrent private placement are not being registered as part of this offering and will be restricted securities. No discounts will be paid to underwriters with respect to shares purchased by our directors, officers and employees or persons having business relationships with us in the directed share program. See “Underwriting” on page 188 of this prospectus for a description of the underwriters’ compensation.

We have granted the underwriters the right to purchase up to 3,180,000 additional shares of our common stock at the public offering price, less the underwriting discounts, solely to cover over-allotments, if any. The underwriters can exercise this right at any time within 30 days after the date of our underwriting agreement with them.

Neither the Securities and Exchange Commission nor any state securities commission or other regulatory body has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the shares of our common stock to purchasers against payment on or about , 2010.

FBR Capital Markets

Macquarie Capital

Oppenheimer & Co.

The date of this prospectus is , 2010.

TABLE OF CONTENTS


	Page

Certain Important Information		ii
Prospectus Summary		1
Risk Factors		14
Forward-Looking Statements		37
Use of Proceeds		38
Dividend Policy		39
Capitalization		40
Dilution		42
Selected Historical Consolidated Financial Information		44
Management’s Discussion and Analysis of Financial Condition and Results of Operations		47
Business		98
Management		155
Executive Compensation		161
Certain Relationships and Related Transactions		176
Principal Stockholders		180
Description of Capital Stock		183
Shares Eligible for Future Sale		186
Underwriting		188
Legal Matters		192
Experts		192
Where You Can Find More Information		192
Index to Financial Statements		F-1
EX-3.1
EX-10.85
EX-23.2

CERTAIN IMPORTANT INFORMATION

For your convenience we have included below definitions of terms used in this prospectus.

In this prospectus:


	•	references to “Patriot,” “our company,” “we,” “us” or “our” refer to Patriot Risk Management, Inc. and its direct and indirect wholly-owned subsidiaries, including Patriot National Insurance Group, Inc., Guarantee Insurance Company, PRS Group, Inc. and its subsidiaries and Patriot Underwriters, Inc. and its subsidiary, unless the context suggests otherwise;

	•	references to “Patriot Risk Management” refer solely to Patriot Risk Management, Inc., unless the context suggests otherwise;

	•	references to “Guarantee Insurance” refer solely to Guarantee Insurance Company, our wholly-owned insurance company;

	•	references to “PUI” refer collectively to Patriot Underwriters, Inc. and its direct wholly-owned subsidiary, Patriot General Agency, Inc.;

	•	references to “PRS” refer collectively to PRS Group, Inc. and its direct and indirect wholly-owned subsidiaries, including Patriot Risk Services, Inc., Patriot Risk Management of Florida, Inc., Patriot Insurance Management Company, Inc., Patriot Re International, Inc. and Patriot Recovery, Inc., unless the context suggests otherwise;

	•	references to “PF&C” and “Argonaut-Southwest” refer solely to Argonaut-Southwest Insurance Company, a shell property and casualty insurance company domiciled in Illinois that is not currently writing new business and that, subject to receiving regulatory approvals, we plan to acquire on or prior to March 31, 2010 and rename as Patriot Fire & Casualty Insurance Company;

	•	references to “alternative market business” refer to arrangements in which workers’ compensation insurance policies are written by Guarantee Insurance and the policyholder or another party bears a substantial portion of the underwriting risk, primarily through the reinsurance of the risk by a segregated portfolio captive (as described below). This business also includes other arrangements through which we share underwriting risk with our policyholders, such as pursuant to a large deductible policy or a retrospectively rated policy;

	•	references to “traditional business” refer to guaranteed cost workers’ compensation insurance policies written by Guarantee Insurance in which Guarantee Insurance bears substantially all of the underwriting risk, subject to reinsurance arrangements;

	•	references to “segregated portfolio captive” refer to a captive reinsurance company that operates as a single legal entity with segregated pools of assets, or segregated portfolio cells. The pool of assets and associated liabilities of each segregated portfolio cell within a segregated portfolio captive are solely for the benefit of the segregated portfolio cell participants, and the pool of assets of one segregated portfolio cell is statutorily protected from the creditors of the others. In this prospectus, we sometimes refer to the segregated portfolio cell participants as the owners of the cell; and

	•	references to “our BPO client” refer only to Ullico Casualty Company.

Unless otherwise stated, in this prospectus:


	•	all amounts assume no exercise of the underwriters’ over-allotment option;

	•	all share numbers assume the automatic conversion of each share of our Series A convertible preferred stock, stated value $1,000 per share, into 198.425 shares of our common stock and the automatic conversion of each share of our Series B common stock, par value $.001 per share, into shares of our common stock on a one-for-one basis upon completion of this offering; and


	•	all share amounts (other than the stock options and warrants to be issued upon completion of this offering) have been adjusted to reflect a 1.1522 to 1 stock split of our outstanding common stock and Series B common stock that was effected on February 4, 2010 after reversing the 1.8575 to 1 stock split of our outstanding common stock and Series B common stock that had been effected on January 26, 2010.

You should rely only on the information contained in this prospectus. We have not, and the underwriters have not, authorized any other person to provide you with information that is different from that contained in this prospectus. If anyone provides you with different or inconsistent information, you should not rely on it. We and the underwriters are offering to sell and seeking offers to buy these securities only in jurisdictions where offers and sales are permitted. You should assume that the information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of common stock. Our business, financial condition, results of operations and prospects may have changed since that date.

iii

PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus. Before making a decision to purchase our common stock, you should read the entire prospectus carefully, including the “Risk Factors” and “Forward-Looking Statements” sections and our consolidated financial statements and the notes to those financial statements. Except as otherwise noted, all information in this prospectus assumes that all of the 21,200,000 shares of common stock offered hereby will be sold and that the underwriters will not exercise their over-allotment option.

Overview


	•	In our insurance services segment, we generate fee income by providing workers’ compensation claims services as well as agency and underwriting services for the benefit of Guarantee Insurance, segregated portfolio captives and Guarantee Insurance’s traditional business quota share reinsurers under the Patriot Risk Services brand, and have recently begun providing these services for another insurance company under the Patriot Underwriters’ brand, a practice which we refer to as business process outsourcing, or BPO.

	•	In our insurance segment, we generate underwriting income and investment income by providing alternative market workers’ compensation risk transfer solutions and traditional workers’ compensation insurance coverage in Florida and 22 other jurisdictions.

We believe that our insurance services capabilities, specialized alternative market product knowledge and our hybrid business model allow us to achieve attractive returns through a range of industry pricing cycles and provide a substantial competitive advantage in areas that are underserved by competitors, which are generally insurance service providers or insurance carriers.

In 2009, we began producing business and performing insurance services for ULLICO Casualty Company, which we refer to as our BPO client. ULLICO Casualty Company is licensed to write workers’ compensation insurance in 47 states plus the District of Columbia and is rated “B+” (Good) by A.M Best. We earn commissions for producing business and insurance services income for providing underwriting, policy and claims administration, nurse case management and cost containment services and, in certain cases, services to segregated portfolio cell captives on the business we produce for our BPO client. Additionally, we assume a portion of the premium and associated losses and loss adjustment expenses on the business we produce for our BPO client, as mutually determined on a policy-by-policy basis.

Our Services and Products

Through our subsidiary, PRS Group, Inc. and its subsidiaries, which we collectively refer to as PRS, and our subsidiary, Patriot Underwriters, Inc. and its subsidiary, which we collectively refer to as PUI, we earn income for workers’ compensation claims services as well as agency and underwriting services. Workers’ compensation claims services include nurse case management, cost containment services and claims administration and adjudication services. Cost containment services refer to workers’ compensation bill review and re-pricing services. Workers’ compensation agency and underwriting services include general agency services and specialty underwriting, policy administration and captive management services. We currently provide these services principally to Guarantee Insurance for its benefit, for the benefit of segregated portfolio captives and for the benefit of Guarantee Insurance’s traditional business quota share reinsurers. We also provide these services to our BPO client.

Through Guarantee Insurance, we provide alternative market workers’ compensation risk transfer solutions, including workers’ compensation policies or arrangements where the policyholder, an agent or

another party generally bears a substantial portion of the underwriting risk. For example, the policyholder, an agent or another party may bear a substantial portion of the underwriting risk through the reinsurance of the risk by a segregated portfolio captive that is controlled by the policyholder, an agent or another party. A segregated portfolio captive refers to a captive reinsurance company that operates as a single legal entity with segregated pools of assets, or segregated portfolio cells, the assets and associated liabilities of which are solely for the benefit of the segregated portfolio cell participants. Through our segregated portfolio captive arrangements, we generally retain between 10% and 90% of the underwriting risk and earn a ceding commission from the segregated portfolio captive, which is payment to Guarantee Insurance by the captive of a commission as compensation for providing underwriting, policy and claims administration, captive management and investment portfolio management services. For the nine months ended September 30, 2009, we retained approximately 14% of the underwriting risk under our segregated portfolio captive arrangements.

Our alternative market business also includes other arrangements through which we share underwriting risk with our policyholders, such as large deductible policies or policies for which the final premium is based on the insured’s actual loss experience during the policy term, which we refer to as retrospectively rated policies. Unlike our traditional workers’ compensation policies, these arrangements align our interests with those of the policyholders or other parties participating in the risk-sharing arrangements, allowing them to share in the underwriting profit or loss. In addition, our alternative market business includes guaranteed cost policies issued to certain professional employer organizations and professional temporary staffing organizations on which we retain the risk. The excess of loss reinsurance on these policies is provided by the same reinsurer that covers our segregated portfolio captive insurance plans, retrospectively rated plans and large deductible plans, and these plans may be converted to risk sharing arrangements in the future.

We provide alternative market risk transfer solutions to companies in a broad array of industries, including employers such as hospitality companies, construction companies, professional employer organizations, clerical and professional temporary staffing companies, industrial companies, car dealerships, food services and retail and wholesale operations.

Through Guarantee Insurance, we also provide traditional workers’ compensation insurance coverage. We manage risk through the use of quota share and excess of loss reinsurance. Quota share reinsurance is a form of proportional reinsurance in which the reinsurer assumes an agreed upon percentage of each risk being insured and shares all premiums and losses with us in that proportion. Excess of loss reinsurance covers all or a specified portion of losses on underlying insurance policies in excess of a specified amount, or retention. We typically provide traditional workers’ compensation insurance coverage to:


	•	small to medium-sized employers in a broad array of industries, including clerical and professional services, food services, retail and wholesale operations and industrial services;

	•	low to medium hazard classes; and

	•	accounts with annual premiums below $250,000.

Our Competitive Strengths

We believe we have the following competitive strengths:


	•	Exclusive Focus on Workers’ Compensation Services and Products. Our operations are focused exclusively on workers’ compensation insurance services, workers’ compensation alternative market risk management solutions and traditional workers’ compensation insurance coverage. We believe this focus allows us to provide superior services and products to our customers relative to multiline insurance service providers and multiline insurance carriers. Furthermore, a significant portion of our services and products are provided in Florida, and we believe that certain of our multiline competitors that offer workers’ compensation coverage as part of a package policy including commercial property coverage tend to compete less for Florida workers’ compensation business because of property-related loss experience.


	•	Hybrid Business Model. In addition to the fee income we earn for nurse case management, cost containment and other insurance services, we also earn ceding commissions on our alternative market business involving segregated portfolio cell captives, and we earn underwriting and investment income on our alternative market and traditional workers’ compensation business. Because our nurse case management and cost containment service income is principally related to workers’ compensation claim frequency and medical costs, the operating results of our insurance services segment are not materially dependent on fluctuations or trends in prevailing workers’ compensation insurance premium rates. We believe that by changing the emphasis we place on our insurance services segment and ceding commission-based alternative market business relative to our traditional workers’ compensation business, we will be better able to achieve attractive returns and growth through a range of market cycles.

	•	Targeted Market for Alternative Market Risk Transfer Solutions. Although other insurers generally only offer alternative market products to large corporate customers, we offer alternative market workers’ compensation solutions to small, medium and larger-sized employers, enabling them and others to share in the claims experience and benefit from favorable loss experience.

	•	Enhanced Traditional Business Product Offerings. In our traditional business, we offer a number of flexible payment plans, including pay-as-you-go plans in which we partner with payroll service companies and our independent agents and their small employer clients to collect premiums and payroll information on a monthly or bi-weekly basis. Pay-as-you-go plans provide us with current payroll data and allow employers to remit premiums through their payroll service provider in an automated fashion. Flexible payment plans give employers a way to purchase workers’ compensation insurance without having to make a large upfront premium deposit payment. We believe that flexible payment plans, including pay-as-you-go plans, for small employers provide us with the opportunity to earn more favorable underwriting margins due to several factors:


	i.	favorable cash flows afforded under this plan can be more important to smaller employers than a price differential;

	ii.	smaller employers are generally less able to obtain premium rate credits and discounts; and

	iii.	the premium remittance mechanism results in a more streamlined renewal process and a lower frequency of business being re-marketed at renewal, leading to more favorable retention rates.


	•	Specialized Underwriting Expertise. We select and price our alternative market and traditional business products based on the specific risk associated with each potential policyholder rather than solely on the policyholder’s industry class. We utilize state-specific actuarial models on accounts with annual premiums over $100,000. In our alternative market business, we seek to align our interests with those of our policyholders or other parties participating in the risk-sharing arrangements by having them share in the underwriting profits and losses. We believe that we can compete effectively for alternative market and traditional insurance business based on our specialized underwriting focus and our accessibility to our clients. We generally compete on these attributes more so than on price, which we believe is generally not a differentiating factor in the states in which we write most of our business. For the nine months ended September 30, 2009 and year ended December 31, 2008, we reported consolidated net loss ratios of 55.9% and 58.3%, respectively. For the nine months ended September 30, 2009 and year ended December 31, 2008, the consolidated net loss ratios from our alternative market business were approximately 46% and 51%, respectively, and the consolidated net loss ratios from our traditional business were approximately 61% and 59%, respectively. The net loss ratio is the ratio between losses and loss adjustment expenses incurred and net premiums earned, and is a measure of the effectiveness of our underwriting efforts.

	•	Effective Claims Management, Nurse Case Management and Cost Containment Services. Guarantee Insurance began writing business as a subsidiary of Patriot Risk Management in the first quarter of 2004. As our business has grown, we have been successful in reasonably estimating our total liabilities for losses and loss adjustment expenses, establishing and maintaining adequate case reserves and


		rapidly closing claims. We provide our customers with an active claims management program. Our claims department employees average more than 24 years of workers’ compensation insurance industry experience, and members of our claims management team average more than 21 years of workers’ compensation experience. In addition, our nurse case management and bill review professionals have extensive training and expertise in assisting injured workers to return to work quickly. As of December 31, 2008, approximately 6%, 2%, 1% and 0.4% of total reported claims for accident years 2007, 2006, 2005 and 2004, respectively, remained open. Final net paid losses and loss adjustment expenses associated with closed claims are approximately 5% less than the initial reserves we established for them.


	•	Strong Distribution Relationships. We maintain relationships with our network of approximately 570 independent, non-exclusive agencies in 23 jurisdictions by emphasizing personal interaction and superior service and maintaining an exclusive focus on alternative market workers’ compensation solutions and traditional workers’ compensation insurance coverage. Our experienced underwriters work closely with our independent agents to market our products and serve the needs of prospective policyholders.

	•	Proven Leadership and Experienced Management. The members of our senior management team average over 20 years of insurance industry experience and workers’ compensation insurance experience. Their authority and areas of responsibility are consistent with their functional and state-specific experience.

Our Strategy

We believe that the net proceeds from this offering and the concurrent private placement will provide us with the additional capital necessary to increase the amount of insurance that we write and to make strategic acquisitions of insurance services operations and insurance companies. We plan to continue pursuing profitable growth and favorable returns on equity and believe that our competitive strengths will help us achieve our goal of delivering attractive returns to our investors. Our strategy to achieve these goals is to:


	•	Expand in Our Existing Markets. In all of the states in which we operate, we believe that a significant portion of total workers’ compensation insurance premium is written by numerous companies that individually have a small market share. We believe that our market share in each of the states in which we currently write business does not exceed 3%. We plan to continue to take advantage of our competitive position to expand in our existing markets. We believe that our risk selection, claims management, nurse case management and cost containment capabilities position us to profitably increase market share in our existing markets.

	•	Expand into Additional Markets. We are licensed to write workers’ compensation insurance in 27 jurisdictions, and we also hold 4 inactive workers’ compensation licenses. For the nine months ended September 30, 2009, we wrote traditional and alternative market business in 23 jurisdictions, principally in those jurisdictions that we believe provide the greatest opportunity for near-term profitable growth. For the nine months ended September 30, 2009, approximately 74% of our traditional and alternative market business was written in Florida, New Jersey, Missouri, Georgia and New York. We wrote approximately 28% of our direct premiums written in Florida for the nine months ended September 30, 2009. We plan to expand our business in states where we believe we can profitably write business. To do this, we plan to continue to leverage our talented pool of personnel, some of whom have prior expertise operating in states in which we do not currently operate. In addition, we may seek to acquire other insurance companies, books of business or other workers’ compensation policy and claims administration providers, general agencies or general underwriting organizations as we expand in our existing markets and into additional markets.

	•	Expand our BPO Business. In 2009, we entered into an agreement to produce business and perform insurance services for our BPO client to gain access to workers’ compensation insurance business in certain additional states. For the nine months ended September 30, 2009, approximately 34% of the business we produced and serviced for our BPO client was in California, and approximately 31% of


		such business was in either Texas, Michigan, Illinois or South Carolina. In the fourth quarter of 2009, we entered into a BPO relationship with another company, and we are seeking to enter into additional BPO relationships.


	•	Expand Nurse Case Management, Cost Containment and Other Insurance Services Operations. We plan to continue to generate fee income through our insurance services segment by offering workers’ compensation nurse case management and cost containment services to segregated portfolio captives and our quota share reinsurers. We plan to offer these services, together with general agency, general underwriting and policy and claims administration services, to other regional and national insurance companies and self-insured employers. We also plan to increase our insurance services income by expanding both organically and through strategic acquisitions of workers’ compensation policy and claims administration service providers, general agencies or general underwriting organizations. Taking advantage of our hybrid business model, we plan to identify and acquire insurance services operations that will create synergies with our alternative market and traditional workers’ compensation business.

	•	Obtain a Favorable Rating from A.M. Best. We have been informed by A.M. Best that after completion of this offering and the concurrent private placement, we may expect Guarantee Insurance to receive a financial strength rating of “A−” (Excellent), which is the fourth highest of fifteen A.M. Best rating levels. This indicative rating assignment is subject to the capitalization of Guarantee Insurance (and PF&C if we acquire it) at a level that A.M. Best requires to support the assignment of the “A−” rating through 2012. We expect that the contribution of $155 million of the net proceeds of this offering and the concurrent private placement to Guarantee Insurance (or the contribution of $20 million to Guarantee Insurance and the capitalization of PF&C with $135 million, if we acquire it) on or prior to March 31, 2010 will be sufficient to satisfy this requirement. If we acquire PF&C as described elsewhere in this prospectus, this rating assignment is also conditioned upon regulatory approval of a pooling agreement between Guarantee Insurance and PF&C that is satisfactory to A.M. Best. Pooling is a risk-sharing arrangement under which premiums and losses are shared between the pool members. We expect to make the contemplated capital contributions when we purchase PF&C or conclude not to proceed with that transaction, in either event prior to March 31, 2010. The indicative rating assignment we received from A.M. Best is not a guarantee of final rating outcome. In addition, in order to maintain this rating, Guarantee Insurance (and PF&C if we acquire it) must maintain capitalization at a level that A.M. Best requires to support the assignment of the “A−” rating, and any material negative developments in our operations, including in terms of management, earnings, capitalization or risk profile could result in negative rating pressure and possibly a rating downgrade. While we have expanded our business profitably without an A.M. Best rating and we believe that we can continue to do so with the net proceeds from this offering and the concurrent private placement, we believe that an “A−” rating from A.M. Best would increase our ability to market to large national brokers and large employers and create new opportunities for our products and services in rating sensitive markets. A.M. Best’s ratings reflect its opinion of an insurance company’s financial strength and ability to meet ongoing obligations to policyholders and are not intended for the protection of investors.

	•	Leverage Existing Infrastructure. We service our insurance services customers and policyholders through regional offices in three states, each of which we believe has been staffed to accommodate a certain level of insurance services business and premium growth. We plan to realize economies of scale in our workforce and leverage other scalable infrastructure costs.

Our Challenges and Risks

Our company and our business are subject to numerous risks as more fully described in the section of this prospectus entitled “Risk Factors.” As part of your evaluation of our business, you should consider the challenges and risks we face in implementing our business strategies, including the following:


	•	Adequacy of Loss Reserves. Our loss reserves are based upon estimates that are uncertain. These estimates may be inadequate to cover our actual losses, in which case we would need to increase our


		reserves, which would result in a decrease in our net income. In addition, Guarantee Insurance has legacy asbestos and environmental claims arising out of the sale of general liability insurance and participations in reinsurance assumed through underwriting management organizations prior to 1984. There are significant additional uncertainties in estimating the amount of potential losses from asbestos and environmental claims. As a result, it is more difficult to estimate what the ultimate loss costs will be for these claims than for other types of claims.


	•	Pricing Our Premiums. We underwrite and price our insurance policies at their inception before all of the underlying costs are known. If we price our premiums too low, we will have insufficient income to cover our losses and expenses. In addition, we do business in several administered pricing states, including Florida, where insurance rates are set by the state insurance regulatory authorities and are adjusted periodically. There can be no assurance that state-mandated insurance rates in administered pricing states will enable us to generate appropriate underwriting margins. For the nine months ended September 30, 2009 and the year ended December 31, 2008, we wrote approximately 52% and 67% of our direct premiums written, respectively, in administered pricing states.

	•	Geographic Concentration. Our business is concentrated in Florida and a few other states. Our financial performance is tied to the business, economic and regulatory conditions in these states. If the environment in these states worsens, there could be an adverse effect on our business, financial condition and results of operations.

	•	Cyclical Nature of the Workers’ Compensation Industry and Economic Downturn. The workers’ compensation insurance industry has historically fluctuated with periods of low premium rates and excess underwriting capacity resulting from increased competition followed by periods of high premium rates and shortages of underwriting capacity resulting from decreased competition. This cyclicality is beyond our control and may adversely affect our overall financial performance. In addition, the prevailing macroeconomic conditions in the fourth quarter of 2008 and in 2009 have led to a decrease in payrolls and a corresponding decrease in workers’ compensation direct premiums written.

	•	Limited Operating History. We commenced operations in 2004 after acquiring Guarantee Insurance, and we formed PRS in 2005. An investor in our common stock should consider that, as a relatively new company, we have a limited operating history on which you can evaluate our performance and base an estimate of our future earning prospects. Accordingly, our future results of operations or financial condition may vary significantly from expectations.

Recent Developments

New BPO Relationship

In December 2009, we entered into a new BPO relationship with Advantage Workers Compensation Insurance Company (Advantage WC), an insurer rated “A−” (Excellent) by A.M. Best, pursuant to which we will produce business and perform insurance services for Advantage WC in certain Midwestern states. We do not expect to assume any risk related to the business we produce for Advantage WC. Because we established this relationship in the fourth quarter of 2009, references in this prospectus to “our BPO client” refer only to Ullico Casualty Company.

Warrant Issuance

On January 13, 2010, our board of directors declared a dividend of warrants to purchase a total of 700,000 shares of our common stock, payable to our stockholders immediately prior to the completion of this offering. Each warrant will represent the right to purchase one share of our common stock at the same price as the common stock sold in this offering. These warrants will be subject to the restrictions contained in the lock-up agreements, and the right to purchase common stock under the warrants will begin upon the expiration of the lock-up agreements as described in “Shares Eligible for Future Sale — Lock-Up Agreements.” The warrants will expire 10 years after the date of issuance. The warrants also will contain a cashless exercise provision.

Acquisition of Shell Insurance Company

On December 18, 2009, we entered into a stock purchase agreement with Argonaut Insurance Company to acquire Argonaut-Southwest Insurance Company, a shell property and casualty insurance company domiciled in Illinois that is licensed to write workers’ compensation insurance in Arizona, Arkansas, California, Illinois, Louisiana, Mississippi, New Jersey, New Mexico, Oklahoma, Oregon, and Texas. Guarantee Insurance is licensed in each of these jurisdictions, except for Arizona, California, Illinois, Oregon, and Texas. We plan to rename Argonaut-Southwest as Patriot Fire & Casualty Insurance Company (PF&C) when we acquire it, and as a condition to the acquisition we will seek to have it redomesticated to Florida. The redomestication and acquisition are subject to regulatory approvals by both the Illinois and Florida insurance departments. In addition, if we acquire PF&C, our indicative rating assignment from A.M. Best is conditioned upon Florida regulatory approval of a pooling agreement between PF&C and Guarantee Insurance that is satisfactory to A.M. Best. If we receive all regulatory approvals for this transaction, we plan to acquire PF&C on or prior to March 31, 2010. There can be no assurance that we will obtain the necessary regulatory approvals to complete this acquisition. We do not believe that our failure to acquire PF&C will adversely affect our business plan or prevent us from obtaining the “A−” rating from A.M. Best that we expect to receive upon completion of this offering and the concurrent private placement.

We intend to contribute a substantial portion of the net proceeds of this offering and the concurrent private placement to Guarantee Insurance and PF&C (if we acquire it) in order to support their premium writings.

Private Placement

Concurrent with the closing of this offering, we will make a private placement of 672,043 shares of our common stock to an affiliate of FBR Capital Markets & Co. (“FBR”) at a price per share equal to the public offering price in this offering, less an amount equal to the underwriting discounts and commissions. We refer to this private offering as the “concurrent private placement.” We will enter into a registration rights agreement with the affiliate of FBR and will agree to register the resale of the shares that such affiliate purchases in the concurrent private placement. The shares are also subject to a 180-day lock-up period. See “Underwriting.”

Our Organization

Patriot Risk Management, Inc. was incorporated in Delaware in April 2003 by Steven M. Mariano, our Chairman, President and Chief Executive Officer. In September 2003, our wholly owned subsidiary, Patriot National Insurance Group, Inc., acquired Guarantee Insurance, a shell property and casualty insurance company that was not writing new business at the time we acquired it. At that time, Guarantee Insurance had approximately $3.2 million in loss and loss adjustment expense reserves relating to commercial general liability claims that had been in run-off since 1983, and was licensed to write insurance business in 41 states and the District of Columbia. Guarantee Insurance is domiciled in Florida and began writing business as a subsidiary of Patriot Risk Management in the first quarter of 2004. Guarantee Insurance is currently licensed to write workers’ compensation insurance in 27 jurisdictions, and also holds 4 inactive workers’ compensation licenses.

In 2005, we formed PRS Group, Inc. as a wholly owned subsidiary and incorporated Patriot Risk Services, Inc. PRS provides nurse case management and cost containment services for the benefit of Guarantee Insurance, segregated portfolio captives, our quota share reinsurers and our BPO client.

In 2008, we formed Patriot Recovery, Inc. to assist us in investigation and subrogation activities.

In 2009, we established Patriot Underwriters, Inc. and its subsidiary, Patriot General Agency, Inc., to provide general agency and general underwriting services to third parties. Through PUI and PRS, we are currently licensed as an insurance agent or producer in 46 jurisdictions, and currently have several pending agency licenses.

Patriot’s current corporate structure is as follows:


*		Subject to obtaining regulatory approvals, we plan to acquire PF&C on or prior to March 31, 2010. See “— Recent Developments — Acquisition of Shell Insurance Company.”

Patriot Risk Management, Inc. is an insurance holding company that was incorporated in Delaware in 2003. Our principal subsidiaries are Guarantee Insurance Company, Patriot Underwriters, Inc. and Patriot Risk Services, Inc. Our executive offices are located at 401 East Las Olas Boulevard, Suite 1540, Fort Lauderdale, Florida 33301, and our telephone number at that location is (954) 670-2900.

The Offering


Shares of common stock offered by us		21,200,000 shares


Over-allotment shares of common stock offered by us		3,180,000 shares


Shares of common stock to be outstanding after the offering		23,390,911 shares


Use of proceeds		We estimate that our net proceeds from this offering and the concurrent private placement will be approximately $160.3 million, after deducting the estimated underwriting discounts and commissions and our estimated offering expenses. We estimate that our net proceeds will be approximately $184.0 million if the underwriters exercise their over-allotment option in full. We intend to contribute approximately $155.0 million to Guarantee Insurance to support its premium writings. As described elsewhere in this prospectus, we have entered into a stock purchase agreement to acquire PF&C, a shell property and casualty insurance company. The acquisition of PF&C is subject to various regulatory approvals. If we obtain these regulatory approvals and consummate the acquisition on or prior to March 31, 2010, we plan instead to use approximately $16.7 million of the net proceeds of this offering and the concurrent private placement to pay the purchase price for PF&C (of which approximately $15.5 million represents the capital and surplus of PF&C), to contribute approximately $119.5 million to PF&C to support its premium writings (thereby increasing PF&C’s capital and surplus to $135 million), and to contribute approximately $20.0 million to Guarantee Insurance to support its premium writings. We expect that the remaining $5.3 million, or $4.1 million if we acquire PF&C, will be used to support our anticipated growth and general corporate purposes and to fund other holding company operations, including the repayment of all or a portion of our existing indebtedness and potential acquisitions although we have no current understandings or agreements regarding any such acquisitions (other than PF&C). If the underwriters exercise all or any portion of their over-allotment option, we intend to use all or a substantial portion of the net proceeds therefrom to pay down the balance of our credit facilities as described elsewhere in this prospectus. See “Use of Proceeds.”


Dividend policy		We do not expect to pay any cash dividends on our common stock for the foreseeable future. We currently intend to retain any additional future earnings to finance our operations and growth. Any future determination to pay cash dividends on our common stock will be at the discretion of our board of directors and will be dependent on our earnings, financial condition, operating results, capital requirements, any contractual, regulatory and other restrictions on the payment of dividends by us or by our subsidiaries to us, and other factors that our board of directors deems relevant.

New York Stock Exchange symbol		“PMG”

The number of shares of common stock shown to be outstanding upon completion of this offering and the concurrent private placement excludes:


	•	up to 3,180,000 shares of common stock that may be issued pursuant to the underwriters’ over-allotment option;


	•	187,235 shares of common stock issuable upon the exercise of options outstanding as of December 31, 2009;


	•	2,192,702 shares of common stock issuable upon the exercise of stock options we intend to grant to our directors, executive officers and other employees upon completion of this offering, at an exercise price equal to the initial public offering price;


	•	700,000 shares of common stock issuable upon the exercise of warrants that will be distributed to our existing stockholders immediately prior to the completion of this offering, at an exercise price equal to the initial public offering price; and


	•	427,428 additional shares of common stock available for future issuance under our 2010 Stock Incentive Plan.

The number of shares of common stock shown to be outstanding upon completion of the offering and the concurrent private placement includes:


	•	672,043 shares of common stock issuable in the concurrent private placement to an affiliate of FBR at a price per share equal to the public offering price, less an amount equal to the underwriting discounts and commissions; and


	•	198,423 shares of common stock issuable upon the conversion of shares of Series A convertible preferred stock upon completion of the offering.

SUMMARY HISTORICAL CONSOLIDATED FINANCIAL INFORMATION

The following income statement data for the nine months ended September 30, 2009 and 2008 and balance sheet data as of September 30, 2009 were derived from our unaudited consolidated financial statements included elsewhere in this prospectus. The income statement data for the years ended December 31, 2008, 2007 and 2006 were derived from our audited consolidated financial statements included elsewhere in this prospectus. The income statement data for the years ended December 31, 2005 and 2004 were derived from our audited consolidated financial statements that are not included in this prospectus. These historical results are not necessarily indicative of results to be expected in any future period. You should read the following summary financial information together with the other information contained in this prospectus, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and related notes.


	Nine Months
	Ended September 30,						Years Ended December 31,
	2009			2008			2008			2007			2006			2005			2004
	(Unaudited)
	In thousands, except per share data and percentages

Income Statement Data
Gross premiums written	$	95,972		$	94,878		$	117,563		$	85,810		$	62,372		$	47,576		$	30,911
Ceded premiums written		56,573			52,926			71,725			54,894			42,986			23,617			22,702

Net premiums written		39,399			41,952			45,838			30,961			19,386			23,959			8,209

Revenues
Net premiums earned		28,369			32,276			49,220			24,613			21,053			21,336			2,948
Insurance services income		9,753			4,706			5,657			7,027			7,175			4,369			6,429
Net investment income		1,354			1,487			2,028			1,326			1,321			1,077			233
Net realized gains (losses) on investments		903			(253	)		(1,037	)		(5	)		(1,346	)		(2,298	)		(4,632	)

Total revenues		40,379			38,216			55,868			32,961			28,203			24,484			4,978

Expenses
Net losses and loss adjustment expenses		15,864			20,719			28,716			15,182			17,839			12,022			2,616
Net policy acquisition and underwriting expenses		8,498			8,176			13,535			6,023			3,834			3,168			2,016
Other operating expenses		11,100			8,055			10,930			8,519			9,704			6,378			4,989
Interest expense		1,119			1,102			1,437			1,290			1,109			1,129			555

Total expenses		36,581			38,052			54,618			31,014			32,486			22,697			10,176

Other income		—			219			1,469			—			796			—			110
Loss from write-off of deferred equity offering costs(1)		—			—			(3,486	)		—			—			—			—
Gain on early extinguishment of debt(2)		—			—			—			—			6,586			—			—

Income (loss) before income tax expense benefit		3,798			383			(767	)		1,947			3,099			1,787			(5,088	)
Income tax expense (benefit)		1,422			(217	)		(643	)		(432	)		1,489			687			(751	)

Net income (loss)	$	2,376		$	600		$	(124	)	$	2,379		$	1,610		$	1,100		$	(4,337	)

Earnings Per Share
Basic		1.70			0.38			(0.08	)		1.54			1.00			0.76			NM	(3)
Diluted		1.68			0.38			(0.08	)		1.53			1.00			0.76			NM	(3)
Weighted Average Common Shares Outstanding:
Basic		1,401			1,568			1,568			1,546			1,604			1,442			NM	(3)
Diluted		1,411			1,579			1,568			1,557			1,611			1,450			NM	(3)
Return on average equity(4)		36.7	%		15.1	%		NM	(5)		58.5	%		107.0	%		NM	(6)		NM	(7)
Selected Insurance Ratios(8)
Net loss ratio		55.9	%		64.2	%		58.3	%		61.7	%		84.7	%		56.3	%		NM	(3)
Net expense ratio		30.0	%		25.3	%		27.5	%		24.5	%		18.2	%		14.8	%		NM	(3)

Net combined ratio		85.9	%		89.5	%		85.8	%		86.2	%		102.9	%		71.1	%		NM	(3)


	September 30, 2009
	Actual		As Adjusted(9)
	(Unaudited)
	In thousands

Balance Sheet Data
Investments	$	47,051		47,051
Cash and cash equivalents		7,452		166,580
Amounts recoverable from reinsurers		58,328		58,328
Premiums receivable, net		83,040		83,040
Prepaid reinsurance premiums		42,010		42,010
Other assets		19,910		21,110

Total assets	$	257,791	$	418,119

Reserves for losses and loss adjustment expenses	$	83,210		83,210
Unearned and advanced premium reserves		63,702		63,702
Reinsurance funds withheld and balances payable		56,458		56,458
Debt and accrued interest		20,089		20,089
Other liabilities		24,203		24,203

Total liabilities		247,662		247,662
Stockholders’ equity		10,129		170,457

Total liabilities and stockholders’ equity	$	257,791	$	418,119


(1)		In 2008, we wrote off approximately $3.5 million of deferred equity offering costs incurred in connection with our prior efforts to consummate an initial public offering during 2007 and 2008.

(2)		In 2006, Guarantee Insurance entered into a settlement and termination agreement with the former owner of Guarantee Insurance that allowed for an early extinguishment of debt in the amount of $8.8 million in exchange for $2.2 million in cash and release of the indemnification agreement previously entered into by the parties. As a result, we recognized a gain on the early extinguishment of debt on a pre-tax basis of approximately $6.6 million. We also recognized other income in connection with the forgiveness of accrued interest associated with the early extinguishment of debt on a pre-tax basis of $796,000.

(3)		We do not believe this metric is meaningful for the period indicated.

(4)		Return on average equity for a given period (annualized in the case of periods less than one year) is calculated by dividing net income for that period by average stockholders’ equity as of the beginning and end of the period.

(5)		In 2008, we reported a net loss of $124,000, principally as a result of a non-recurring loss from the write-off of deferred equity offering costs of approximately $3.5 million as described above. Due to this non-recurring charge, our return on average equity for 2008 was (2.0)%, which we do not believe is meaningful.

(6)		In 2005, we reported net income of $1.1 million. However, our average stockholders’ equity for 2005 was only approximately $180,000, which results in a return on average equity of 609.4%, which we do not believe is meaningful.

(7)		In 2004, we reported a net loss of $4.3 million, principally as a result of a loss from the write-off of an investment in Foundation Insurance Company, a subsidiary of Tarheel Group, Inc., as described below under “Certain Relationships and Related Transactions.” Due to this change, our return on average equity for 2004 was (19,275.6)%, which we do not believe is meaningful.

(8)		The net loss ratio is calculated by dividing net losses and loss adjustment expenses by net premiums earned. The net expense ratio is calculated by dividing net policy acquisition and underwriting expenses (which are comprised of gross policy acquisition costs and other gross expenses incurred in our insurance


		operations, net of ceding commissions earned from our reinsurers) by net premiums earned. The net combined ratio is the sum of the net loss ratio and the net expense ratio.


(9)		The As Adjusted balance sheet data as of September 30, 2009 reflects the issuance of 21,200,000 shares of our common stock at the assumed initial public offering price of $8.00 per share and the application of the net proceeds therefrom, including the acquisition of PF&C, after deducting estimated underwriting discounts and commissions and our estimated offering expenses, and the concurrent private placement of 672,043 shares of our common stock to an affiliate of FBR at a price per share equal to the public offering price in this offering, less an amount equal to the underwriting discounts and commissions.

RISK FACTORS

An investment in our common stock involves a number of risks. Before making a decision to purchase our common stock, you should carefully consider the following information about these risks, together with the other information contained in this prospectus. Many factors, including the risks described below, could result in a significant or material adverse effect on our business, financial condition and results of operations. If this were to happen, the price of our shares could decline significantly and you could lose all or part of your investment.

Risks Related to Our Business

Our business, financial condition and results of operations may be adversely affected if our actual losses and loss adjustment expenses exceed our estimated loss and loss adjustment expense reserves.

We maintain reserves for estimated losses and loss adjustment expenses. Loss and loss adjustment expense reserves represent an estimate of amounts needed to pay and administer claims with respect to insured events that have occurred, including events that have occurred but have not yet been reported to us. Such reserves are estimates and are therefore inherently uncertain. Judgment is required to determine the degree to which historical payment and claim settlement patterns should be considered in establishing loss and loss adjustment expense reserves. The interpretation of historical data can be impacted by external forces, such as legislative changes, economic fluctuations and legal trends.

Our net reserves for losses and loss adjustment expenses at December 31, 2008, 2007, 2006, 2005 and 2004 were $37.1 million, $26.6 million, $24.8 million, $17.4 million and $11.8 million, respectively. At December 31, 2008, our re-estimated reserves for the years ended December 31, 2007, 2006, 2005 and 2004 were $27.9 million, $21.3 million, $16.7 million and $11.4 million, respectively. Accordingly, at December 31, 2008, our reserves for the years ended December 31, 2007, 2006, 2005 and 2004 showed a net cumulative redundancy (deficiency) of approximately ($1.3 million), $3.6 million, $697,000 and $429,000, respectively. Our historical claims data is not fully developed, and, accordingly, in addition to our own historical claims data, we currently utilize industry data in establishing our reserves. Key assumptions that we utilize to estimate our reserves include industry frequency and severity trends and health care cost and utilization patterns. There can be no assurance that our reserves will be adequate in the future. If there are unfavorable changes in our assumptions, our reserves may need to be increased.

It is difficult to estimate reserves for workers’ compensation claims, because workers’ compensation claims are often paid over a long period of time, and there are no policy limits on liability for claim amounts. Accordingly, our reserves may prove to be inadequate to cover our actual losses. We review our loss reserves each quarter. We may adjust our loss reserves based on the results of these reviews, and these adjustments could be significant. If we change our estimates, these changes would result in adjustments to our loss reserves and losses and loss adjustment expenses incurred in the period in which the estimates are changed. If the estimate is increased, our pre-tax income for the period in which we make the change will decrease by a corresponding amount.

Additionally, we have certain exposures related to legacy commercial general liability claims, including asbestos and environmental liability claims, and there can be no assurance that our loss and loss adjustment expense reserves for these claims are adequate. See “— Guarantee Insurance has legacy commercial general liability claims, including asbestos and environmental liability claims.”

If we do not properly price our insurance policies, our business, financial condition and results of operations will be adversely affected; we do not set prices for our policies in Florida or the other administered pricing states where we write premiums.

If our premium rates are too low, our results of operations and our profitability will be adversely affected, and if our premium rates are too high, our competitiveness may be reduced and we may generate lower revenues.

In general, the premium rates for our insurance policies are established by us (in states other than administered pricing states, as discussed below) when coverage is initiated and, therefore, before all of the underlying costs are known. Like other workers’ compensation insurance companies and insurance holding companies, we rely on estimates and assumptions in setting our premium rates. Establishing adequate rates is necessary to generate sufficient revenue, together with investment income, to operate profitably. If we fail to accurately assess the risks that we assume, we may fail to charge adequate premium rates. For example, when underwriting coverage on a new policy, we estimate future claims expense based, in part, on prior claims information provided by the policyholder’s previous insurance carriers. If this prior claims information is not accurate or not indicative of future claims experience, we may under-price our policies by using claims estimates that are too low. As a result, our actual costs for providing insurance coverage to our policyholders may be significantly higher than our premiums. In order to set premium rates accurately, we must:


	•	collect and properly analyze a substantial volume of data;

	•	develop, test and apply appropriate rating formulae;

	•	closely monitor and timely recognize changes in trends; and

	•	make assumptions regarding both the frequency and severity of losses with reasonable accuracy.

We must also price our insurance policies appropriately for each jurisdiction. The assumptions we make regarding our premium rates in states in which we currently write policies may not be appropriate for new geographic markets into which we may expand. Our ability to establish appropriate premium rates in new markets is subject to a number of risks and uncertainties, principally:


	•	insufficient reliable data;

	•	incorrect or incomplete analysis of available data;

	•	uncertainties generally inherent in estimates and assumptions, especially in markets in which we have less experience;

	•	our inability to implement appropriate rating formulae or other pricing methodologies;

	•	regulatory constraints on rate increases;

	•	costs of ongoing medical treatment;

	•	our inability to accurately estimate retention, investment yields and the duration of our liability for losses and loss adjustment expenses; and

	•	unanticipated court decisions, legislation or regulatory action.

For the nine months ended September 30, 2009 and the years ended December 31, 2008 and 2007, we wrote approximately 52%, 67% and 74% of our direct premiums written, respectively, in administered pricing states — Florida, Indiana, New Jersey, and, prior to October 1, 2008, New York. Effective October 1, 2008, New York is no longer an administered pricing state. In 2008, we wrote approximately 46% of our direct premiums written in Florida. In administered pricing states, insurance rates are set by the state insurance regulators and are adjusted periodically. Rate competition generally is not permitted in these states. Therefore, rather than setting rates for the policies, our underwriting efforts in these states for our traditional business relate primarily to the selection of the policies we choose to write at the premium rates that have been set.

The Florida Office of Insurance Regulation, or the Florida OIR, has approved overall workers’ compensation rate decreases of 6.8%, 18.6%, 18.4% and 15.7%, effective as of January 1, 2010, 2009, 2008 and 2007, respectively. If a state insurance regulator lowers premium rates, we may be less profitable, and we may choose not to write policies in that state. We have responded to Florida rate decreases by expanding our alternative market business in Florida and strengthening our collateral on that business where appropriate. In addition, we have the ability to offer different kinds of policies in administered pricing states, including retrospectively rated policies and dividend policies, for which an insured can receive a return of a portion of the premium paid if the insured’s claims experience is favorable. We expect an increase in Florida experience

rate modifications, which permit us to increase the premium charged based on a policyholder’s loss history. We anticipate that our ability to adjust to these market changes will create opportunities as our competitors find the Florida market less desirable. However, there can be no assurance that state mandated insurance rates in administered pricing states will enable us to generate appropriate underwriting margins. Furthermore, there can be no assurance that alternative kinds of policies in administered pricing states will continue to be permitted or will enable us to generate appropriate underwriting margins.

Our geographic concentration ties our performance to business, economic and regulatory conditions in Florida and certain other states.

In 2008, we wrote insurance in 22 states and the District of Columbia. For the nine months ended September 30, 2009 and the years ended December 31, 2008 and 2007, approximately 28%, 46% and 59% of our total direct premiums written, respectively, were concentrated in our largest state, Florida.

For the nine months ended September 30, 2009, approximately 34% of our alternative market business direct premiums written were concentrated in Florida, and approximately 20%, 12% and 10% were concentrated in New Jersey, Georgia and New York, respectively. No other state accounted for more than 5% of our alternative market business direct premiums written for the nine months ended September 30, 2009.

For the nine months ended September 30, 2009, approximately 22% and 21% of our traditional business direct premiums written were concentrated in Florida and New Jersey, respectively, and between 5% and 10% were concentrated in each of Georgia, Indiana, Arkansas, New York and Missouri. No other state accounted for more than 5% of our traditional business direct premiums written for the nine months ended September 30, 2009.

Unfavorable business, economic or regulatory conditions in the states where we conduct the majority of our traditional and alternative market business could have a significant adverse impact on our business, financial condition and results of operations. In Florida and New Jersey, the states in which we write the majority of our premiums, and also in Indiana, insurance regulators establish the premium rates we charge. In these states, insurance regulators may set rates below those that we require to maintain profitability.

Because our business is concentrated in Florida, New Jersey and certain other states, we may be exposed to economic and regulatory risks that are greater than the risks we would face if our business were spread more evenly by state. Our workers’ compensation insurance operations are affected by the economic health of the states in which we operate. Premium growth is dependent upon payroll growth, which, in turn, is affected by economic conditions. Furthermore, losses and loss adjustment expenses can increase in weak economic conditions because it is more difficult to return injured workers to work when employers are otherwise reducing payrolls. Florida is exposed to severe natural perils, such as hurricanes. If Florida were to experience a natural peril of the magnitude of Hurricane Katrina or other catastrophic event, the result could be a disruption of the entire local economy and the loss of jobs, which could have a material adverse effect on our business, financial condition and results of operations. We could also be adversely affected by any material change in Florida law or regulation or any Florida court decision affecting workers’ compensation carriers generally. Unfavorable changes in economic conditions affecting the states in which we write business could adversely affect our business, financial condition and results of operations.

The workers’ compensation insurance industry is cyclical in nature, which may affect our overall financial performance.

Historically, the workers’ compensation insurance market has undergone cyclical periods of price competition and excess underwriting capacity (known as a soft market), followed by periods of high premium rates and shortages of underwriting capacity (known as a hard market). Although an individual insurance company’s financial performance is dependent on its own specific business characteristics, the profitability of most workers’ compensation insurance companies tends to follow this cyclical market pattern. Additional underwriting capacity, and the resulting increased competition for premium, is the result of insurance companies expanding the types or amounts of business they write, or of companies seeking to maintain or increase market share at the expense of underwriting discipline. In our traditional workers’ compensation

business, we have been experiencing increased price competition since 2007 in certain markets, and these cyclical patterns, the actions of our competitors and general economic factors could cause our revenue and net income to fluctuate, which may cause the price of our common stock to be volatile. Because this cyclicality is due in large part to the actions of our competitors and general economic factors beyond our control, we cannot predict with certainty the timing or duration of changes in the market cycle.

Because we have a limited operating history, our future operating results and financial condition are more likely to vary from expectations.

We commenced operations in 2004 after acquiring Guarantee Insurance, and we formed PRS Group, Inc. in 2005. As a relatively new company, we have a limited operating history on which you can evaluate our performance and base an estimate of our future earning prospects. In addition, our business plan contemplates that we will expand into new geographic areas and provide claims administration, general agency and general underwriting services to other insurance companies and self-insured employers through additional business process outsourcing relationships. We cannot assure you that we will obtain the regulatory approvals necessary for us to conduct business as planned or that any approval granted will not be subject to conditions that restrict our operations. In addition, we cannot assure you that we will have, or be able to raise, the funds necessary to capitalize our subsidiaries in order to further grow our business. Accordingly, our future results of operations or financial condition may vary significantly from expectations.

Our insurance services fee income and insurance services net income is currently substantially dependent on Guarantee Insurance’s premium levels.

Our insurance services fee income and insurance services net income is generated primarily from Guarantee Insurance, segregated portfolio captives and our quota share reinsurers. If Guarantee Insurance premium levels decrease, we would experience a corresponding decrease in insurance services fee income and insurance services net income. There can be no assurance that Guarantee Insurance premium levels will not decrease.

Our insurance services fee income is currently substantially dependent on Guarantee Insurance’s risk retention levels.

Because insurance services fee income earned by PRS from Guarantee Insurance attributable to the portion of the insurance risk that Guarantee Insurance retains and assumes from other insurance companies is eliminated upon consolidation, our insurance services income, on a consolidated basis, is currently substantially dependent on Guarantee Insurance’s risk retention levels. If Guarantee Insurance increases its risk retention levels, our insurance services fee income will decrease, in which case we would also experience a corresponding decrease in our losses and loss adjustment expenses and net policy acquisition and underwriting expenses. Guarantee Insurance’s risk retention levels, measured by the ratio of net premiums earned to gross premiums earned, were 49% and 33% for the years ended December 31, 2008 and 2007, respectively. Guarantee Insurance entered into additional quota share agreements effective December 31, 2008 and January 1, 2009 which reduced our risk retention levels in 2009. Our risk retention rate for the nine months ended September 30, 2009 was 37%. There can be no assurance as to our overall risk retention levels in the future.

We need to obtain additional licenses to allow us to provide insurance services to third parties.

As part of our business plan, we expect to expand our fee-generating insurance services by offering policy and claims administration, general agency and general underwriting services to other regional and national insurance companies and self-insured employers. We also plan to explore strategic acquisitions of policy and claims administrators, general agencies or general underwriters. In order to expand these services, we will need to obtain additional licenses to allow us to provide certain of these services to third parties. However, there can be no assurance that we will be successful in expanding these fee-generating services or obtaining the necessary licenses. Our failure to expand these services would have a material adverse effect on our business plan.

Guarantee Insurance has legacy commercial general liability claims, including asbestos and environmental liability claims.

Guarantee Insurance has legacy commercial general liability claims, including asbestos and environmental liability claims, arising out of the sale of general liability insurance and participations in reinsurance assumed through underwriting management organizations, commonly referred to as pools. Guarantee Insurance ceased offering direct liability coverage in 1983 and ceased participations in reinsurance pools after 1982. In addition to the general uncertainties encountered in estimating workers’ compensation loss and loss adjustment expense reserves described above, there are significant additional uncertainties in estimating the amount of our potential losses from asbestos and environmental claims. Generally, reserves for asbestos and environmental claims cannot be estimated with traditional loss reserving techniques that rely on historical accident year development factors due to the uncertainties surrounding asbestos and environmental liability claims. Among the uncertainties impacting the estimation of such losses are:


	•	potentially long waiting periods between exposure and emergence of any bodily injury or property damage;

	•	difficulty in identifying sources of environmental or asbestos contamination;

	•	difficulty in properly allocating responsibility and liability for environmental or asbestos damage;

	•	changes in underlying laws and judicial interpretation of those laws;

	•	potential for an environmental or asbestos claim to involve many insurance providers over many policy periods;

	•	long reporting delays from insureds to insurance companies;

	•	historical data concerning asbestos and environmental losses being more limited than historical information on other types of claims;

	•	questions concerning interpretation and application of insurance coverage; and

	•	uncertainty regarding the number and identity of insureds with potential asbestos or environmental exposure.

These factors generally render traditional actuarial methods less effective at estimating reserves for asbestos and environmental losses than reserves on other types of losses. As of December 31, 2008, we had established gross reserves of approximately $6.8 million and net reserves, net of reinsurance recoverable on unpaid losses and loss adjustment expenses, of approximately $3.0 million for legacy asbestos and environmental claims, which include 29 direct claims and Guarantee Insurance’s participation in two reinsurance pools and our estimate for the impact of unreported claims. As of December 31, 2008, one of the pools in which we are a participant (which accounted for approximately 80% of these net reserves at December 31, 2008) had approximately 1,600 open claims. Of these, one claim carries reserves of more than $100,000. In this pool, Guarantee Insurance reinsured the risks of other insurers and then ceded a portion (generally 80%) of these reinsurance risks to other reinsurers, which we refer to as participating pool reinsurers. Under this structure, Guarantee Insurance remains obligated for the total liability under each reinsurance contract to the extent any of the participating pool reinsurers fails to pay its share. Over time, Guarantee Insurance’s net liabilities under these reinsurance contracts have increased from approximately 20% to approximately 50% of the pooled risks due to the insolvency of some participating pool reinsurers. In the second pool (which accounted for approximately 20% of our net reserves for legacy asbestos and environmental claims at December 31, 2008), Guarantee Insurance is one of a number of participating pool reinsurers, and Guarantee Insurance’s liability is based on the percentage share of the pool obligations it reinsures. We review our loss and loss adjustment expense reserves for asbestos and environmental claims based on historical experience, current developments and actuarial reports for the pools, and this review entails a detailed analysis of our direct and assumed exposure.

In addition, as of December 31, 2008, we had established gross reserves of approximately $3.6 million and net reserves, net of reinsurance recoverable on unpaid losses and loss adjustment expenses, of approximately $1.5 million for legacy commercial general liability claims.

For the year ended December 31, 2008, incurred losses and loss adjustment expenses associated with adverse development of reserves for legacy claims were approximately $709,000. For the year ended December 31, 2007, we recognized a reduction of incurred losses and loss adjustment expenses attributable to favorable development of reserves for legacy claims of approximately $1.3 million. For the year ended December 31, 2006, incurred losses and loss adjustment expenses associated with adverse development of reserves for legacy asbestos and environmental and commercial general liability claims were approximately $516,000.

We plan to continue to monitor industry trends and our own experience in order to determine the adequacy of our environmental and asbestos reserves. However, there can be no assurance that the reserves we have established are adequate. In addition, we are reviewing whether to adopt the survival ratio reserve methodology for our asbestos and environmental exposures, an asbestos and environmental exposure reserving methodology commonly utilized by our publicly held insurance company peers. If we had adopted the survival ratio reserve methodology as of December 31, 2008, our net reserve for asbestos and environmental exposures would have been approximately $5.1 million, representing an increase in net losses and net loss adjustment expenses of approximately $2.1 million. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Outlook — Insurance Operations — Reserving Methodology for Legacy Asbestos and Environmental Exposures.”

If we cannot sustain our relationships with independent agencies, we may be unable to operate profitably.

We market and sell our insurance products and services primarily through direct contracts with approximately 570 independent, non-exclusive agencies. Our products are marketed by independent wholesale and retail agencies, some of which account for a large portion of our revenues. Other insurance companies compete with us for the services and allegiance of these agents. These agents may choose to direct business to our competitors, or may direct less desirable business to us. Our business relationships are generally governed by agreements with agents that may be terminated on short notice. For the nine months ended September 30, 2009, approximately 11.2% and 6.5% of our total new and renewal direct premiums written were derived from various offices of Appalachian Underwriters, Inc. and the Insurance Office of America, Inc., respectively, and no other agent accounted for more than 5% of our new and renewal direct premiums written. For the year ended December 31, 2008, approximately 14% of our total new and renewal direct premiums written were derived from the agent whose single account with us in 2008 was Progressive Employer Services, Inc., or PES, our then largest policyholder. The policy with PES was cancelled in October 2008. For the year ended December 31, 2008, approximately 9% and 7% of our total new and renewal direct premiums written were derived from various offices of Appalachian Underwriters, Inc. and the Insurance Office of America, Inc., respectively, and no other agent accounted for more than 5% of our new and renewal direct premiums written. As a result, our continued profitability depends, in part, on the marketing efforts of our independent agencies and on our ability to offer workers’ compensation insurance that meets the requirements and preferences of our independent agencies and their customers. A significant decrease in business from, or the entire loss of, our largest agency or several of our other large agencies would have a material adverse effect on our business, financial condition and results of operations.

We have filed a lawsuit against our former largest customer regarding amounts we contend are due and owing and are in dispute. This customer is controlled by an individual who was one of our stockholders as of December 31, 2008. We may never receive any of the disputed amounts that we contend are due and owing.

For the years ended December 31, 2008 and 2007, approximately 14% and 16% of our direct premiums written, respectively, were attributable to one customer, PES. The policy was cancelled in October 2008 for non-payment of premium and duplicate coverage. PES is a company controlled by Steven Herrig, an individual who, as of December 31, 2008, beneficially owned shares of our common stock through Westwind Holding

Company, LLC, or Westwind, a company controlled by Mr. Herrig. Westwind’s stock ownership represented approximately 15.8% of our outstanding common stock as of December 31, 2008. Most of PES’s employees are located in Florida, where workers’ compensation insurance premium rates are established by the state. Premiums receivable from PES totaled approximately $8.3 million as of September 30, 2009 and December 31, 2008. This amount is comprised of approximately $1.1 million for billed but unpaid premium audits for the 2006 policy year, approximately $2.0 million for a billed but unpaid experience rate modification as determined by NCCI, approximately $300,000 for billed but unpaid premium installments for the 2008 policy year and approximately $4.9 million of estimated but unbilled premium audits for the 2007 and 2008 policy years.

We have filed a lawsuit against PES to collect these and additional amounts we believe are due and owing. See “Business — Legal Proceedings — Actions Involving Progressive Employer Services, et al.” We have the right to access certain collateral pledged by Westwind to offset against premium and other amounts owed by PES and Westwind to Guarantee Insurance, including funds held under reinsurance treaties, which totaled approximately $3.3 million as of September 30, 2009 and approximately $3.7 million as of December 31, 2008. Additionally, in March 2009, we exercised a call option on all 248,026 shares of our common stock owned by Westwind to partially satisfy the amounts we contend are due and owing. On May 11, 2009, Westwind filed a complaint in Florida State Court related to the exercise of the call option, claiming breach of contract and conversion, seeking damages of $2.2 million and other damages as determined by the court. There can be no assurance that we will prevail in the lawsuit or that, if we prevail, we ultimately will be able to collect any amounts awarded. PES has contended that we have failed to arrange for the issuance of a dividend from Guarantee Insurance to PES from the segregated portfolio cell controlled by it in the amount of $3.9 million and that we have failed to provide PES with certain information. Moreover, PES may bring claims against us alleging that our conduct has damaged it. As the litigation continues, we and PES may identify additional amounts in dispute. If we are unable to recover from PES any of the $8.3 million premiums receivable plus the $2.2 million that we have offset against the premiums receivable through the exercise of our call option, we would recognize a pre-tax charge in the amount of such unrecovered amount.

If we do not obtain reinsurance from traditional reinsurers or segregated portfolio captives on favorable terms, our business, financial condition and results of operations could be adversely affected.

We purchase reinsurance to manage our risk and exposure to losses. Reinsurance is a transaction between insurance companies in which an original insurer, or ceding company, remits a portion of its premiums to a reinsurer, or assuming company, as payment for the reinsurer’s commitment to indemnify the original insurer for a portion of its insurance liability. In return, the reinsurer assumes insurance risk from the ceding company. We participate in quota share and excess of loss reinsurance arrangements. Our quota share reinsurers include Swiss Reinsurance America Corporation, one of the largest reinsurers in the United States and rated “A” (Excellent) by A.M. Best Company, ULLICO Casualty Company, rated “B+” (Good) by A.M Best and Harco National Insurance Company rated “A−” (Excellent) by A.M. Best. Under our traditional business quota share reinsurance agreement effective July 1, 2008, we ceded 50% of all net retained liabilities arising from all traditional business premiums written, excluding certain states, for all losses up to $500,000 per occurrence, subject to various restrictions and exclusions. Effective January 1, 2009, coverage from one of the reinsurers under this quota share agreement, which comprised 37.5% of the total 50.0% coverage, expired, the participation of the other quota share reinsurer was increased from 12.5% to 25.0% and previously excluded states were added to the coverage. We entered into an additional traditional business quota share agreement pursuant to which we ceded 37.83% of our gross unearned premium reserves as of December 31, 2008. Additionally, effective January 1, 2009, we entered into a traditional business quota share agreement pursuant to which we cede 68% of all traditional business written in Florida, Georgia and New Jersey during calendar year 2009 for all losses up to $1.0 million per occurrence, subject to various restrictions, exclusions and limitations. We do not have any other quota share reinsurance arrangements for our traditional business.

We reinsure, on a quota share basis, a substantial portion of our underwriting risk on our alternative market business to segregated portfolio captives in which our policyholders or other parties have an economic interest. Generally, we cede between 10% and 90% of the premium and losses under such alternative market

policies to segregated portfolio captives, up to $1 million per occurrence subject to various restrictions and exclusions, including an aggregate limit on the captive’s reinsurance obligations. For the year ended December 31, 2008, we ceded approximately 88% of our segregated portfolio captive alternative market gross premiums written under quota share reinsurance agreements with segregated portfolio captives. For the years ended December 31, 2007 and 2006, we ceded 82% and 87% of our segregated portfolio captive alternative market gross premiums written under quota share reinsurance agreements with segregated portfolio captives, respectively. On our segregated portfolio captive alternative market business, any losses in excess of the aggregate limit are borne by us. Thus, if we set this aggregate limit too low, our business, financial condition and results of operations would be adversely affected.

The excess of loss reinsurance for both our traditional and alternative market business under our 2009/2010 reinsurance program covers, subject to certain restrictions and exclusions, losses that exceed $1.0 million per occurrence up to $29.0 million per occurrence per life, with coverage of up to an additional $20.0 million per occurrence for certain losses involving injuries to several employees. Since Guarantee Insurance’s quota share reinsurance is included within its retention for purposes of its excess of loss reinsurance, its effective retention for a $1.0 million claim arising out of its traditional business covered by quota share reinsurance would be $875,000 in all states except Georgia, Florida and New Jersey where the effective retention is $195,000.

The excess of loss reinsurance for both our traditional and alternative market business under our 2008/2009 reinsurance program covers, subject to certain restrictions and exclusions, losses that exceed $1.0 million per occurrence up to $9.0 million per occurrence, with coverage of up to an additional $10.0 million per occurrence for certain losses involving injuries to several employees. However, effective July 1, 2008, the first layer of this excess of loss reinsurance for our traditional business ($4.0 million excess of a $1.0 million retention) is subject to an annual deductible of $1.0 million such that this reinsurance only applies to losses in excess of $1.0 million per occurrence after July 1, 2008 to the extent that such losses exceed $1.0 million in the aggregate. See “Business — Insurance Segment — Reinsurance.”

The availability, amount and cost of reinsurance are subject to market conditions and our experience with insured losses. There can be no assurance that our reinsurance agreements can be renewed or replaced prior to expiration upon terms as satisfactory to us as those currently in effect. If we are unable to renew or replace any of our quota share or excess of loss reinsurance agreements, our net liability on individual risks would increase, we would have greater exposure to catastrophic losses, our underwriting results would be subject to greater variability, and our underwriting capacity would be reduced. Any reduction or other changes in our reinsurance arrangements could materially adversely affect our business, financial condition and results of operations.

If we are not able to recover amounts due from our reinsurers, our business, financial condition and results of operations would be adversely affected.

Reinsurance does not discharge us of our obligations under our insurance policies. We remain liable to our policyholders even if we are unable to make recoveries that we believe we are entitled to receive under our reinsurance contracts. As a result, we are subject to credit risk with respect to our reinsurers. Losses are recovered from our reinsurers as claims are paid. With respect to long-term workers’ compensation claims, the creditworthiness of our reinsurers may change before we recover amounts to which we are entitled. If a reinsurer is unable to meet any of its obligations to us, we would be responsible for all claims and claim settlement expenses for which we would have otherwise received payment from the reinsurer. For example, we have experienced an increase in certain liabilities relating to some of our legacy exposures as a result of the insolvency of some participating pool reinsurers. See — “Guarantee Insurance has legacy commercial general liability claims, including asbestos and environmental liability claims.”

As of December 31, 2008, we had $42.1 million of gross exposures to reinsurers, comprised of reinsurance recoverables on paid and unpaid losses and loss adjustment expenses. Furthermore, as of December 31, 2008, we had $26.1 million of net exposure to reinsurers — $23.5 million from reinsurers licensed in Florida, which we refer to as authorized reinsurers, and $2.6 million from reinsurers not licensed in

Florida, which we refer to as unauthorized reinsurers. If we are unable to collect amounts recoverable from our reinsurers, our business, financial condition and results of operations would be adversely affected.

We are subject to extensive state regulation; regulatory and legislative changes may adversely impact our business.

We are subject to extensive regulation by the Florida OIR, and the insurance regulatory agencies of other states in which we are licensed and, to a lesser extent, federal regulation. State agencies have broad regulatory powers designed primarily to protect policyholders and their employees, and not our stockholders. Regulations vary from state to state, but typically address:


	•	standards of solvency, including risk-based capital measurements;

	•	restrictions on the nature, quality and concentration of investments;

	•	restrictions on the terms of insurance policies;

	•	restrictions on the way premium rates are established and the premium rates are charged;

	•	procedures for adjusting claims, which can affect the ultimate amount for which a claim is settled;

	•	standards for appointing general agencies;

	•	limitations on transactions with affiliates;

	•	restrictions on mergers and acquisitions;

	•	medical privacy standards;

	•	restrictions on the ability of insurance companies to pay dividends;

	•	establishment of reserves for unearned premiums, losses and other purposes;

	•	licensing requirements and approvals that affect our ability to do business;

	•	certain required methods of accounting; and

	•	potential assessments for state guaranty funds, second injury funds and other mandatory pooling arrangements.

We may be unable to comply fully with the wide variety of applicable laws and regulations that are frequently undergoing revision. In addition, we follow practices based on our interpretations of laws and regulations that we believe are generally followed by the insurance industry. These practices may be different from interpretations of insurance regulatory agencies. As a result, insurance regulatory agencies could preclude us from conducting some or all of our activities or otherwise penalize or fine us. Moreover, in order to enforce applicable laws and regulations or to protect policyholders, insurance regulatory agencies have relatively broad discretion to impose a variety of sanctions, including examinations, corrective orders, suspension, revocation or denial of licenses and the takeover of insurance companies. As a result, if we fail to comply with applicable laws or regulations, insurance regulatory agencies could preclude us from conducting some or all of our activities or otherwise penalize us. The extensive regulation of our business may increase the cost of our insurance and may limit our ability to obtain premium rate increases or to take other actions to increase our profitability. For example, as a result of a financial examination by the Florida OIR in 2006 for the year ended December 31, 2004, Guarantee Insurance was fined $40,000 for various violations including failure to maintain a minimum statutory policyholders’ surplus. Also, as a result of writing premiums in South Carolina in an inadvertent breach of our agreement with the South Carolina Department of Insurance not to write any new business in South Carolina without the Department’s consent, we may be required to pay a fine or face other disciplinary action.

Guarantee Insurance is subject to periodic examinations by state insurance departments in the states in which it is licensed. In March 2008, the Florida OIR completed its financial examination of Guarantee Insurance as of and for the year ended December 31, 2006. In its examination report, the Florida OIR made a

number of findings relating to Guarantee Insurance’s failure to comply with corrective comments made in earlier examination reports by the Florida OIR for the year ended December 31, 2004 and by the South Carolina Department of Insurance for the year ended December 31, 2005. The Florida OIR also made a number of proposed adjustments to the statutory financial statements of Guarantee Insurance for the year ended December 31, 2006, attributable to, among other things, corrections of accounting errors and an upward adjustment in Guarantee Insurance’s reserves for unpaid losses and loss adjustment expenses. These proposed adjustments resulted in a $119,000 net decrease in Guarantee Insurance’s reported policyholders surplus but did not cause Guarantee Insurance to be in violation of a consent order issued by the Florida OIR in 2006 in connection with the redomestication of Guarantee Insurance from South Carolina to Florida that requires Guarantee Insurance to maintain a minimum statutory policyholders surplus of the greater of $9.0 million or 10% of total liabilities excluding taxes, expenses and other obligations due or accrued, and Guarantee Insurance was not required to file an amended 2006 annual statement with the Florida OIR reflecting these adjustments.

In connection with the Florida OIR examination report for the year ended December 31, 2006, the Florida OIR issued a consent order requiring Guarantee Insurance to pay a penalty of $50,000, pay $25,000 to cover administrative costs and undergo an examination prior to June 1, 2008 to verify that it had addressed all of the matters raised in the examination report. In addition, the consent order required Guarantee Insurance to hold annual stockholder meetings, maintain complete and accurate minutes of all stockholder and board of director meetings, implement additional controls and review procedures for its reinsurance accounting, perform accurate and timely reconciliations for certain accounts, establish additional procedures in accordance with Florida OIR information technology specialist recommendations, correctly report all annual statement amounts, continue to maintain adequate loss and loss adjustment reserves and continue to maintain a minimum statutory policyholders surplus of the greater of $9.0 million or 10% of total liabilities excluding taxes, expenses and other obligations due or accrued. The consent order required Guarantee Insurance to provide documentation of compliance with these requirements. In 2008, the Florida OIR engaged a consultant to perform a target examination of Guarantee Insurance to assess its compliance with these requirements. In August 2008, the consultant’s target examination fieldwork was completed, and the Florida OIR issued its report on the target examination, concluding that, with certain immaterial exceptions, Guarantee Insurance was in compliance with all of the findings from the examination report for the year ended December 31, 2006.

State laws require insurance companies to maintain minimum surplus balances and place limits on the amount of insurance a company may write based on the amount of that company’s surplus. These limitations may restrict the rate at which our insurance operations can grow.

In May 2009 in connection with a Florida OIR targeted examination, we advised the Florida OIR that all intercompany receivables would be settled within 30 days. As of September 30, 2009, Guarantee Insurance had approximately $2.1 million in intercompany receivables that had been outstanding for more than 30 days, and approximately $975,000 that had been outstanding for more than 90 days (although subsequent to September 30, 2009, these balances were repaid). Because some of the intercompany receivables were outstanding for more than 30 days, the Florida OIR may object to these transactions or take other regulatory action against us. In addition, under statutory accounting rules, Guarantee Insurance is required to record the amount of any intercompany receivables that have been outstanding for more than 90 days as a nonadmitted asset. Therefore, to the extent that any intercompany receivables have been outstanding for more than 90 days, Guarantee Insurance will be required to nonadmit the amount of such receivables, which will result in a corresponding decrease in the surplus of Guarantee Insurance. If the decrease in Guarantee Insurance’s surplus were to cause Guarantee Insurance to be out of compliance with certain ratios or minimum surplus levels as required by the Florida OIR, we could face possible regulatory action and would be required to obtain additional reinsurance, reduce our insurance writings or add capital to Guarantee Insurance.

State laws also require insurance companies to establish reserves for payments of policyholder liabilities and impose restrictions on the kinds of assets in which insurance companies may invest. These restrictions may require Guarantee Insurance to invest in assets more conservatively than it would if we were not subject to state law restrictions and may prevent it from obtaining as high a return on its assets as it might otherwise be able to realize.

State regulation of insurance company financial transactions and financial condition are based on statutory accounting principles, or SAP. State insurance regulators closely monitor the financial condition of insurance companies reflected in SAP financial statements and can impose significant operating restrictions on an insurance company that becomes financially impaired. Regulators generally have the power to impose restrictions or conditions on the following kinds of activities of a financially impaired insurance company: transfer or disposition of assets, withdrawal of funds from bank accounts, extension of credit or advancement of loans and investment of funds.

Many states have laws and regulations that limit an insurer’s ability to withdraw from a particular market. For example, states may limit an insurer’s ability to cancel or not renew policies. Furthermore, certain states prohibit an insurer from withdrawing from one or more lines of business in the state, except pursuant to a plan that is approved by the state insurance department. The state insurance department may disapprove a plan that may lead to market disruption. Laws and regulations that limit cancellation and non-renewal and that subject program withdrawals to prior approval requirements may restrict our ability to exit unprofitable markets.

Licensing laws and regulations vary from state to state. In all states, the applicable licensing laws and regulations are subject to amendment or interpretation by regulatory authorities. Generally such authorities are vested with relatively broad and general discretion as to the granting, renewing and revoking of licenses and approvals. Licenses may be denied or revoked for various reasons, including the violation of regulations and conviction of crimes. Possible sanctions which may be imposed by regulatory authorities include the suspension of individual employees, limitations on engaging in a particular business for specified periods of time, revocation of licenses, censures, redress to clients and fines.

In some instances, we follow practices based on interpretations of laws and regulations generally followed by the industry, which may prove to be different from the interpretations of regulatory authorities.

We currently are not rated by A.M. Best or any other insurance rating agency, and if we do not receive a favorable rating from A.M. Best after the offering and the concurrent private placement, or if we do obtain such a rating and then fail to maintain it, our business, financial condition and results of operations may be adversely affected.

Rating agencies rate insurance companies based on their financial strength and their ability to pay claims, factors that are relevant to agents and policyholders. We have never been rated by any nationally recognized independent rating agency. The ratings assigned by nationally recognized independent rating agencies, particularly A.M. Best, may become material to our ability to maintain and expand our business. Ratings from A.M. Best and other rating agencies are used by some insurance buyers, agents and brokers as an indicator of financial strength and security.

We have been informed by A.M. Best that after completion of this offering and the concurrent private placement, we may expect Guarantee Insurance to receive a financial strength rating of “A−” (Excellent), which is the fourth highest of fifteen A.M. Best rating levels. This indicative rating assignment is subject to the capitalization of Guarantee Insurance (and PF&C if we acquire it) at a level that A.M. Best requires to support the assignment of the “A−” rating through 2012 . We expect that the contribution of $155 million of the net proceeds of this offering and the concurrent private placement to Guarantee Insurance (or the contribution of $20 million to Guarantee Insurance and the capitalization of PF&C with $135 million, if we acquire it) on or prior to March 31, 2010 will be sufficient to satisfy this requirement. If we acquire PF&C as described elsewhere in this prospectus, this rating assignment is also conditioned upon regulatory approval of a pooling agreement between Guarantee Insurance and PF&C that is satisfactory to A.M. Best. Pooling is a risk-sharing arrangement under which premiums and losses are shared between the pool members. We expect to make the contemplated capital contributions when we purchase PF&C or conclude not to proceed with that transaction, in either event prior to March 31, 2010. The indicative rating assignment we received from A.M. Best is not a guarantee of final rating outcome. In addition, in order to maintain this rating, Guarantee Insurance (and PF&C if we acquire it) must maintain capitalization at a level that A.M. Best requires to support the assignment of the “A−” rating, and any material negative developments in our operations, including in terms of management, earnings, capitalization or risk profile could result in negative rating

pressure and possibly a rating downgrade. While we have expanded our business profitably without an A.M. Best rating and we believe that we can continue to do so with the net proceeds from this offering and the concurrent private placement, we believe that an “A−” rating from A.M. Best would increase our ability to market to large national brokers and large employers and create new opportunities for our products and services in rating sensitive markets. A.M. Best’s ratings reflect its opinion of an insurance company’s financial strength and ability to meet ongoing obligations to policyholders and are not intended for the protection of investors.

A.M. Best ratings tend to be more important to our alternative market customers than our traditional business customers. A favorable A.M. Best rating would increase our ability to sell our alternative market products to larger employers. We believe that a favorable rating would also open significant new markets for our products and services. Our failure to obtain or maintain a favorable rating may have a material adverse affect on our business plan.

We expect to apply to A.M. Best for a rating as soon as practicable. We may not be given a favorable rating or if we are given a favorable rating such rating may be downgraded, which may adversely affect our ability to obtain business and may adversely affect the price we can charge for the insurance policies we write. The ratings of A.M. Best are subject to periodic review using, among other things, proprietary capital adequacy models, and are subject to revision or withdrawal at any time. Other companies in our industry that have been rated and have had their rating downgraded have experienced negative effects. A.M. Best ratings are directed toward the concerns of policyholders and insurance agencies and are not intended for the protection of investors or as a recommendation to buy, hold or sell securities. Although we are not currently rated by A.M. Best, if we obtain an A.M. Best rating after this offering and the concurrent private placement, our competitive position relative to other companies will be determined in part by our A.M. Best rating.

If we are unable to realize our investment objectives, our business, financial condition and results of operations may be adversely affected.

Investment income is an important component of our net income. As of September 30, 2009 and December 31, 2008, our investment portfolio, including cash and cash equivalents, had a carrying value of $54.5 million and $63.4 million, respectively. For the nine months ended September 30, 2009 and the year ended December 31, 2008, we had net investment income of $1.4 million and $2.0 million, respectively. Our investment portfolio is managed by Gen Re — New England Asset Management (a subsidiary of Berkshire Hathaway, Inc.), an independent asset manager, pursuant to investment guidelines approved by Guarantee Insurance’s board of directors. Although these guidelines stress diversification and capital preservation, our investments are subject to a variety of risks, including risks related to general economic conditions, interest rate fluctuations and market volatility. For example, over the past three years, credit markets were significantly impacted by sub-prime mortgage losses, increased mortgage defaults and worldwide market dislocations. Furthermore, financial markets experienced substantial and unprecedented volatility as a result of further dislocations in the credit markets, including the bankruptcy of Lehman Brothers Holdings Inc. In 2008, we recognized an other-than-temporary-impairment charge of approximately $350,000 related to investments in certain bonds issued by Lehman Brothers Holdings, Inc., which filed a voluntary petition for relief under Chapter 11 of Title 11 of the United States Code in the United States Bankruptcy Court, and approximately $875,000 related to investments in certain common stocks purchased in 2005.

In addition, our investment portfolio includes asset-backed and mortgage-backed securities. As of September 30, 2009 and December 31, 2008, asset-backed and mortgage-backed securities constituted approximately 25% and 26% of our invested assets, respectively, including cash and cash equivalents. As with other fixed income investments, the fair market value of these securities fluctuates depending on market and other general economic conditions and the interest rate environment. Interest rates are highly sensitive to many factors, including governmental monetary policies and domestic and international economic and political conditions. Changes in interest rates could have an adverse effect on the value of our investment portfolio and future investment income. For example, changes in interest rates can expose us to prepayment risks on asset-backed and mortgage-backed securities included in our investment portfolio. When interest rates fall, asset-backed and mortgage-backed securities are prepaid more quickly than expected and the holder must reinvest

the proceeds at lower interest rates. In periods of increasing interest rates, asset-backed and mortgage-backed securities are prepaid more slowly, which may require us to receive interest payments that are below the interest rates then prevailing for longer than expected.

We also seek to manage our investment portfolio such that the security maturities provide adequate liquidity relative to our expected claims payout pattern. However, the duration of our insurance liabilities may differ from our expectations. If we need to liquidate invested assets prematurely in order to satisfy our claim obligations and the fair value of such assets is below our original cost, we may recognize losses on investments, which could have a material adverse effect on our business, financial condition and results of operations.

Additionally, our fixed maturity securities were reclassified as available for sale at December 31, 2008 and, accordingly, are carried at market value. Decreases in the value of our fixed securities may have a material adverse effect on our business, financial condition and results of operations.

General economic conditions may be adversely affected by a variety of factors, including U.S. involvement in hostilities with other countries, large-scale acts of terrorism and the threat of hostilities or terrorist acts. These and other factors affect the capital markets and, consequently, the value of our investment portfolio and our investment income. Any significant decline in our investment income would adversely affect our business, financial condition and results of operations.

We are more vulnerable to negative developments in the workers’ compensation insurance industry than companies that also write other lines of insurance.

Our business involves providing insurance services related to underwriting workers’ compensation insurance policies, and we have no current plans to focus our efforts on offering other lines of insurance. As a result, negative developments in the economic, competitive or regulatory conditions affecting the workers’ compensation insurance industry could have a material adverse effect on our business, financial condition and results of operations. Negative developments in the workers’ compensation insurance industry could have a greater effect on us than on more diversified insurance companies that also sell other lines of insurance.

We derive a significant portion of our insurance services income from our BPO client.

For the nine months ended September 30, 2009, approximately 35% of our insurance services income was derived from our BPO client. Our BPO client may terminate its service arrangement with us at anytime without cause, upon 180 days’ notice, so there is no assurance that our arrangement with our BPO client will continue. The loss of our BPO client would, and the loss of any additional BPO client that we may develop may, have a material adverse effect on our business, financial condition and results of operations.

New agreements involving fronting arrangements or distribution and insurance services relationships with other carriers or acquisitions could result in operating difficulties and other harmful consequences.

In 2009, we started producing business and performing insurance services for our BPO client and entered into a BPO relationship with another company. We are seeking to enter into additional BPO relationships. Developing the technology infrastructure necessary to service or facilitate new relationships will require substantial time and effort on our part, and the integration and management of these relationships may divert management time and focus from operating our current business.

We have limited experience in acquiring other companies, and we may have difficulty integrating the operations of companies that we may acquire and may incur substantial costs in connection therewith.

Our business plan includes growing our revenues through the acquisition of other insurance services operations and insurance companies. However, our experience acquiring companies has been limited to our acquisition of Guarantee Insurance and our proposed acquisition of PF&C. See “Prospectus Summary — Recent Developments — Acquisition of Shell Insurance Company.” We have evaluated, and expect to continue to evaluate, a wide array of potential strategic transactions. From time to time, we may engage in discussions

regarding potential acquisitions. The costs and benefits of future acquisitions are uncertain. Any of these transactions could be material to our business, financial condition and results of operations. In addition, the process of integrating the operations of an acquired company may create unforeseen operating difficulties and expenditures and is risky. The areas where we may face risks include:


	•	the need to implement or remediate controls, procedures and policies appropriate for a public company at companies that, prior to the acquisition, lacked these controls, procedures and policies;

	•	diversion of management time and focus from operating our business to acquisition integration challenges;

	•	cultural challenges associated with integrating employees from the acquired company into our organization;

	•	retaining employees from the businesses we acquire; and

	•	the need to integrate each company’s accounting, management information, human resource and other administrative systems to permit effective management.

We operate in a highly competitive industry, and others may have greater financial resources to compete effectively.

The market for workers’ compensation insurance products and risk management services is highly competitive. Competition in our business is based on many factors, including pricing (with respect to insurance products, either through premiums charged or policyholder dividends), services provided, underwriting practices, financial ratings assigned by independent rating agencies, capitalization levels, quality of care management services, speed of claims payments, reputation, perceived financial strength, effective loss prevention, ability to reduce claims expenses and general experience. In some cases, our competitors offer lower priced products and services than we do. If our competitors offer more competitive prices, payment plans, services or commissions to independent agencies, we could lose market share or have to reduce our prices in order to maintain market share, which would adversely affect our profitability. Our competitors are insurance companies, self-insurance funds, state insurance pools and workers’ compensation insurance service providers, many of which are significantly larger and possess considerably greater financial, marketing, management and other resources than we do. Consequently, they can offer a broader range of products, provide their services nationwide and capitalize on lower expenses to offer more competitive pricing.

With respect to our insurance services business, we believe PRS’s principal competitors in the nurse case management and cost containment services market are CorVel Corporation, GENEX Services, Inc. and various other smaller providers. In the general agency market, we believe we compete with numerous national wholesale agents and brokers.

With respect to our insurance business, we believe our principal competitors are American International Group, Inc., Liberty Mutual Insurance Company and Hartford Insurance Company, as well as smaller regional carriers. Many of our competitors are substantially larger and have substantially greater market share and capital resources than we have.

State insurance regulations require maintenance of minimum levels of surplus and of ratios of net premiums written to surplus. Accordingly, competitors with more surplus than us have the potential to expand in our markets more quickly and to a greater extent than we can. Additionally, greater financial resources permit a carrier to gain market share through more competitive pricing, even if that pricing results in reduced underwriting margins or an underwriting loss. Many of our competitors are multi-line carriers that can price the workers’ compensation insurance that they offer at a loss in order to obtain other lines of business at a profit. If we are unable to compete effectively, our business, financial condition and results of operations could be materially adversely affected.

An inability to effectively manage the growth of our operations could make it difficult for us to compete and affect our ability to operate profitably.

Our continuing growth strategy includes expanding in our existing markets, acquiring insurance services companies, entering new geographic markets and further developing our agency relationships. Our growth strategy is subject to various risks, including risks associated with our ability to:


	•	identify profitable new geographic markets for entry;

	•	attract and retain qualified personnel for expanded operations;

	•	identify potential acquisition targets and successfully acquire them;

	•	expand existing and develop new agency relationships;

	•	identify, recruit and integrate new independent agencies; and

	•	augment our internal monitoring and control systems as we expand our business.

The effects of emerging claim and coverage issues on our business are uncertain.

As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect our business by either extending coverage beyond our underwriting intent or by increasing the number or size of claims. In some instances, these changes may not become apparent until after we have issued insurance policies that are affected by the changes. As a result, the full extent of our liability under an insurance policy may not be known until many years after the policy is issued. For example, medical costs associated with permanent and partial disabilities may increase more rapidly or be higher than we currently expect. Changes of this nature may expose us to higher claims than we anticipated when we wrote the underlying policy. As of December 31, 2008, approximately 0.4%, 1%, 2% and 6% of our total reported claims for accident years 2004, 2005, 2006 and 2007, respectively, remained open.

As more fully described under “Business — Legal Proceedings,” we are involved in certain litigation matters. Litigation is subject to inherent uncertainties, and if there were an outcome unfavorable to us, our business, financial condition and results of operations could be materially adversely affected.

Our business is dependent on the efforts of our senior management and other key employees because of their industry expertise, knowledge of our markets and relationships with the independent agencies that sell our insurance.

We believe our success will depend in substantial part upon our ability to attract and retain qualified executive officers, experienced underwriting talent and other skilled employees who are knowledgeable about our business. We rely substantially on the services of our executive management team and other key employees. The key executive officers and employees upon whom we rely are Steven M. Mariano, Chairman of the Board, President and Chief Executive Officer; Michael W. Grandstaff, Senior Vice President and Chief Financial Officer; Charles K. Schuver, Senior Vice President and Chief Underwriting Officer of Guarantee Insurance; Timothy J. Ermatinger, Chief Executive Officer of PRS Group, Inc.; Richard G. Turner, Senior Vice President of Alternative Markets and Theodore G. Bryant, Senior Vice President, Counsel and Secretary. We entered into employment agreements with each of these officers in 2008. Although we are not aware of any planned departures or retirements, if we were to lose the services of members of our senior management team, our business, financial condition and results of operations could be adversely affected. We do not currently maintain key man life insurance policies with respect to our employees.

Our ability to attract and retain new key employees may be adversely impacted by the limited number of shares available for future grants (427,428 shares) under our 2010 Stock Plan after option grants are made at the time this offering is completed. In addition, our compensation for our independent directors includes an equity component, which will utilize a portion of available shares. While we would not expect new grants to be made to current officers in the near term, we may need to offer equity compensation as a component of

compensation for hiring new members of senior management as we grow. In the absence of our ability to do this, we may need to pay higher levels of cash compensation in the near term to attract desired candidates and may be unable to hire some candidates.

Our status as an insurance holding company with no direct operations could adversely affect our ability to pay dividends in the future.

Patriot Risk Management is a holding company that transacts business through its operating subsidiaries. Patriot Risk Management’s primary assets are the capital stock of these operating subsidiaries. Thus, the ability of Patriot Risk Management to pay dividends to our stockholders depends upon the surplus and earnings of our subsidiaries and their ability to pay dividends to Patriot Risk Management. Payment of dividends by our insurance subsidiary is restricted by state insurance laws, including laws establishing minimum solvency and liquidity thresholds, and could be subject to contractual restrictions in the future, including those imposed by indebtedness we may incur in the future. See “Business — Regulation — Dividend Limitations.” As a result, Patriot Risk Management may not be able to receive dividends from Guarantee Insurance, its insurance company subsidiary, or may not receive dividends in amounts necessary to pay dividends on our capital stock.

Neither PRS nor PUI is statutorily restricted from paying dividends to Patriot Risk Management, although our credit facilities prohibit us and our operating subsidiaries from paying any dividends on our and their respective capital stock at any time when Patriot Risk Management’s consolidated stockholders equity is less than $50 million without the consent of our lenders. In addition, future debt agreements may contain certain prohibitions or limitations on the payment of dividends. Because Guarantee Insurance is, and if we acquire it, PF&C will be, regulated by the Florida OIR, both companies will be subject to significant regulatory restrictions limiting their ability to declare and pay dividends.

At the time we acquired Guarantee Insurance, it had a large statutory unassigned deficit. See Note 13 to our audited consolidated financial statements as of December 31, 2008 and for the year then ended, which financial statements are included elsewhere in this prospectus (our “Consolidated Financial Statements”). As of September 30, 2009, Guarantee Insurance’s statutory unassigned deficit was $95.5 million. Under Florida law, insurance companies may only pay dividends out of available and accumulated surplus funds derived from realized net operating profits on their business and net realized capital gains, except under limited circumstances with the prior approval of the Florida OIR. Pursuant to a consent order issued by the Florida OIR on December 29, 2006 in connection with the redomestication of Guarantee Insurance from South Carolina to Florida, Guarantee Insurance was prohibited from paying dividends, without approval of the Florida OIR, until December 29, 2009. Moreover, Florida law has several different tests that limit the payment of dividends, without the prior approval of the Florida OIR, to an amount generally equal to 10% of the surplus or gain from operations, with additional restrictions. Therefore, it is unlikely that Guarantee Insurance will be able to pay dividends for the foreseeable future without prior approval of the Florida OIR. Currently, we do not intend to pay cash dividends on our common stock.

Additional capital that we may require in the future may not be available to us or may be available to us only on unfavorable terms.

Our future capital requirements will depend on many factors, including state regulatory requirements, the financial stability of our reinsurers, future acquisitions and our ability to write new business and establish premium rates sufficient to cover our estimated claims. We may need to raise additional capital or curtail our growth if the portion of our net proceeds of this offering and the concurrent private placement to be contributed to the capital of our insurance subsidiaries is insufficient to support future operating requirements or cover claims.

If we need to raise additional capital, equity or debt financing may not be available to us or may be available only on terms that are not favorable to us. In the case of equity financings, dilution to our stockholders could result and the securities sold may have rights, preferences and privileges senior to the common stock sold in this offering. In addition, under certain circumstances, we may sell our common stock, or securities convertible or exchangeable into shares of our common stock, at a price per share less than the

market value of our common stock. In the case of debt financings, we may be subject to unfavorable interest rates and covenants that restrict our ability to operate our business freely. We may need to finance our expansion or future acquisitions with borrowings under one or more financing facilities. As of the date of this prospectus, we do not have any commitment for any such facility. If we cannot obtain financing on commercially reasonable terms, we may be required to modify our expansion plans, delay acquisitions or incur higher than anticipated financing costs, any of which could have an adverse impact on the execution of our growth strategy and business. If we cannot obtain adequate capital on favorable terms or at all, we may be unable to support future growth or operating requirements, and, as a result, our business, financial condition and results of operations could be adversely affected.

Assessments for state guaranty funds and second injury funds and other mandatory pooling arrangements may reduce our profitability.

Most states require insurance companies licensed to do business in their state to participate in guaranty funds, which require the insurance companies to bear a portion of the unfunded obligations of impaired, insolvent or failed insurance companies. These obligations are funded by assessments, which are expected to continue in the future. State guaranty associations levy assessments, up to prescribed limits, on all member insurance companies in the state based on their proportionate share of premiums written in the lines of business in which the impaired, insolvent or failed insurance companies are engaged. See “Business — Regulation.” Accordingly, the assessments levied on Guarantee Insurance may increase as it increases its premiums written. Some states also have laws that establish second injury funds to reimburse insurers and employers for claims paid to injured employees for aggravation of prior conditions or injuries. These funds are supported by assessments based on premiums or paid losses. For the years ended December 31, 2008 and 2007, gross expenses incurred in connection with assessments for state guaranty funds and second injury funds were $4.1 million and $3.4 million, respectively. Our alternative market customers reimburse us for their pro rata share of any such amounts that we are assessed with respect to premiums written for such customers.

In addition, as a condition to conducting business in some states, insurance companies are required to participate in residual market programs to provide insurance to those employers who cannot procure coverage from an insurance carrier on a negotiated basis. Insurance companies generally can fulfill their residual market obligations by, among other things, participating in a reinsurance pool where the results of all policies provided through the pool are shared by the participating insurance companies. Although we price our insurance to account for obligations we may have under these pooling arrangements, we may not be successful in estimating our liability for these obligations. It is possible that losses from our participation in these pools may exceed the premiums we receive from the pools. Accordingly, mandatory pooling arrangements may cause a decrease in our profits. Guarantee Insurance currently participates in the NCCI national workers’ compensation insurance pool. Net underwriting income (losses) associated with this mandatory pooling arrangement for the years ended December 31, 2008 and 2007 were approximately ($98,000) and $159,000, respectively. As we write policies in new states that have mandatory pooling arrangements, we will be required to participate in additional pooling arrangements. Furthermore, the impairment, insolvency or failure of other insurance companies in these pooling arrangements would likely increase our liability under these pooling arrangements. The effect of assessments or changes in assessments could reduce our profitability in any given period or limit our ability to grow our business.

The outcome of insurance industry investigations and regulatory proposals could adversely affect our business, financial condition and results of operations.

The United States insurance industry has in recent years become the focus of investigations and increased scrutiny by regulatory and law enforcement authorities, as well as class action attorneys and the general public, relating to allegations of improper special payments, price-fixing, bid-rigging, improper accounting practices and other alleged misconduct, including payments made by insurers to brokers and the practices surrounding the placement of insurance business. Formal and informal inquiries have been made of a large segment of the industry, and a number of companies in the insurance industry have received or may receive subpoenas, requests for information from regulatory agencies or other inquiries relating to these and similar

matters. For example, on September 28, 2007, we received a Subpoena from the New Jersey Office of the Insurance Fraud Prosecutor regarding insurance policies issued to one of our policyholders. We have responded to the subpoena and expect no further action. These efforts have resulted and are expected to result in both enforcement actions and proposals for new state and federal regulation. Some states have adopted new disclosure requirements in connection with the placement of insurance business. It is difficult to predict the outcome of these investigations, whether they will expand into other areas not yet contemplated, whether activities and practices currently thought to be lawful will be characterized as unlawful, what form any additional laws or regulations will have when finally adopted and the impact, if any, of increased regulatory and law enforcement action and litigation on our business, financial condition and results of operations.

Recently, Congress has examined a possible repeal of the McCarran-Ferguson Act, which exempts the insurance industry from federal anti-trust laws. There can be no assurance that the McCarran-Ferguson Act will not be repealed, or that any such repeal, if enacted, would not have a material adverse effect on our business, financial condition and results of operations.

We may have exposure to losses from terrorism for which we are required by law to provide coverage.

When writing workers’ compensation insurance policies, we are required by law to provide workers’ compensation benefits for losses arising from acts of terrorism. The impact of any terrorist act is unpredictable, and the ultimate impact on our business would depend upon the nature, extent, location and timing of such an act as well as the availability of any reinsurance that we purchase for terrorism losses and of any assistance for the payment of such losses provided by the Federal government pursuant to the Terrorism Risk Insurance Act of 2002, or TRIA.

TRIA provides co-assistance to commercial property and casualty insurers for payment of losses from an act of terrorism which is declared by the U.S. Secretary of Treasury to be a “certified act of terrorism.” Assistance under the TRIA program is subject to other limitations and restrictions. Such assistance is only available for losses from a certified act of terrorism if aggregate insurance industry losses from the act exceed $100 million. As originally enacted, TRIA only applied to acts of terrorism committed on behalf of foreign persons or interests. However, legislation extending the program through December 31, 2014 removed this restriction so that TRIA now applies to both domestic and foreign terrorism occurring in the U.S. Under the TRIA program, the federal government covers 85% of the losses from covered certified acts of terrorism in excess of a deductible amount. This deductible is calculated as 20% of an affiliated insurance group’s prior year premiums on commercial lines policies (with certain exceptions, such as commercial auto insurance policies) covering risks in the United States. We estimate that our deductible would be approximately $23.5 million for 2009. Because TRIA does not cover 100% of our exposure to terrorism losses and there are substantial limitations and restrictions on the protection against terrorism losses provided to us by our reinsurance, the risk of severe losses to us from acts of terrorism remains. Accordingly, events constituting acts of terrorism may not be covered by, or may exceed the capacity of, our reinsurance and TRIA protections and could adversely affect our business, financial condition and results of operations.

The federal terrorism risk assistance provided by TRIA will expire at the end of 2014 and may not be renewed. Any renewal may be on substantially less favorable terms.

Risks Related to Our Common Stock and This Offering

There has been no prior public market for our common stock, and, therefore, you cannot be certain that an active trading market or a specific share price will be established.

Currently, there is no public trading market for our common stock, and it is possible that an active trading market will not develop upon completion of this offering or that the market price of our common stock will decline below the initial public offering price. Our common stock has been approved for listing on the New York Stock Exchange under the symbol “PMG.” The initial public offering price per share will be determined by negotiation among us and the underwriters and may not be indicative of the market price of our common stock after completion of this offering.

The trading price of our common stock may decline after this offering.

The trading price of our common stock may decline after this offering for many reasons, some of which are beyond our control, including, among others:


	•	our results of operations;

	•	changes in expectations as to our future results of operations, including financial estimates and projections by securities analysts and investors;

	•	results of operations that vary from those expected by securities analysts and investors;

	•	developments in the healthcare or insurance industry;

	•	changes in laws and regulations;

	•	announcements of claims against us by third parties;

	•	future sales of our common stock;

	•	rising levels of claims costs, including medical and prescription drug costs, that we cannot anticipate at the time we establish our premium rates;

	•	fluctuations in interest rates, inflationary pressures and other changes in the investment environment that affect returns on invested assets;

	•	changes in the frequency or severity of claims;

	•	the financial stability of our reinsurers and changes in the level of reinsurance capacity and our capital and surplus;

	•	new types of claims and new or changing judicial interpretations relating to the scope of liabilities of insurance companies;

	•	volatile and unpredictable developments, including man-made, weather-related and other natural catastrophes or terrorist attacks; and

	•	price competition.

In addition, the stock market in general has experienced significant volatility that often has been unrelated to the operating performance of companies whose shares are traded. These market fluctuations could adversely affect the trading price of our common stock, regardless of our actual operating performance. As a result, the trading price of our common stock may be less than the initial public offering price, and you may not be able to sell your shares at or above the price you pay to purchase them.

Public investors will suffer immediate and substantial dilution as a result of this offering.

The initial public offering price per share is significantly higher than our pro forma net tangible book value per share of our common stock. Accordingly, if you purchase shares in this offering, you will suffer immediate and substantial dilution of your investment. Based upon the issuance and sale of 21,200,000 shares of our common stock at an assumed initial offering price of $8.00 per share, and the concurrent private placement of 672,043 shares of our common stock at this assumed price per share, less an amount equal to the underwriting discounts and commissions, you will incur immediate dilution of approximately $0.82 in the pro forma net tangible book value per share if you purchase common stock in this offering. See “Dilution.” In addition, investors in this offering will:


	•	pay a price per share that substantially exceeds the book value of our assets after subtracting liabilities; and


	•	contribute 95.5% of the total amount invested to date to fund our company based on an assumed initial offering price to the public of $8.00 per share, but will own only 90.6% of the shares of common stock outstanding after completion of this offering.

Future sales of our common stock may affect the trading price of our common stock and the future exercise of options may lower the price of our common stock.

We cannot predict what effect, if any, future sales of our common stock, or the availability of shares for future sale, will have on the trading price of our common stock. Sales of a substantial number of shares of our common stock in the public market after completion of this offering, or the perception that such sales could occur, may adversely affect the trading price of our common stock and may make it more difficult for you to sell your shares at a time and price that you determine appropriate. See “Shares Eligible for Future Sale” for further information regarding circumstances under which additional shares of our common stock may be sold. Upon completion of this offering and the concurrent private placement, there will be 23,390,911 shares of our common stock outstanding. An additional 700,000 shares of common stock will be issuable upon the exercise of warrants we intend to distribute to our existing stockholders immediately prior to the completion of this offering, at an exercise price equal to the initial public offering price. Moreover, 187,235 additional shares of our common stock are issuable upon the exercise of options granted under our equity compensation plans prior to the completion of this offering and 2,192,702 shares will be issuable upon the exercise of outstanding options that we intend to grant to our directors, executive officers and other employees upon the completion of this offering, at an exercise price equal to the initial public offering price. Following completion of this offering, we intend to register all 2,379,937 of these shares and also the 427,428 shares reserved for issuance under the 2010 Stock Incentive Plan. See “Description of Capital Stock” and “Executive Compensation.” We and our current directors, executive officers and stockholders have entered into 180-day lock-up agreements. The lock-up agreements are described in “Shares Eligible for Future Sale — Lock-Up Agreements.” An aggregate of 1,518,868 shares of our common stock will be subject to these lock-up agreements upon completion of this offering (excluding any shares these persons may purchase in our directed share program). We expect that we will enter into a registration rights agreement with the affiliate of FBR in connection with the concurrent private placement, pursuant to which we will agree to register the resale of the shares of our common stock that the affiliate purchases in the concurrent private placement. We also expect that we will enter into a 180-day lock-up agreement with the affiliate of FBR relating to the 672,043 shares of our common stock that such affiliate will purchase in the concurrent private placement.

Being a public company will increase our expenses and administrative workload and will expose us to risks relating to evaluation of our internal controls over financial reporting required by Section 404 of the Sarbanes-Oxley Act of 2002.

As a public company, we will need to comply with additional laws and regulations, including the Sarbanes-Oxley Act of 2002 and related rules of the Securities and Exchange Commission, or the SEC, and requirements of the New York Stock Exchange. We were not required to comply with these laws and requirements as a private company. Complying with these laws and regulations will require the time and attention of our board of directors and management and will increase our expenses. Among other things, we will need to: design, establish, evaluate and maintain a system of internal controls over financial reporting in compliance with the requirements of Section 404 of the Sarbanes-Oxley Act and the related rules and regulations of the SEC and the Public Company Accounting Oversight Board; prepare and distribute periodic reports in compliance with our obligations under the federal securities laws; establish new internal policies, principally those relating to disclosure controls and procedures and corporate governance; institute a more comprehensive compliance function; and involve to a greater degree our outside legal counsel and accountants in the above activities.

In addition, we also expect that being a public company will make it more expensive for us to obtain director and officer liability insurance. We may be required to accept reduced coverage or incur substantially higher costs to obtain this coverage. These factors could also make it more difficult for us to attract and retain qualified executives and members of our board of directors, particularly directors willing to serve on our audit committee.

We are in the process of evaluating our internal control systems to allow management to report on, and our independent auditors to assess, our internal controls over financial reporting. We plan to perform the system and process evaluation and testing (and any necessary remediation) required to comply with the management certification and auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act. We are required to comply with Section 404 in our annual report for the year ending December 31, 2010.

However, we cannot be certain as to the timing of completion of our evaluation, testing and remediation actions or the impact of the same on our operations. Furthermore, upon completion of this process, we may identify control deficiencies of varying degrees of severity under applicable SEC and Public Company Accounting Oversight Board rules and regulations that remain unremediated.

If we fail to implement the requirements of Section 404 in a timely manner, we might be subject to sanctions or investigation by regulatory agencies such as the SEC. In addition, failure to comply with Section 404 or the report by us of a material weakness may cause investors to lose confidence in our financial statements or the trading price of our common stock to decline. If we fail to remediate any material weakness, our financial statements may be inaccurate, our access to the capital markets may be restricted and the trading price of our common stock may decline.

As a public company, we will be required to report, among other things, control deficiencies that constitute a “material weakness” or changes in internal controls that materially affect, or are reasonably likely to materially affect, internal controls over financial reporting. A “control deficiency” exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis. A “significant deficiency” is a control deficiency, or combination of control deficiencies, that adversely affects the ability to initiate, authorize, record, process or report financial data reliably in accordance with generally accepted accounting principles that results in more than a remote likelihood that a misstatement of financial statements that is more than inconsequential will not be prevented or detected. A “material weakness” is a significant deficiency, or a combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

Our independent registered public accounting firm has in the past identified certain deficiencies in internal controls that it considered to be control deficiencies and material weaknesses. If we fail to remediate these internal control deficiencies and material weaknesses and maintain an effective system of internal controls over financial reporting, we may not be able to accurately report our financial results.

During their audit of our financial statements for the year ended December 31, 2006, BDO Seidman, LLP, our independent registered public accounting firm (independent auditors), identified certain deficiencies in internal controls that they considered to be control deficiencies and material weaknesses. Specifically, our independent auditors identified material weaknesses relating to: (1) a lack of independent reconciliation regarding the schedule of premiums receivable, and (2) problems regarding the files maintained for reinsurance agreements, making it difficult to determine which agreement was in force and which versions of the various agreements are in force.

In response, we initiated corrective actions to remediate these control deficiencies and material weaknesses, including the implementation of timely account reconciliations, formal purchasing policies, accurate premium tax accruals, the appropriate segregation of accounting duties, a formal impairment analysis for intangible assets, proper accounting for equity-based compensation in accordance with Financial Accounting Standards Board (FASB) guidance and enhanced reinsurance documentation and risk transfer analysis.

Our independent auditors did not identify any material weaknesses during their audit of our 2007 and 2008 financial statements. However, during their audit of our financial statements for the year ended December 31, 2008, our independent auditors identified certain deficiencies in internal controls that they considered to be significant control deficiencies, but not material weaknesses. The significant control deficiencies identified by our independent auditors related to insufficient internal controls in our financial reporting process, specifically due to a lack of segregation of duties in the financial statement preparation process, and the insufficient assessment and documentation of management’s consideration of significant accounting issues, including the appropriate accounting literature cited, conclusions reached and an appropriate level of review and approval for such decisions. In connection with their review of our financial statements for the nine months ended September 30, 2009, our independent auditors noted that certain of these significant deficiencies had not yet been remediated. In response, we have taken the following actions to address these deficiencies: improving our financial statement review process by adding an independent review of the financial statements by qualified management, actively seeking to hire a corporate controller who is a certified public accountant with significant

public-company accounting and reporting experience, identifying other accounting personnel requirements, and initiating the process to engage a qualified independent consulting firm to evaluate our internal controls and identify areas for improvement, including areas related to the deficiencies identified by our independent auditors. However, we have not yet completed the process of identifying and implementing enhanced controls that we believe will be necessary to remediate these deficiencies.

It is possible that we or our independent auditors may identify additional significant deficiencies or material weaknesses in our internal control over financial reporting in the future. Any failure or difficulties in implementing and maintaining these controls could cause us to fail to meet the periodic reporting obligations that we will become subject to after this offering or result in material misstatements in our financial statements. The existence of a material weakness could result in errors to our financial statements requiring a restatement of our financial statements, cause us to fail to meet our reporting obligations and cause investors to lose confidence in our reported financial information, which could lead to a decline in our stock price.

Due to the concentration of our capital stock ownership with our founder, Chairman, President and Chief Executive Officer, Steven M. Mariano, he may be able to influence stockholder decisions, which may conflict with your interests as a stockholder.

Immediately upon completion of this offering and the concurrent private placement, Steven M. Mariano, our founder, Chairman, President and Chief Executive Officer, directly and through trusts that he controls, will beneficially own shares representing approximately 5.4% of the voting power of our common stock. As a result of his ownership position, Mr. Mariano may have the ability to significantly influence matters requiring stockholder approval, including, without limitation, the election or removal of directors, mergers, acquisitions, changes of control of our company and sales of all or substantially all of our assets. Your interests as a stockholder may conflict with his interests, and the trading price of shares of our common stock could be adversely affected.

Provisions in our executive officers’ employment agreements, our indemnity agreement with Mr. Mariano and provisions in our certificate of incorporation and bylaws and under the laws of the State of Delaware and the State of Florida could impede an attempt to replace or remove our directors or otherwise effect a change of control of Patriot Risk Management, which could diminish the price of our common stock.

We have entered into employment agreements with our executive officers. These agreements provide for substantial payments upon a change in control. These payments may deter any transaction that would result in a change in control. See “Executive Compensation — Employment Agreements.”

We have entered into an indemnification and pledge agreement with Steven M. Mariano, our Chairman, President and Chief Executive Officer, under which Mr. Mariano has agreed to indemnify us against certain losses, if any, suffered as a result of the litigation between us and Westwind, PES and other related entities as described above. This agreement will terminate upon the occurrence of a change in control of Patriot. The loss of this indemnification protection upon a change of control may deter any transaction that would result in a change of control. See “Certain Relationships and Related Transactions — Westwind Holding Company, LLC and Progressive Employer Services.”

Our charter and bylaws contain provisions that may entrench directors and make it more difficult for stockholders to replace directors even if the stockholders consider it beneficial to do so. In particular, stockholders are required to provide us with advance notice of stockholder nominations and proposals to be brought before any annual meeting of stockholders, which could discourage or deter a third party from conducting a solicitation of proxies to elect its own slate of directors or to introduce a proposal. In addition, our charter eliminates our stockholders’ ability to act without a meeting.

These provisions could delay or prevent a change of control that a stockholder might consider favorable. For example, these provisions may prevent a stockholder from receiving the benefit from any premium over the market price of our common stock offered by a bidder in a potential takeover. Even in the absence of an attempt to effect a change in management or a takeover attempt, these provisions may materially adversely affect the prevailing market price of our common stock if they are viewed as discouraging changes in management and takeover attempts in the future.

Further, our amended and restated certificate of incorporation and our amended and restated bylaws provide that the number of directors shall be fixed from time to time by our board of directors, provided that the board shall consist of at least three and no more than thirteen members. Our board of directors is divided into three classes with the number of directors in each class being as nearly equal as possible. Each director serves a three-year term. The classification and term of office for each of our directors is noted in the table listing our directors and executive officers under “Management — Directors, Executive Officers and Key Employees.” These provisions make it more difficult for stockholders to replace directors, which may materially adversely affect the prevailing market price of our common stock if they are viewed as discouraging changes in management and takeover attempts in the future.

In addition, Section 203 of the Delaware General Corporation Law may limit the ability of an “interested stockholder” to engage in business combinations with us. An interested stockholder is defined to include persons owning 15% or more of any class of our outstanding voting stock. See “Description of Capital Stock — Anti-Takeover Effects of Delaware Law and Our Certificate of Incorporation and Bylaws.”

Florida insurance law prohibits any person from acquiring 5% or more of our outstanding voting securities or those of any of our insurance subsidiaries without the prior approval of the Florida OIR. However, a party may acquire less than 10% of our voting securities without prior approval if the party files a disclaimer of affiliation and control. Any person wishing to acquire control of us or of any substantial portion of our outstanding shares would first be required to obtain the approval of the Florida OIR or file such a disclaimer. In addition, any transaction that would constitute a change of control of Guarantee Insurance, including a change of control of Patriot, may require pre-notification in other states in which Guarantee Insurance operates. Obtaining these approvals may result in the material delay of, or may deter, any such transaction.

FORWARD-LOOKING STATEMENTS

Some of the statements under the captions “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” and elsewhere in this prospectus may include forward-looking statements. These statements reflect the current views of our senior management with respect to future events and our financial performance. These statements include forward-looking statements with respect to our business and the insurance industry in general. Statements that include the words “expect,” “intend,” “plan,” “believe,” “project,” “estimate,” “may,” “should,” “anticipate” and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the federal securities laws or otherwise.

Forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in these statements. We believe that these factors include, but are not limited to, the following:


	•	greater frequency or severity of claims and loss activity, including as a result of natural or man-made catastrophic events, than our underwriting, reserving or investment practices anticipate based on historical experience or industry data;

	•	increased competition on the basis of coverage availability, claims management, loss control services, payment terms, premium rates, policy terms, types of insurance offered, overall financial strength, financial ratings and reputation;

	•	regulatory risks, including further rate decreases in Florida and other states where we write business;

	•	the cyclical nature of the workers’ compensation insurance industry;

	•	negative developments in the workers’ compensation insurance industry;

	•	decreased level of business activity of our policyholders;

	•	decreased demand for our insurance;

	•	adverse developments regarding our legacy asbestos and environmental claims arising from policies written or assumed prior to 1983;

	•	changes in the availability, cost or quality of reinsurance and the failure of our reinsurers to pay claims in a timely manner or at all;

	•	changes in regulations or laws applicable to us, our policyholders or the agencies that sell our insurance;

	•	changes in rating agency policies or practices;

	•	changes in legal theories of liability under our insurance policies;

	•	developments in capital markets that adversely affect the performance of our investments;

	•	loss of the services of any of our senior management or other key employees;

	•	the effects of U.S. involvement in hostilities with other countries and large-scale acts of terrorism, or the threat of hostilities or terrorist acts; and

	•	changes in general economic conditions, including inflation and other factors.

The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this prospectus, including in particular the risks described under “Risk Factors” beginning on page 14 of this prospectus. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. Any forward-looking statements you read in this prospectus reflect our views as of the date of this prospectus with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. Before making a decision to purchase our common stock, you should carefully consider all of the factors identified in this prospectus that could cause actual results to differ.

USE OF PROCEEDS

We estimate that our net proceeds from this offering and the concurrent private placement, based on (1) the sale of 21,200,000 shares of our common stock at an assumed initial public offering price of $8.00 per share, after deducting the underwriting discounts and commissions and our estimated offering expenses, and (2) the concurrent private placement of 672,043 shares of our common stock to an affiliate of FBR at a price per share equal to the assumed offering price, less an amount equal to the underwriting discounts and commissions, will be approximately $160.3 million. We estimate that our net proceeds from this offering and the concurrent private placement will be $184.0 million if the underwriters exercise their over-allotment option in full.

We intend to contribute approximately $155.0 million to Guarantee Insurance to support its premium writings. As described elsewhere in this prospectus, we have entered into a stock purchase agreement to acquire PF&C, a shell property and casualty insurance company. The acquisition of PF&C is subject to various regulatory approvals. If we obtain these regulatory approvals and consummate the acquisition on or prior to March 31, 2010, we plan instead to use approximately $16.7 million of the net proceeds of this offering and the concurrent private placement to pay the purchase price for PF&C (of which approximately $15.5 million represents the capital and surplus of PF&C), to contribute approximately $119.5 million to PF&C to support its premium writings (thereby increasing PF&C’s capital and surplus to $135 million), and to contribute approximately $20.0 million to Guarantee Insurance to support its premium writings.

We expect that the remaining $5.3 million, or $4.1 million if we acquire PF&C, will be used to support our anticipated growth and general corporate purposes and to fund other holding company operations, including the repayment of all or a portion of our existing indebtedness and potential acquisitions, although we have no current understandings or agreements regarding any such acquisitions (other than PF&C).

If the underwriters exercise all or any portion of their over-allotment option, we intend to use all or a substantial portion of the net proceeds from any such exercise to pay down the balance of our credit facilities with Brooke Credit Corporation (Brooke) and ULLICO, Inc. (ULLICO). If the over-allotment option is exercised in full, we intend to use approximately $11.1 million and $4.9 of the net proceeds therefrom to pay off the credit facilities with Brooke and ULLICO, respectively, and the remaining $13.0 million, or $11.8 million if we acquire PF&C, for general corporate purposes.

Pending the use of the net proceeds from this offering and the concurrent private placement as discussed above, we may invest some of the proceeds in certain short-term high-grade instruments.

DIVIDEND POLICY

We do not expect to pay any cash dividends on our common stock for the foreseeable future. We currently intend to retain any additional future earnings to finance our operations and growth. Any future determination to pay cash dividends on our common stock will be at the discretion of our board of directors and will be dependent on our earnings, financial condition, operating results, capital requirements, any contractual, regulatory and other restrictions on the payment of dividends by us or by our subsidiaries to us, and other factors that our board of directors deems relevant.

Patriot Risk Management is a holding company and has no direct operations. Our ability to pay dividends in the future depends on the ability of our operating subsidiaries to pay dividends to us. Neither PRS nor PUI is statutorily restricted from paying dividends to us, although our credit facilities prohibit us and our operating subsidiaries from paying any dividends on our and their respective capital stock without the consent of our lenders at anytime when Patriot Risk Management’s consolidated stockholders’ equity is less than $50 million. In addition, future debt agreements may contain certain prohibitions or limitations on the payment of dividends. Because Guarantee Insurance is, and if we acquire it, PF&C will be, regulated by the Florida OIR, both companies will be subject to significant regulatory restrictions limiting their ability to declare and pay dividends.

At the time we acquired Guarantee Insurance, it had a large statutory unassigned deficit. As of September 30, 2009, Guarantee Insurance’s statutory unassigned deficit was $95.5 million. Under Florida law, insurance companies may only pay dividends out of available and accumulated surplus funds which are derived from realized net operating profits on their business and net realized capital gains, except under certain limited circumstances with the approval of the Florida OIR. Consequently, for the foreseeable future no dividends may be paid by Guarantee Insurance except with the prior approval of the Florida OIR.

For additional information regarding restrictions on the payment of dividends by us and our insurance company subsidiaries, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” and “Business — Regulation — Dividend Limitations.”

CAPITALIZATION

The table below sets forth our consolidated capitalization as of September 30, 2009 on an actual basis and on an as adjusted basis giving effect to (i) the sale of 21,200,000 shares of common stock in this offering at an assumed initial public offering price of $8.00 per share, after deducting the underwriting discounts and commissions and our estimated offering expenses, (ii) the concurrent private placement of 672,043 shares of our common stock to an affiliate of FBR at a price per share equal to the assumed offering price, less an amount equal to the underwriting discounts and commissions, and (iii) the conversion our outstanding shares of Series A convertible preferred stock into 198,423 shares of common stock at an assumed initial public offering price of $8.00 per share, and assuming that the underwriters do not exercise their over-allotment option.

You should read this table in conjunction with the “Use of Proceeds,” “Selected Historical Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections of this prospectus and our financial statements and related notes included in the back of this prospectus.


	As of September 30, 2009
	Actual		As Adjusted
	(Unaudited)
	In thousands

Debt Outstanding
Notes payable	$	16,815	$	16,815
Surplus notes		1,187		1,187
Subordinated debentures		1,634		1,634

Total debt outstanding		19,636		19,636

Stockholders’ equity
Series A convertible preferred stock, par value $.001 per share, 1,200 shares authorized; 1,000 shares issued and outstanding, actual; no shares issued and outstanding, as adjusted(1)		1,000		—
Preferred stock, par value $.001 per share, 5,000,000 shares authorized; no shares issued and outstanding, actual and as adjusted		—		—
Common stock, par value $.001 per share, 40,000,000 shares authorized, 398,685 shares issued and outstanding, actual; 23,390,911 shares issued or outstanding, as adjusted		—		23
Series B common stock, par value $.001 per share, 4,000,000 shares authorized, 921,760 shares issued and outstanding, actual; no shares authorized, issued or outstanding, as adjusted(2)		1		—
Additional paid-in capital(1)		5,521		167,328
Retained earnings(1)		2,390		1,890
Accumulated other comprehensive income (loss), net of deferred income tax expense (benefit)		1,216		1,216

Total stockholders’ equity		10,129		170,457

Total capitalization	$	29,765	$	190,093


(1)		At the closing of this offering, our outstanding shares of Series A convertible preferred stock will be automatically converted into 198,423 shares of common stock, based on an assumed initial public offering price of $8.00 per share. We expect to record a beneficial conversion feature of approximately $500,000 as a result of the conversion of the Series A convertible preferred stock that will be reflected as a preferred stock dividend at the time of the conversion, resulting in a $500,000 decrease in income available to common stockholders, a $500,000 reduction in retained earnings and a corresponding increase in additional paid in capital.


(2)		At the closing of this offering, all outstanding shares of Series B common stock will be automatically converted into shares of common stock on a one-for-one basis.

The number of shares of common stock shown to be outstanding upon the completion of this offering and the concurrent private placement excludes:


	•	up to 3,180,000 shares of common stock that may be issued pursuant to the underwriters’ over-allotment option;


	•	187,235 shares of common stock issuable upon the exercise of options outstanding as of December 31, 2009;


	•	2,192,702 shares of common stock issuable upon the exercise of stock options we intend to grant to our directors, executive officers and other employees upon completion of this offering, at an exercise price equal to the initial public offering price;


	•	700,000 shares of common stock issuable upon the exercise of warrants that will be distributed to our existing stockholders upon completion of this offering, at an exercise price equal to the initial public offering price; and


	•	427,428 additional shares available for future issuance under our 2010 Stock Incentive Plan.

DILUTION

As of September 30, 2009, our net tangible book value was $8.8 million, or $6.70 per share of common stock. Net tangible book value per share represents the amount of our total tangible assets less our total liabilities divided by the number of shares of our common stock outstanding. Our net tangible book value as of September 30, 2009 is presented in the table below on a pro forma basis, assuming the conversion of our outstanding shares of Series A convertible preferred stock into 198,423 shares of common stock based on an assumed public offering price of $8.00 per share. As of September 30, 2009, this pro forma net tangible book value was $8.8 million, or $5.82 per share of common stock. Our pro forma net tangible book value per share after this offering represents the amount of our total tangible assets less total liabilities divided by the number of shares of common stock outstanding, and assuming the conversion of our outstanding shares of Series A convertible preferred stock as described above. After giving effect to the issuance of 21,200,000 shares of our common stock at the assumed initial public offering price of $8.00 per share, and the concurrent private placement of 672,043 shares of our common stock to an affiliate of FBR at a price per share equal to the assumed initial public offering price, less an amount equal to the underwriting discounts and commissions, and the application of the estimated net proceeds therefrom (including for the acquisition of PF&C), and after deducting estimated underwriting discounts and commissions and our estimated offering expenses, as of September 30, 2009 this pro forma net tangible book value would have been approximately $168.0 million, or $7.18 per share of common stock. This amount represents an immediate increase in net tangible book value of $1.36 per share to our existing stockholders (assuming the conversion of our outstanding shares of Series A convertible preferred stock as described above) and an immediate dilution of $0.82 per share from the assumed initial public offering price of $8.00 per share issued to new investors purchasing shares in this offering. The table below illustrates the dilution on a per share basis:


Assumed initial public offering price per share			$	8.00
Pro forma net tangible book value per share as of September 30, 2009	$	5.82
Increase in pro forma net tangible book value per share attributable to this offering and the concurrent private placement		1.36

Pro forma net tangible book value per share after this offering and the concurrent private placement				7.18

Dilution per share to new investors in this offering(1)			$	0.82


(1)		If the underwriters’ over-allotment is exercised in full, dilution per share to new investors will be $0.79.

The table below sets forth, as of September 30, 2009, the number of shares of our common stock issued to (assuming the conversion of our outstanding shares of Series A convertible preferred stock into 198,423 shares of common stock), the total consideration paid, and the average price per share paid, by our existing stockholders, the investors in the concurrent private placement discussed above and our new investors in this offering, after giving effect to the issuance of 21,200,000 shares of common stock in this offering at the assumed initial public offering price of $8.00 per share, before deducting underwriting discounts and commissions and our estimated offering expenses, and the concurrent private placement of 672,043 shares of our common stock to an affiliate of FBR at a price per share equal to the assumed offering price, less an amount equal to the underwriting discounts and commissions.


											Average
	Shares Issued					Total Consideration					Price
	Number		Percent			Amount		Percent			per Share

Existing stockholders		1,518,868		6.5	%	$	2,974,012		1.7	%	$	1.96
Investors in concurrent private placement		672,043		2.9			5,000,000		2.8			7.44
New investors		21,200,000		90.6			169,600,000		95.5			8.00

Total		23,390,911		100.0	%	$	177,574,012		100.0	%	$	7.59

This table does not give effect to:


	•	up to 3,180,000 shares of common stock that may be issued pursuant to the underwriters’ over-allotment option;


	•	187,235 shares of common stock issuable upon the exercise of options outstanding as of December 31, 2009;


	•	2,192,702 shares of common stock issuable upon the exercise of stock options we intend to grant to our directors, executive officers and other employees upon completion of this offering, at an exercise price equal to the initial public offering price;


	•	700,000 shares of common stock issuable upon the exercise of warrants that will be distributed to our existing stockholders immediately prior to the completion of this offering, at an exercise price equal to the initial public offering price; and


	•	427,428 additional shares available for future issuance under our 2010 Stock Incentive Plan.

To the extent that options with an exercise price below the initial price to the public are exercised, there will be further dilution to new investors.

SELECTED HISTORICAL CONSOLIDATED FINANCIAL INFORMATION

The following table sets forth selected consolidated financial information as of such dates and for such periods indicated below. The following income statement data for the nine months ended September 30, 2009 and 2008 and balance sheet data as of September 30, 2009 were derived from our unaudited consolidated financial statements included elsewhere in this prospectus. Such unaudited financial statements include, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, which we consider necessary for a fair presentation of our financial position and results of operations. The income statement data for the years ended December 31, 2008, 2007 and 2006 and balance sheet data as of December 31, 2008 and 2007 were derived from our audited consolidated financial statements included elsewhere in this prospectus. The income statement data for the years ended December 31, 2005 and 2004 and balance sheet data as of December 31, 2006, 2005 and 2004 were derived from our audited consolidated financial statements that are not included in this prospectus. These historical results are not necessarily indicative of results to be expected in any future period. You should read the following summary financial information together with the other information contained in this prospectus, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and related notes.


	Nine Months
	Ended September 30,						Years Ended December 31,
	2009			2008			2008			2007			2006			2005			2004
	In thousands, except per share data and percentages

Income Statement Data
Gross premiums written	$	95,972		$	94,878		$	117,563		$	85,810		$	62,372		$	47,576		$	30,911
Ceded premiums written		56,573			52,926			71,725			54,894			42,986			23,617			22,702

Net premiums written		39,399			41,952			45,838			30,961			19,386			23,959			8,209

Revenues
Net premiums earned		28,369			32,276			49,220			24,613			21,053			21,336			2,948
Insurance services income		9,753			4,706			5,657			7,027			7,175			4,369			6,429
Net investment income		1,354			1,487			2,028			1,326			1,321			1,077			233
Net realized gains (losses) on investments		903			(253	)		(1,037	)		(5	)		(1,346	)		(2,298	)		(4,632	)

Total revenues		40,379			38,216			55,868			32,961			28,203			24,484			4,978

Expenses
Net losses and loss adjustment expenses		15,864			20,719			28,716			15,182			17,839			12,022			2,616
Net policy acquisition and underwriting expenses		8,498			8,176			13,535			6,023			3,834			3,168			2,016
Other operating expenses		11,100			8,055			10,930			8,519			9,704			6,378			4,989
Interest expense		1,119			1,102			1,437			1,290			1,109			1,129			555

Total expenses		36,581			38,052			54,618			31,014			32,486			22,697			10,176

Other income		—			219			1,469			—			796			—			110
Loss from write-off of deferred equity offering costs(1)		—			—			(3,486	)		—			—			—			—
Gain on early extinguishment of debt(2)		—			—			—			—			6,586			—			—

Income (loss) before income tax expense benefit		3,798			383			(767	)		1,947			3,099			1,787			(5,088	)
Income tax expense (benefit)		1,422			(217	)		(643	)		(432	)		1,489			687			(751	)

Net income (loss)	$	2,376		$	600		$	(124	)	$	2,379		$	1,610		$	1,100		$	(4,337	)

Earnings Per Share
Basic	$	1.70		$	0.38		$	(0.08	)		1.54		$	1.00		$	0.76			NM	(3)
Diluted		1.68			0.38			(0.08	)		1.53			1.00			0.76			NM	(3)
Weighted Average Common Shares Outstanding:
Basic		1,401			1,568			1,568			1,546			1,604			1,442			NM	(3)
Diluted		1,411			1,579			1,568			1,557			1,611			1,450			NM	(3)
Return on average equity(4)		36.7	%		15.1	%		NM(5	)		58.5	%		107.0	%		NM(6	)		NM	(7)
Selected Insurance Ratios(8)
Net loss ratio		55.9	%		64.2	%		58.3	%		61.7	%		84.7	%		56.3	%		NM	(3)
Net expense ratio		30.0	%		25.3	%		27.5	%		24.5	%		18.2	%		14.8	%		NM	(3)

Net combined ratio		85.9	%		89.5	%		85.8	%		86.2	%		102.9	%		71.1	%		NM	(3)


	September 30,		December 31,
	2009		2008		2007		2006		2005		2004
	In thousands

Balance Sheet Data
Investments	$	47,051	$	55,089	$	56,816	$	32,543	$	20,955	$	16,446
Cash and cash equivalents		7,452		8,333		4,946		17,841		20,420		3,965
Amounts recoverable from reinsurers		58,328		42,134		47,519		41,531		22,955		10,978
Premiums receivable, net		83,040		58,826		36,748		19,450		21,943		19,244
Prepaid reinsurance premiums		42,010		33,731		14,963		7,466		4,402		14,925
Other assets		19,910		13,179		14,248		11,838		9,563		8,957

Total assets	$	257,791	$	211,292	$	175,237	$	130,669	$	100,238	$	74,515

Reserves for losses and loss adjustment expenses		83,210		74,550		69,881		65,953		39,478		19,885
Unearned and advanced premium reserves		63,702		44,613		29,160		15,643		13,214		20,185
Reinsurance funds withheld and balances payable		56,458		47,449		44,073		26,787		25,195		15,697
Debt and accrued interest		20,089		22,592		16,907		11,741		11,995		10,379
Other liabilities		24,203		14,951		9,780		7,851		10,040		8,324

Total liabilities		247,662		204,155		169,801		127,975		99,922		74,470
Stockholders’ equity		10,129		7,137		5,436		2,694		316		45

Total liabilities and stockholders’ equity	$	257,791	$	211,292	$	175,237	$	130,669	$	100,238	$	74,515


(1)		In 2008, we wrote off approximately $3.5 million of deferred equity offering costs incurred in connection with our prior efforts to consummate an initial public offering in 2007 and 2008.

(2)		In 2006, Guarantee Insurance entered into a settlement and termination agreement with the former owner of Guarantee Insurance that allowed for an early extinguishment of debt in the amount of $8.8 million in exchange for $2.2 million in cash and release of the indemnification agreement previously entered into by the parties. As a result, we recognized a gain on the early extinguishment of debt on a pre-tax basis of approximately $6.6 million. We also recognized other income in connection with the forgiveness of accrued interest associated with the early extinguishment of debt on a pre-tax basis of $796,000.

(3)		We do not believe this metric is meaningful for the period indicated.

(4)		Return on average equity for a given period (annualized in the case of periods less than one year) is calculated by dividing net income for that period by average stockholders’ equity as of the beginning and end of the period.

(5)		In 2008, we reported a net loss of $124,000, principally as a result of a non-recurring loss from the write-off of deferred equity offering costs of approximately $3.5 million as described above. Due to this non-recurring charge, our return on average equity for 2008 was (2.0)%, which we do not believe is meaningful.

(6)		In 2005, we reported net income of $1.1 million. However, our average stockholders’ equity for 2005 was only approximately $180,000, which results in a return on average equity of 609.4%, which we do not believe is meaningful.


(7)		In 2004, we reported a net loss of $4.3 million, principally as a result of a loss from the write-off of an investment in Foundation Insurance Company, a subsidiary of Tarheel Group, Inc., as described below under “Certain Relationships and Related Transactions.” Due to this change, our return on average equity for 2004 was (19,275.6)%, which we do not believe is meaningful.

(8)		The net loss ratio is calculated by dividing net losses and loss adjustment expenses by net earned premiums. The net expense ratio is calculated by dividing net policy acquisition and underwriting expenses (which are comprised of gross policy acquisition costs and other gross expenses incurred in our insurance operations, net of ceding commissions earned from our reinsurers) by net earned premiums. The net combined ratio is the sum of the net loss ratio and the net expense ratio.

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

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this prospectus. This discussion includes forward-looking statements that are subject to risks, uncertainties and other factors described under the captions “Risk Factors” and “Forward-Looking Statements.” These factors could cause our actual results to differ materially from those expressed in, or implied by, those forward-looking statements.

Overview

Insurance Services Operations

Through our subsidiary, PRS Group, Inc. and its subsidiaries, which we collectively refer to as PRS, and our subsidiary, Patriot Underwriters, Inc. and its subsidiary, which we collectively refer to as PUI, we earn income for workers’ compensation claims services as well as agency and underwriting services. Workers’ compensation claims services include nurse case management, cost containment services and, beginning in 2009, claims administration and adjudication services. Cost containment services refer to workers’ compensation bill review and re-pricing services. Workers’ compensation agency and underwriting services include general agency services and, beginning in 2009, specialty underwriting, policy administration and captive management services. We currently provide these services to Guarantee Insurance for its benefit, for the benefit of segregated portfolio captives and for the benefit of Guarantee Insurance’s traditional business quota share reinsurers, all under the Patriot Risk Services brand. We also provide these services for the benefit of another insurance company under the Patriot Underwriters’ brand, a practice which we refer to as business process outsourcing, as described below.

In the second quarter of 2009, we entered into an arrangement with ULLICO Casualty Company, which we refer to as our BPO client, to gain access to workers’ compensation insurance business in certain additional states, including California and Texas. ULLICO is licensed to write workers’ compensation insurance in 47 states plus the District of Columbia and is rated “B+” (Good) by A.M Best. Under this arrangement, we earn commissions for producing business and insurance services income for providing underwriting, policy and claims administration, nurse case management and cost containment services and, in certain cases, services to segregated portfolio cell captives on the business we produce for our BPO client. For certain of these services, we earn insurance services income based on a percentage of premiums produced. For other services, we earn insurance services income based on a percentage of what we refer to as reference premiums produced. Reference premiums produced refers to premiums produced for large deductible policies. Premiums on large deductible policies are substantially reduced, through premium rate credits, due to the fact that the insurer has no exposure to losses below the per occurrence deductible. Reference premiums produced equal the premiums produced for large deductible policies, grossed up to include the premium credits applicable to the large deductible policy, as if the policy did not feature a per occurrence deductible. For the nine months ended September 30, 2009, premiums produced for our BPO client were approximately $19.4 million, and reference premiums produced were approximately $36.5 million. With respect to premiums produced for our BPO client, policy coverage is generally provided by our BPO client, which has the primary obligation to indemnify its policyholders for covered claims. Accordingly, such premiums produced for our BPO client are not included in gross written premiums in our consolidated results of operations. However, Guarantee

Insurance assumes a portion of the premium and associated losses and loss adjustment expenses on the business we produce for our BPO client. This assumed written premium is included in our gross written premiums in our consolidated results of operations.

In the fourth quarter of 2009, we entered into an agreement with Advantage Workers Compensation Insurance Company, an insurer rated “A-” by A.M. Best (Advantage WC). Under this arrangement, we expect to earn commissions for producing business and insurance services income for providing underwriting, policy and claims administration, nurse case management and cost containment services based on a percentage of premiums on the business we produce for this client. We do not expect to include any premiums produced for Advantage WC in gross written premiums in our consolidated results of operations, because Advantage WC will provide the policy coverage and have the primary obligation to indemnify its policyholders for covered claims. Guarantee Insurance does not expect to assume any portion of the premium or associated losses and loss adjustment expenses on the business produced for Advantage WC. Our agreement with Advantage WC has an initial one-year term, and thereafter it automatically renews for additional one-year terms. However, either party may terminate the agreement at any time upon 90 days’ prior written notice.

We continue to seek to enter into additional BPO relationships. These additional relationships may be solely distribution and insurance services relationships, where we do not assume any underwriting risk but earn commissions for producing business and insurance services income for providing underwriting, policy and claims administration, nurse case management and cost containment services and, in certain cases, services to segregated portfolio captives.

Insurance Operations

We currently write insurance in 22 states and the District of Columbia. For the nine months ended September 30, 2009, approximately 52% of our total direct and assumed premiums written involved workers’ compensation alternative market insurance solutions and approximately 48% represented workers’ compensation traditional business. For the nine months ended September 30, 2009 and the years ended December 31, 2008 and 2007, approximately 28%, 46% and 59% of our total direct premiums written, respectively, were concentrated in Florida.

For the nine months ended September 30, 2009, approximately 33% of our alternative market business direct premiums written were concentrated in Florida, and approximately 20%, 13% and 10% were concentrated in New Jersey, Georgia and New York, respectively. No other state accounted for more than 5% of our alternative market business direct premiums written for the nine months ended September 30, 2009.

For the nine months ended September 30, 2009, approximately 22% and 20% of our traditional business direct premiums written were concentrated in Florida and New Jersey, respectively, and between 5% and 10% were concentrated in each of Georgia, Indiana, Arkansas, New York, and Missouri. No other state accounted for more than 5% of our traditional business direct premiums written for the nine months ended September 30, 2009.

Investment income is an important part of our insurance operations. We hold invested assets associated with the statutory surplus we maintain for the benefit of our policyholders. Additionally, because a period of time elapses between the receipt of premiums and the ultimate settlement of claims, we hold invested assets associated with our reserves for losses and loss adjustment expenses which we believe will be paid at a future date. Generally, the period of time that elapses from the receipt of premium to the ultimate settlement of claims for workers’ compensation insurance is longer than many other property and casualty insurance products. Accordingly, we are generally able to generate more investment income on our loss and loss adjustment expense reserves than insurance companies operating in most other lines of business. As of September 30, 2009, our investment portfolio, including cash and cash equivalents, was approximately $54.5 million, and for the nine months ended September 30, 2009, our net investment income was approximately $1.4 million.

We utilize quota share and excess of loss reinsurance to maintain what we believe are appropriate leverage ratios and reduce our exposure to losses and loss adjustment expenses. Quota share reinsurance is a form of proportional reinsurance in which the reinsurer assumes an agreed upon percentage of each risk being insured and shares all premiums and losses with us in that proportion. Excess of loss reinsurance covers all or

a specified portion of losses on underlying insurance policies in excess of a specified amount, or retention. The cost and limits of the reinsurance coverage we purchase vary from year to year based upon the availability of reinsurance at acceptable prices and our desired level of retention. Retention refers to the amount of risk we retain for our own account. See “Business — Insurance Segment — Reinsurance.”

Under the segregated portfolio cell captive insurance plans in our alternative market business, we provide workers’ compensation insurance to employers and facilitate the establishment of a segregated portfolio cell within a segregated portfolio captive by coordinating the necessary interactions among the party controlling the cell, the insurance agency, the segregated portfolio captive, its manager and insurance regulators in the jurisdiction where the captive is domiciled. Segregated portfolio cells may be controlled by policyholders, parties related to policyholders, insurance agencies or others. Once the segregated portfolio cell is established, Guarantee Insurance enters into a quota share reinsurance agreement (“captive reinsurance agreement”) with the segregated portfolio captive acting on behalf of the segregated portfolio cell. For the nine months ended September 30, 2009, Guarantee Insurance ceded to the segregated portfolio captive either 90% or between 10% and 50% of the risk up to a level specified in the captive reinsurance agreement. For the nine months ended September 30, 2009, approximately 93% of the direct premiums written by Guarantee Insurance that were subject to segregated portfolio arrangements were ceded on a 90% basis, and approximately 7% of such premiums were ceded on a 10% to 50% basis. If the aggregate covered losses for the segregated portfolio cell exceed the level specified in the reinsurance agreement, the segregated portfolio captive reinsures the entire amount of the excess losses up to the aggregate liability limit specified in the captive reinsurance agreement. If the aggregate losses for the segregated portfolio cell exceed the aggregate liability limit, Guarantee Insurance retains 100% of those excess losses. Any amount of losses in excess of $1.0 million per occurrence is not covered by the captive reinsurance agreement. To the extent that any loss exceeds $1.0 million per occurrence, the amount of such loss in excess of $1.0 million is reinsured under Guarantee Insurance’s excess of loss reinsurance program. See “Business — Reinsurance — Alternative Market Business.”

Under our traditional business, Guarantee Insurance had three quota share reinsurance treaties inforce for the nine months ended September 30, 2009 with Swiss Reinsurance America Corporation, one of the largest reinsurers in the United States and rated “A” by A.M. Best Company, and two other authorized reinsurers. Any loss in excess of $1.0 million is also reinsured under Guarantee Insurance’s excess of loss reinsurance program for traditional business. See “Business — Reinsurance — Traditional Business.”

In addition to reinsurance, we also reduce our exposure to losses from events that cause unfavorable underwriting results through the use of large deductible policies, which we define as policies with a deductible of at least $250,000 per occurrence. Premiums on large deductible policies are substantially reduced through premium rate credits, due to the fact that the we have no exposure to losses below the per occurrence deductible. However, through PRS Group, Inc., we earn certain insurance services income from Guarantee Insurance, both on its behalf and on behalf of the segregated portfolio captives and its quota share reinsurers, on all managed claims irrespective of deductible. For the nine months ended September 30, 2009 and 2008, direct premiums written were net of premium rate credits attributable to large deductible policies of approximately $6.8 million and $9.2 million, respectively. For the year ended December 31, 2008, direct premiums written were net of premium rate credits attributable to large deductible policies of approximately $9.1 million. No large deductible policies were written during the years ended December 31, 2007 and 2006.

The workers’ compensation insurance industry is cyclical in nature and influenced by many factors, including price competition, medical cost increases, natural and man-made disasters, changes in interest rates, changes in state laws and regulations and general economic conditions. A hard market cycle in the workers’ compensation insurance industry is characterized by decreased competition that results in higher premium rates, more restrictive policy coverage terms and lower commissions paid to agencies. In contrast, a soft market cycle is characterized by increased competition that results in lower premium rates, expanded policy coverage terms and higher commissions paid to agencies. We believe that the current workers’ compensation insurance market has been experiencing a soft market cycle in which underwriting capacity and price competition have increased. In our traditional workers’ compensation business, we have experienced increased price competition since 2007 in certain markets. In addition, for the nine months ended September 30, 2009

compared to the same period in 2008, we experienced a decrease in traditional business gross premiums written generally attributable to lower payrolls associated with increases in overall unemployment.

For the nine months ended September 30, 2009, we wrote approximately 52% of our direct premiums written in administered pricing states — Florida, Indiana and New Jersey. In administered pricing states, insurance rates are set by the state insurance regulators and are adjusted periodically. Rate competition generally is not permitted in these states. Therefore, rather than setting rates for the policies, our underwriting efforts in these states for our traditional business relate primarily to the selection of the policies we choose to write at the premium rates that have been set.

The Florida OIR has approved average statewide rate decreases in each of the past three years, and has also approved a rate decrease for 2010. If a state insurance regulator lowers premium rates, our insurance operations will be less profitable, and we may choose not to write policies in that state. We have responded to these rate decreases by expanding our alternative market business in Florida and strengthening our collateral on that business where appropriate. In addition, we have the ability to offer different kinds of policies in administered pricing states, including retrospectively rated policies and dividend policies, for which an insured can receive a return of a portion of the premium paid if the insured’s claims experience is favorable. We expect an increase in Florida experience modifications, which permit us to increase the premiums we charge based on a policyholder’s loss history. We anticipate that our ability to adjust to these market changes will create opportunities as our competitors with higher expense ratios find the Florida market less desirable.

The cyclical nature of the industry, the actions of our competitors, state insurance regulation and general economic factors could cause our revenues and net income from insurance operations to fluctuate. We manage our insurance operations across market cycles by striving to maintain premium rates in non-administrative pricing states, deploy capital judiciously, manage our expenses and focus on underserved sectors within our target markets that we believe will provide opportunities for favorable underwriting margins.

In September 2003, our wholly-owned subsidiary, Patriot National Insurance Group, Inc., acquired Guarantee Insurance, a shell property and casualty insurance company that was not then writing new business, for a purchase price of approximately $9.5 million, in the form of $750,000 in cash and a note in the amount of approximately $8.8 million. At that time, Guarantee Insurance had a number of commercial general liability claims, including asbestos and environmental claims, that had been in run-off since 1983. The former owner of Guarantee Insurance agreed to indemnify us for certain losses in excess of reserves arising from these claims up to the amount of the original purchase price. On March 30, 2006, we entered into a settlement and termination agreement with the seller where the note issued as part of the purchase price was released in exchange for a cash payment of $2.2 million and the release of the seller’s agreement to indemnify us for losses in excess of reserves. In 2006, we recognized a pre-tax $6.6 million gain on early extinguishment of debt in connection with this settlement and termination agreement. As of September 30, 2009, we held net reserves in the amount of approximately $4.2 million for losses attributable to the legacy claims.

Principal Revenue and Expense Items

Our revenues consist primarily of the following:

Premiums Earned

Premiums earned represent the earned portion of our net premiums written. Net premiums written are equal to gross premiums written less premiums ceded to reinsurers. Gross premiums written include the estimated annual direct premiums written from each insurance policy we write or renew during the reporting period based on the policy effective date or the date the policy is bound, whichever is later, as well as premiums assumed.

Premiums are earned on a daily pro rata basis over the term of the policy. At the end of each reporting period, premiums written that are not yet earned are classified as unearned premiums and are earned in subsequent periods over the remaining term of the policy. Our insurance policies typically have a term of one

year. Thus, for a one-year policy written on July 1, 2009 for an employer with constant payroll during the term of the policy, we would earn half of the premiums in 2009 and the other half in 2010.

Many of our policies renew on January 1 of each year. As a result, we have experienced some seasonality in our gross and net premiums written in that generally we write more new and renewal policies during the first quarter of the calendar year. The actual premium we earn on a policy is based on the actual payroll during the term of the policy. We conduct premium audits on our traditional and alternative market policyholders annually upon the expiration of each policy, including when the policy is renewed. The purpose of these audits is to verify that policyholders have accurately reported their payroll expenses and employee job classifications and therefore have paid us the premium required under the terms of their policies. In addition to annual audits, we selectively perform interim audits on certain classes of business if significant or unusual claims are filed or if the monthly reports submitted by a policyholder reflect a payroll pattern or any aberrations that cause underwriting, safety or fraud concerns.

Insurance Services Income

Insurance services income is a key component of our hybrid business model. Our insurance services segment income includes all nurse case management, cost containment and other insurance services fee income earned by PRS and PUI. However, the fees earned by PRS and PUI that are attributable to the portion of the insurance risk that Guarantee Insurance retains or assumes from other insurance companies are eliminated upon consolidation. Therefore, our insurance services income, on a consolidated basis, consists of income for services provided to unaffiliated clients.

In 2009, we began producing business and performing insurance services for our BPO client. We earn insurance services income for producing business, providing underwriting, policy and claims administration, nurse case management and cost containment services and, in certain cases, providing services to segregated portfolio cell captives on the business we produce for our BPO client. We collect fronting fees from policyholders and remit such fees to our BPO client. Additionally, Guarantee Insurance assumes a portion of the premium and associated losses and loss adjustment expenses on the business we produce for our BPO client. Commission income and other insurance services income attributable to underwriting, policy and claims administration services and services to segregated portfolio cell captives associated with this business are based on a percentage of premiums produced or reference premiums produced, as applicable, for our BPO client, reduced by an allowance for estimated insurance services income that will not be received due to the cancellation of policies prior to expiration and reductions in payroll. Income attributable to nurse case management and cost containment services is recognized in the period during which such services are provided.

Guarantee Insurance assumes a portion of the premium and associated losses and loss adjustment expenses on the business we produce for our BPO client, which is mutually determined by the parties for each policy. The portion of risk assumed by Guarantee Insurance on business we produced for our BPO client during the third quarter of 2009 ranged from approximately 10% to 100%. Based on the total amount of premiums on the business produced for our BPO client, Guarantee Insurance assumed an average of approximately 40% of the business produced during the third quarter of 2009, although we expect this percentage may vary significantly from quarter to quarter. For the nine months ended September 30, 2009, Guarantee Insurance assumed approximately 100% of the risk on large deductible business produced for our BPO client and 10% to 30% of the risk on all other business produced for our BPO client. In connection with business assumed by us under this arrangement, we provide collateral in the form of cash, letters of credit or other forms of acceptable collateral, as required by the agreement. No collateral was required as of September 30, 2009.

With respect to business written by Guarantee Insurance, the fees earned by PUI and PRS represent the fees paid by segregated portfolio captives and our quota share reinsurers for services performed on their behalf and for which Guarantee Insurance is reimbursed through a ceding commission. For financial reporting purposes, we treat these ceding commissions as a reduction in net policy acquisition and underwriting expenses. With respect to business produced for our BPO client, the fees earned by PRS and PUI represent fees paid by the BPO client attributable to the portion of insurance risk it retains.

Because our insurance services income is currently generated principally from the services we provide to Guarantee Insurance for the benefit of segregated portfolio captives and our quota share reinsurers, our insurance services income is currently substantially dependent on Guarantee Insurance’s premium and risk retention levels. However, we expect that our nurse case management, cost containment and other insurance services operations will become less dependent over time on Guarantee Insurance’s premium and risk retention levels as we expand our business process outsourcing relationships and develop additional general agency appointments and enter into agreements with other BPO clients for nurse case management, cost containment and other insurance services.

General agency services on Guarantee Insurance’s alternative market segregated portfolio captive business were provided by PRS prior to 2008, pursuant to which Guarantee Insurance paid PRS a general agency commission, a portion of which was retained by PRS and a portion of which was paid by PRS as commission compensation to the producing agents. Effective January 1, 2008, Guarantee Insurance began working directly with agents to market segregated portfolio captive business and paying commissions directly to the producing agents. As a result, PRS ceased earning general agency commissions and ceased paying commissions to producing agents attributable to Guarantee Insurance business.

Net Investment Income and Net Realized Gains and Losses on Investments

Our net investment income includes interest and dividends earned on our invested assets, net of investment expenses. In 2007, we purchased tax exempt municipal debt securities, which are classified as available-for-sale, to help increase the after-tax contribution of net investment income. Tax exempt securities typically have an adverse effect on net investment income and pre-tax investment portfolio yields, which effect is generally offset by a reduction in aggregate effective federal income tax rates.

We assess the performance of our investment portfolio using a standard tax equivalent yield metric. Investment income that is tax exempt is grossed up by our marginal federal tax rate of 34% to express yield on tax-exempt securities on the same basis as taxable securities. Net realized gains and losses on investments are reported separately from our net investment income. Net realized gains occur when investment securities are sold for more than their costs or amortized costs, as applicable. Net realized losses occur when investment securities are sold for less than their costs or amortized costs, as applicable, or are written down as a result of an other-than-temporary impairment.

Our expenses consist primarily of the following:

Losses and Loss Adjustment Expenses Incurred

Losses and loss adjustment expenses incurred represent our largest expense item. Losses and loss adjustment expenses are comprised of paid losses and loss adjustment expenses, estimates of future claim payments on claims reported in the period, changes in those estimates from prior reporting periods and costs associated with investigating, defending and servicing reported claims. These expenses fluctuate based on the amount and types of risks we insure. We record losses and loss adjustment expenses related to estimates of future claim payments based on case-by-case valuations and statistical analyses. We seek to establish reserves at the most likely ultimate exposure based on our historical claims experience and industry data. More serious claims typically take several years to close, and we revise our estimates as we receive additional information about the condition of injured employees and as industry conditions change. Our ability to estimate losses and loss adjustment expenses accurately at the time we price our insurance policies is a critical factor in our profitability.

Net Policy Acquisition and Underwriting Expenses

Net policy acquisition and underwriting expenses represent the costs we incur in connection with our insurance operations, principally costs to acquire, underwrite and administer traditional and alternative market workers’ compensation insurance policies. These expenses include commissions, salaries and benefits related to insurance operations, state and local premium taxes and fees and other operating costs, partially offset by ceding commissions we earn from reinsurers under our reinsurance program.

Other Operating Expenses

Other operating expenses represent the costs we incur other than those associated with our insurance operations, principally costs incurred in connection with our insurance services operations and holding company expenses. The costs associated with our insurance services operations include the cost of providing nurse case management services, preferred provider network costs for access to discounted health care services and commissions to producing agents. With respect to business produced for our BPO client, commissions to producing agencies and certain marketing and underwriting costs, which are generally based on a percentage of premiums produced or reference premiums produced, as applicable, for our BPO client, are reduced by (i) an allowance for estimated commissions that will not be paid due to the cancellation of policies prior to expiration and reductions in payroll and (ii) policy administration and claims costs, which are expensed as incurred. All such expenses are included in other operating expenses in our consolidated statements of income.

Interest Expense

Interest expense represents amounts we incur on our outstanding indebtedness based on the applicable interest rates during the relevant periods.

Income Tax Expense

Income tax expense represents both current and deferred federal income taxes incurred.

Measurement of Results

We use various measures to analyze the growth and profitability of our operations.

For our insurance services operations, we measure growth in terms of fee income produced from insurance services, which is dependent on the number and size of claims being managed as well as the amount of premium we produce for other insurance companies. For our insurance operations, we measure growth in terms of gross and net premiums written and we measure underwriting profitability by examining our net loss, net expense and combined ratios. A combined ratio is the sum of the net loss ratio and the net underwriting expense ratio, each calculated as described below. We also measure our gross and net premiums written to surplus ratios to assess the adequacy of capital in relation to premiums written. We measure profitability in terms of pre-tax net income, net income and return on average equity.

Premiums Written

Gross premiums written represent the estimated gross premiums for the duration of the policy, recognized at the inception of the policy. We use gross premiums written to measure our sales for our insurance operations. Gross premiums written also correlates to our ability to generate net premiums earned and, with respect to the premiums we cede to segregated portfolio cell captives and our quota share reinsurers, ceding commissions and insurance services income.

Loss Ratio

We use calendar year and accident year loss ratios to measure our underwriting profitability. A calendar year loss ratio measures losses and loss adjustment expense for insured events occurring during a particular year, together with changes in loss reserves from prior accident years, as a percentage of premiums earned during that year. An accident year loss ratio measures losses and loss adjustment expenses for insured events occurring in a particular year, regardless of when they are reported, as a percentage of premium earned during that year. The net loss ratio is calculated by dividing net losses and loss adjustment expenses by net earned premiums. The net loss ratio measures claims experience, net of the effects of reinsurance, and therefore is a measure of the effectiveness of our underwriting efforts. We report our net loss ratio on both a calendar year and accident year basis.

Net Expense Ratio

The net expense ratio is calculated by dividing net policy acquisition and underwriting expenses (which are comprised of gross policy acquisition costs and other gross expenses incurred in our insurance operations, net of ceding commissions earned from our reinsurers) by net earned premiums. The expense ratio measures our operational efficiency in producing, underwriting and administering our insurance operations. The gross expense ratio is calculated before the effect of ceded reinsurance. We calculate our expense ratio on a net basis (after the effect of ceded premium and related ceding commissions) to measure the results of our consolidated insurance operations. Ceding commissions reduce our gross underwriting expenses in our insurance operations.

Combined Ratio

We use the combined ratio to measure the underwriting profitability of our insurance operations. The combined ratio is the sum of the net loss ratio and the net expense ratio.

Net Income and Return on Average Equity

We use net income to measure our profits and return on average equity to measure the effectiveness in utilizing our stockholders’ equity to generate net income on a consolidated basis. In determining return on average equity for a given period, net income is divided by the average of stockholders’ equity at the beginning and end of that period and annualized in the case of periods less than one year.

Outlook

Set forth below are certain of our objectives with respect to our business subsequent to this initial public offering and concurrent private placement. We caution you that these objectives may not materialize and are not indicative of the actual results that we will achieve. Many factors and future developments may cause our actual results to differ materially and significantly from the information set forth below. See “Risk Factors” and “Forward-Looking Statements.”

Upon completion of this initial public offering and concurrent private placement, the majority of the net proceeds of the offering and concurrent private placement will be contributed to Guarantee Insurance and, if we acquire it, PF&C, and deployed in accordance with our primary investment objectives of preserving capital and achieving an appropriate risk adjusted return, with an emphasis on liquidity to meet claims obligations.

Return on Average Equity

One of the key financial measures that we will use to evaluate our operating performance will be return on average equity. We will calculate return on average equity for a given year by dividing net income by the average of stockholders’ equity for that year. Our return on average equity was 36.7% for the nine months ended September 30, 2009. With the increased capitalization as a result of this initial public offering and concurrent private placement, we expect a lower return on average equity. Our objective is to produce a return on average equity in the area of 15% in the near term and in the area of 20% in the long term. To help achieve our return on average equity objective, we may consider funding our operations, in part, with borrowings or other non-equity sources of capital in the future.

Indebtedness

We may utilize additional debt, as appropriate, to maintain a net leverage ratio on our insurance operations that satisfies the regulatory authorities that oversee Guarantee Insurance’s operations. Furthermore, we may utilize additional debt, as appropriate, in connection with the acquisition of an insurance or insurance services organization or book of business. Over the long term, we expect to target a debt to equity ratio of 10% to 25%.

Insurance Services Operations

Insurance Services Income

Our insurance services income comprised approximately 24% of total revenues for the nine months ended September 30, 2009. We target our insurance services income to be 30% to 40% of total revenues in the near term. Additionally, we target our insurance services operating leverage ratio, as measured by dividing insurance services income by average stockholders’ equity, to be between 20% and 40% in the near term.

Pre-Tax Margin on Insurance Services Income

Our pre-tax margin on insurance services income was 35% for the nine months ended September 30, 2009. Primarily due to economies of scale related to generally fixed holding company expenses allocated to the insurance services segment, we target our pre-tax margin on insurance services income to increase to 40% to 45% over the long term.

Insurance Operations

Mix of Business

Alternative market and traditional gross premiums written comprised approximately 49% and 51% of our total direct premiums written, respectively, for the nine months ended September 30, 2009. Upon completion of this offering and concurrent private placement, we plan to increase our alternative market business more significantly than our traditional business. In the near term, we target our alternative market gross premiums written to comprise 55% to 70% of our total direct premiums written.

Underwriting Ratios

The net loss ratio is calculated by dividing consolidated net losses and loss adjustment expenses by net earned premiums. The net expense ratio is calculated by dividing consolidated net policy acquisition and underwriting expenses (which are comprised of gross policy acquisition costs and other gross expenses incurred in our insurance operations, net of ceding commissions earned from our reinsurers) by net earned premiums. The net combined ratio is the sum of the net loss ratio and the net expense ratio. Our net loss ratio, net expense ratio and net combined ratio were 55.9%, 30.0% and 85.9% for the nine months ended September 30, 2009. Over the long term, we target a net combined ratio of less than 80% and a net loss ratio at between 55% and 65%. We expect our net expense ratio to decline over time as our alternative market direct premiums written increase in proportion to our total direct premiums written due to the fact that ceding commissions on our segregated portfolio cell captive business, which are recognized as a contra-expense, generally exceed our gross expense ratio. Additionally, we expect our net expense ratio to decline over time as our total direct premiums written increase and we realize certain economies of scale.

Aggregate Risk Retention Levels and Operating Leverage

Our aggregate risk retention level, as measured by dividing alternative market and traditional net premiums written by alternative market and traditional gross premiums written, was 42% for the nine months ended September 30, 2009. Over the long term, we target our aggregate risk retention level to decrease to 25% to 35% due to our expected increase in the proportion of alternative market direct premiums written, a substantial portion of which is comprised of segregated portfolio cell captive arrangements, on which we retained approximately 14% of the underwriting risk for the nine months ended September 30, 2009.

Our net operating leverage ratio, as measured by dividing net premiums earned by average stockholders’ equity, was approximately 7.8 to 1 for 2008. With the increased capital from this offering and concurrent private placement, we expect our net operating leverage ratio to decrease significantly. In the near term, we target a net leverage ratio of between 0.3 to 1 and 0.5 to 1. Actual operating leverage ratios may vary from targets due to factors that affect our ratings with various organizations and capital adequacy requirements imposed by insurance regulatory authorities. These factors include the amount of our statutory surplus and stockholders’ equity, premium growth, debt facilities, quality and terms of reinsurance and business mix.

Investment Leverage Ratio

We expect most of our investment portfolio to continue to principally consist of high quality fixed income securities. We plan to continue to pursue competitive investment returns while maintaining a diversified portfolio of securities with a primary emphasis on the preservation of principal through high credit quality issuers with limited exposure to any one issuer. We expect our investment income to increase as our invested assets grow. The tax-adjusted yield on our current portfolio was approximately 4.7% as of September 30, 2009. We estimate that prevailing tax-adjusted yields on similar securities are currently approximately 100 basis points lower than the tax-adjusted yield on our current portfolio. Accordingly, we target a tax-adjusted yield on our investment portfolio after the net proceeds of this offering and the concurrent private placement are fully deployed of 3.5% to 4.5% in the near term. As we fully deploy the capital from this offering and the concurrent private placement, we expect to target an investment leverage ratio, which is the ratio of average invested assets to average equity, of between 1.0 to 1 and 1.5 to 1.

Reserving Methodology for Legacy Asbestos and Environmental Exposures

When we acquired Guarantee Insurance in 2003, it had certain asbestos and environmental liability exposures arising out of the sale of general liability insurance and participations in reinsurance assumed through underwriting management organizations, commonly referred to as pools. Generally, reserves for asbestos and environmental claims cannot be estimated with traditional loss reserving techniques that rely on historical accident year development factors due to the uncertainties surrounding asbestos and environmental liability claims. As of December 31, 2008, we had established reserves, net of reinsurance recoverables on unpaid losses, of approximately $3.0 million attributable to asbestos and environmental exposures. These reserves are attributable to 29 direct claims, Guarantee Insurance’s share of two reinsurance pool claims and our estimate of the impact of unreported claims. In one of these pools, Guarantee Insurance reinsured the risks of other insurers and then ceded a portion (generally 80%) of these reinsurance risks to other reinsurers, which we call participating pool reinsurers. Under this structure, Guarantee Insurance remains obligated for the total liability under each reinsurance contract it issued, to the extent any of the participating pool reinsurers fails to pay its share. Over time, Guarantee Insurance’s net liabilities under these reinsurance contracts have increased from approximately 20% to approximately 50% of the pooled risks, due to the insolvency of some participating pool reinsurers. In the other pool, Guarantee Insurance is one of a number of participating pool reinsurers, and its liability is based on the percentage share of the pool obligations it reinsures. Our reserves for direct asbestos and environmental liability claims are based on a detailed review of each case. Our reserves for pooled asbestos and environmental liability exposures are based on our share of aggregate reserves established by pool administrators through their consultation with independent actuarial consultants.

We believe that our reserve methodology results in net reserves for asbestos and environmental claims that are adequate to cover the ultimate cost of losses and loss adjustment expenses thereon. However, we believe that adopting the survival ratio reserve methodology for asbestos and environmental exposures would make our reserve methodology for these exposures generally consistent with our publicly held insurance company peers. Accordingly, we are evaluating the possibility of adopting this methodology. Under the survival ratio reserve methodology, our net reserve for asbestos and environmental liability exposures would be estimated based on a multiple of approximately 15 times our average net paid asbestos and environmental claims for the three most recent years. If we had adopted the survival ratio reserve methodology as of December 31, 2008, our net reserve for asbestos and environmental exposures would have been approximately $5.1 million, representing an increase in net losses and loss adjustment expenses of approximately $2.1 million.

We expect to make a decision with respect to the adoption of the survival ratio reserve methodology in connection with the preparation of our financial statements for the fourth quarter of 2009. If we adopt this methodology, our pre-tax income for the period in which we increase our reserves will decrease by a corresponding amount.

Target Direct Premiums Written, Insurance Services Income and Premiums Produced

Our financial statements for the year ended December 31, 2009 are not yet available and have not been audited. However, for the fourth quarter of 2009, we expect (i) direct premiums written of approximately $15.5 million to $17.0 million (including approximately $11.0 million of alternative market business and

approximately $5.2 million of traditional business), net of large deductible policy premium rate credits of approximately $8.5 million to $9.5 million, and (ii) insurance services income of approximately $4.2 million to $4.7 million, a significant portion of which is expected to result from fee income earned on premiums produced for our BPO client, which are expected be approximately $17.5 million to $19.0 million, and reference premiums produced for our BPO client, which are expected to be approximately $20.0 million to $22.0 million.

For the year ended December 31, 2009, we are targeting (i) direct premiums written for new business of approximately $60 million to $65 million, net of large deductible policy premium rate credits of approximately $7 million to $9 million, and (ii) insurance services income of approximately $14.0 million to $14.5 million, a significant portion of which is expected to result from fee income earned on reference premiums produced on new business for our BPO client, which are expected to be approximately $50 to $55 million.

Critical Accounting Policies

The following is a description of the accounting policies management considers important to the understanding of our financial condition and results of operations.

Reserves for Losses and Loss Adjustment Expenses

We record reserves for estimated losses under insurance policies that we write and for loss adjustment expenses related to the investigation and settlement of policy claims. Our reserves for losses and loss adjustment expenses represent the estimated cost of all reported and unreported losses and loss adjustment expenses incurred and unpaid at any given point in time based on facts and circumstances known to us at the time. Our reserves for losses and loss adjustment expenses are estimated using case-by-case valuations and statistical analyses. These estimates are inherently uncertain. In establishing these estimates, we make various assumptions regarding a number of factors, including frequency and severity of claims, length of time to achieve the ultimate settlement of claims, projected inflation of medical costs and wages, insurance policy coverage interpretations, judicial determinations and regulatory changes. Due to the inherent uncertainty associated with these estimates, our actual liabilities may be different from our original estimates. On a quarterly basis, we review our reserves for losses and loss adjustment expenses to determine whether any further adjustments are appropriate. Any resulting adjustments are included in the current period’s results. We do not discount loss and loss adjustment expense reserves for the time value of money from the date claims are incurred to the date they are paid. Additional information regarding our reserves for losses and loss adjustment expenses can be found in “Business — Loss and Loss Adjustment Expense Reserves.”

As a result of unfavorable development on prior accident year reserves, our estimate for incurred losses and loss adjustment expenses increased by approximately $1.7 million and $1.3 million for the nine months ended September 30, 2009 and for the year ended December 31, 2008, respectively. As a result of favorable development on prior accident year reserves, our estimate for incurred losses and loss adjustment expenses decreased by approximately $3.5 million for the year ended December 31, 2007. As a result of unfavorable development on prior accident year reserves, our estimate for incurred losses and loss adjustment expenses increased by approximately $2.5 million for the year ended December 31, 2006. See “Business — Reconciliation of Reserves for Losses and Loss Adjustment Expenses.’’

Amounts Recoverable from Reinsurers

Amounts recoverable from reinsurers represent the portion of our paid and unpaid losses and loss adjustment expenses that is assumed by reinsurers. These amounts are reported on our balance sheet as assets and do not reduce our reserves for losses and loss adjustment expenses because reinsurance does not relieve us of our primary obligation to our policyholders. We are required to pay claims even if a reinsurer fails to pay us under the terms of a reinsurance contract. We calculate amounts recoverable from reinsurers based on our estimates of the underlying losses and loss adjustment expenses and the terms and conditions of our reinsurance contracts, which could be subject to interpretation. In addition, we bear credit risk with respect to our reinsurers, which can be significant because some of the unpaid losses and loss adjustment expenses for which we have reinsurance coverage remain outstanding for extended periods of time.

We have reinsurance agreements with both authorized and unauthorized reinsurers. Authorized reinsurers are licensed or otherwise authorized to conduct business in the state of Florida, Guarantee Insurance’s state of domicile. Under statutory accounting principles, Guarantee Insurance receives credit on its statutory financial statements for all paid and unpaid losses ceded to authorized reinsurers. Unauthorized reinsurers are not licensed or otherwise authorized to conduct business in the state of Florida. Under statutory accounting principles, Guarantee Insurance receives credit for paid and unpaid losses ceded to unauthorized reinsurers to the extent these liabilities are secured by funds held, letters of credit or other forms of acceptable collateral. With respect to authorized reinsurers, we manage our credit risk by generally selecting reinsurers with a financial strength rating of “A−” (Excellent) or better by A.M. Best and by performing quarterly credit reviews of our reinsurers. With respect to unauthorized reinsurers, including segregated portfolio captives, we manage our credit risk by generally maintaining collateral, typically in the form of funds withheld and letters of credit, to cover reinsurance recoverable balances. If one of our reinsurers suffers a credit downgrade, we may consider various options to lessen the risk of asset impairment, including commutation, novation and additional collateral.

In order to qualify for reinsurance accounting and provide accounting benefit to us, reinsurance agreements must transfer insurance risk to the reinsurer. Risk transfer standards under generally accepted accounting principles (GAAP) require that (a) the reinsurer assume significant insurance risk (underwriting risk and timing risk) under the reinsured portions of the underlying insurance agreements, and (b) it be reasonably possible that the reinsurer may realize a significant loss from the transaction. In determining whether the degree of risk transfer is adequate to qualify for reinsurance accounting, each reinsurance contract is evaluated on its own facts and circumstances. To the extent that the accounting risk transfer thresholds are not met, the reinsurance transaction is accounted for as a deposit. The treatment of reinsurance transactions as deposits does not mean that economic risk has not been transferred, but rather that the nature and the amount of the risk transferred do not sufficiently satisfy GAAP risk transfer criteria to be afforded reinsurance accounting treatment. We evaluate our reinsurance contracts at their inception and upon subsequent amendments to determine whether reinsurance accounting or deposit accounting is appropriate.

Our reinsurance recoverable balance was carried net of an allowance for doubtful accounts of $300,000 at September 30, 2009 and December 31, 2008. For the nine months ended September 30, 2009 and the years ended December 31, 2008, 2007 and 2006, we did not, in the aggregate, experience material difficulties in collecting balances from our reinsurers. No assurance can be given, however, regarding the future ability of our reinsurers to meet their obligations.

Premiums Receivable

Premiums receivable are uncollateralized policyholder obligations due under normal policy terms requiring payment within a specified period from the invoice date. Premium receivable balances are reviewed for collectability and management provides an allowance for estimated doubtful accounts, which reduces premiums receivable. Our premiums receivable were carried net of an allowance for uncollectible accounts, based upon a specific impairment basis methodology, of $650,000 at September 30, 2009 and December 31, 2008. Due to an increase in the aging of our premiums receivable and exposure to uncollateralized balances, we may establish an additional allowance for accounts that may not be collectible but which we have not specifically identified as impaired. We believe that this methodology is consistent with the methodology utilized by our publicly held insurance company peers. We anticipate that the additional allowance amount that may be required based upon this analysis is between $500,000 and $1.0 million. This additional allowance, if determined by management to be appropriate, would be recorded in the fourth quarter of 2009. No assurance can be given regarding the future ability of our policyholders to meet their obligations.

Revenue Recognition

Through PRS, we earn insurance services income by providing nurse case management and cost containment services to Guarantee Insurance, on its behalf, on behalf of the segregated portfolio captives and on behalf of Guarantee Insurance’s quota share reinsurers. Through PRS and PUI, we also earn insurance services income by providing nurse case management, cost containment, claims administration, sales,

underwriting, policy administration and, in certain cases, segregated portfolio captive management services to our BPO client.

Insurance services income for nurse case management services is based on a monthly charge per claimant. Insurance services income for cost containment services is based on a percentage of claim savings. Insurance services income for claims administration is based on a percentage of reference premiums produced for our BPO client (recognized on a pro rata basis over the period of time we are contractually obligated to administer the claims). Insurance services income for sales, underwriting and segregated portfolio cell captive setup, policy administration and captive management services is based on a percentage of premiums produced for our BPO client, reduced by an allowance for estimated insurance services income that will not be received due to the cancellation of policies prior to expiration and reductions in payrolls. Insurance services income for policy administration and captive management is based on a percentage of premiums produced for our BPO client, recognized on a pro rata basis over the lives of the policies produced.

Insurance services income includes all insurance services income earned by PRS and PUI. However, the insurance services income earned by PRS and PUI that is attributable to the portion of the insurance risk that Guarantee Insurance retains or assumes from our BPO client is eliminated upon consolidation. Therefore, our insurance services income, on a consolidated basis, consists of the fees earned by PUI and PRS that are attributable to the portion of the insurance risk assumed by the segregated portfolio captives, assumed by Guarantee Insurance’s quota share reinsurers or retained by our BPO client.

Premiums are earned pro rata over the terms of the policies, which are typically annual. The portion of premiums that will be earned in the future is deferred and reported as unearned premiums. We estimate earned but unbilled premiums at the end of the period by analyzing historical earned premium adjustments made and applying an adjustment percentage to premiums earned for the period. For the year ended December 31, 2008, we reduced our earned but unbilled premium percentage to reflect lower payrolls which we believe were largely reflective of employment trends in the economy. For the nine months ended September 30, 2009 and the year ended December 31, 2008, we did not experience any material changes in estimates related to premiums earned, including earned but unbilled premiums. No assurance can be given that there will be no material changes in estimates related to premiums earned, including earned but unbilled premiums, in the future.

Deferred Policy Acquisition Costs and Deferred Ceding Commissions

We defer commission expenses, premium taxes and certain marketing, sales and underwriting costs that vary with and are primarily related to the acquisition of insurance policies. We also defer associated ceding commissions. These acquisition costs are capitalized and charged to expense ratably as premiums are earned. In calculating deferred policy acquisition costs and deferred ceding commissions, we only include costs to the extent of their estimated realizable value, which gives effect to the premiums expected to be earned, anticipated losses and settlement expenses and certain other costs we expect to incur as the premiums are earned, less related net investment income. Judgments as to the ultimate recoverability of deferred policy acquisition costs and deferred ceding commissions are highly dependent upon estimated future profitability of unearned premiums. If unearned premiums are less than our expected claims and expenses after considering investment income, we reduce the related deferred policy acquisition costs. For the nine months ended September 30, 2009 and the years ended December 31, 2008 and 2007, we did not, in the aggregate, experience material changes in our deferred policy acquisition costs or deferred ceding commissions in connection with changes in estimated recoverability. No assurance can be given, however, regarding the future recoverability of deferred policy acquisition costs or deferred ceding commissions.

Deferred Income Taxes

We use the liability method of accounting for income taxes. Under this method, deferred income tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in

which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities resulting from a tax rate change will impact our net income or loss in the reporting period that includes the enactment date of the tax rate change. In assessing whether our deferred tax assets will be realized, we consider whether it is more likely than not that we will generate future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, tax planning strategies and projected future taxable income in making this assessment. If necessary, we will establish a valuation allowance to reduce the deferred tax assets to the amounts that are more likely than not to be realized.

At December 31, 2006, we provided a full valuation allowance on the deferred tax asset attributable to net operating loss carry forwards generated by The Tarheel Group, Inc., or Tarheel. On April 1, 2007, when our majority stockholder contributed all the outstanding capital stock of Tarheel to Patriot Risk Management, we determined that our operating performance, coupled with our expectations to generate future taxable income, indicated that it was more likely than not that we would be able to utilize this asset to offset future taxes and, accordingly, we reversed this valuation allowance. The deferred tax asset associated with net operating loss carry forwards from Tarheel and its subsidiary, Tarheel Insurance Management Company, or TIMCO, was fully utilized as of September 30, 2009. As of September 30, 2009 and December 31, 2008, no other deferred tax assets have been deemed more likely than not to be unrealizable and, accordingly, no valuation allowance was deemed necessary for unrealizable deferred tax assets. No assurance can be given, however, regarding the future realization of deferred tax assets.

Assessments

We are subject to various assessments related to our insurance operations, including assessments for state guaranty funds and second injury funds. State guaranty fund assessments are used by state insurance oversight agencies to pay claims of policyholders of impaired, insolvent or failed insurance companies and the operating expenses of those agencies. Second injury funds are used by states to reimburse insurers and employers for claims paid to injured employees for aggravation of prior conditions or injuries. In some states, these assessments may be partially recovered through a reduction in future premium taxes. In accordance with Financial Accounting Standards Board (FASB) guidance contained in Accounting Standards Codification (ASC) 450, Contingencies, we establish a provision for these assessments at the time the amounts are probable and estimable. Assessments based on premiums are generally paid one year after the calendar year in which the policies are written. Assessments based on losses are generally paid within one year of when claims are paid by us. For the nine months ended September 30, 2009 and the years ended December 31, 2008 and 2007, we did not experience any material changes in our estimates of assessments for state guaranty funds and second injury funds. No assurance can be given, however, regarding the future changes in estimates of such assessments.

Share-Based Compensation Costs

In December 2004, the FASB issued guidance for accounting for stock-based compensation costs, now part of ASC 718, Compensation-Stock Compensation, which requires the compensation costs relating to stock options granted or modified after December 31, 2005 to be recognized in financial statements using the fair value of the equity instruments issued on the grant date of such instruments and to be recognized as compensation expense over the period during which an individual is required to provide service in exchange for the award (typically the vesting period). We adopted this guidance effective January 1, 2006, and the impact of the adoption was not significant to our financial statements for the nine months ended September 30, 2009 or 2008 or the years ended December 31, 2008 or 2007. We estimate share-based compensation costs of approximately $2.7 million, $2.6 million and $2.5 million for the years ending December 31, 2010, 2011 and 2012, respectively, relating to stock options that we have granted and expect to grant to our management and members of our board of directors, recognized on a pro rata basis over the vesting period. As of December 31, 2009, we had 187,235 outstanding options. For the nine months ended September 30, 2009 and the years ended December 31, 2008 and 2007, we did not experience any material changes in our estimates of share-

based compensation costs. No assurance can be given, however, regarding the future changes in estimates of share-based compensation costs.

The fair value of the underlying common stock for all option grants made between December 2005 and July 2007 was determined by the board of directors to be $6.96, which was based on the board’s evaluation of our financial condition and results of operations. Our financial condition, as measured by our internal financial statements and by Guarantee Insurance’s statutory surplus levels and uncertainties related to our abilities to increase premium writings due to surplus constraints, did not change materially between December 2005 and July 2007. We did not secure an independent appraisal to verify that valuation because we concluded that an independent appraisal would not result in a more meaningful or accurate determination of fair value under the circumstances.

As of December 31, 2009, the intrinsic value of outstanding vested and unvested options based on the anticipated offering price of $8.00 per share is approximately $294,000 and $6,000, respectively.

The increase from the $6.96 per share fair value as of July 10, 2007, the most recent stock option grant date, to the estimated initial public offering price is largely attributable to the growth of our company during this period, as well as to these three principal factors:


	•	The first factor is the evolution of our hybrid business model during this period. Until the second quarter of 2009, when we starting producing business for our BPO client, our insurance services income was generated principally from Guarantee Insurance, the segregated portfolio captives and our quota share reinsurers, and as such was almost wholly dependent on Guarantee Insurance’s risk retention levels. In the second quarter of 2009, we began producing insurances services income from our BPO client. For the nine months ended September 30, 2009 (representing just two quarters of BPO production), we recognized approximately $3.5 million of fee income from our BPO client, which represented 35% of our insurance services income for the period.

As a result of the development of our BPO business, our insurance services income has become less dependent on Guarantee Insurance’s retention levels. Our insurance services income tends to be a higher margin business than our insurance underwriting business. The development and expansion of our BPO business is a significant driver for our insurance services income and for our consolidated net income. For the nine months ended September 30, 2009, our consolidated net income of $2.4 million consisted of net income from our insurance services segment of $3.3 million and net income from our insurance segment of $817,000 (exclusive of net investment income of $1.4 million), less $1.8 million of non-allocated items.


	•	The second factor relates to the strength of our company and our growth prospects as a result of the capital to be raised in this offering and the concurrent private placement, as compared to our historical financial condition. The net proceeds from this offering and the concurrent private placement will increase our stockholders’ equity from $10.1 million at September 31, 2009 to an estimated $170.5 million based on $8.00 per share, an increase of over 1,500%. With the additional capital from this offering and the concurrent private placement, our risk profile will be substantially improved as compared to our historical levels of stockholders’ equity. The $6.96 strike price of the options granted in July 2007 reflects the greater risk inherent in a thinly capitalized company, as well as the fact that in July 2007 we had a more limited operating history than we do now. The increase in the per share fair value over this period also reflects the fact that with the increased capital from this offering and the concurrent private placement, we will have the capacity to write more business and retain more of our business, the capital to absorb more losses should they occur and the opportunity to obtain an “A−” (Excellent) rating from A.M. Best. See “Business — Our Strategy — Obtain a Favorable Rating from A.M. Best.”


	•	The third factor is the liquidity driven valuation premium inherently available to a company as it transitions from privately held to publicly traded status.

No options or stock awards were granted during the nine months ended September 30, 2009 or the year ended December 31, 2008.

See Note 8 to our interim consolidated financial statements as of September 30, 2009 and for the nine months then ended and Note 12 to our consolidated financial statements as of December 31, 2008 and for the year then ended for more information regarding our stock option plans, stock options and stock awards granted during 2007 and 2006.

Impairment of Invested Assets

Impairment of an invested asset results in a reduction of the carrying value of the asset and the realization of a loss when the fair value of the asset declines below our carrying value and the impairment is deemed to be other-than-temporary. We regularly review our investment portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of our invested assets. We consider various factors in determining if a decline in the fair value of a security is other-than-temporary, including the scope of the decline in value, the amount of time that the fair value of the asset has been below carrying value, the financial condition of the issuer and our intent and ability to hold the asset for a period sufficient for us to recover its value.

For the nine months ended September 30, 2009, we did not recognize any other-than-temporary impairments. For the year ended December 31, 2008, we recognized an other-than-temporary impairment charge of approximately $875,000 related to investments in certain equity securities. Additionally, during 2008, we recognized an other-than-temporary-impairment charge of approximately $355,000 on our investment of approximately $400,000 in certain Lehman Brothers Holdings, Inc. bonds as a result of Lehman Brothers’ bankruptcy. For the year ended December 31, 2007, we did not recognize any other than temporary impairments. For the year ended December 31, 2006, Tarheel invested approximately $1.7 million in Foundation Insurance Company, a limited purpose captive insurance subsidiary of Tarheel that reinsured workers’ compensation program business, in order to permit Foundation to settle certain obligations relating to its business. We wrote down this investment in 2006. No assurance can be given regarding future changes in estimates related to other-than-temporary impairment of our investment securities.

Adoption of New Accounting Standards and Recent Accounting Pronouncements

Accounting Standards Codification

In June 2009, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162” (the Codification). The Codification reorganized existing U.S. accounting and reporting standards issued by the FASB and other related private sector standard setters into a single source of authoritative accounting principles arranged by topic. The Codification supersedes all existing U.S. accounting standards. All other accounting literature not included in the Codification, other than SEC guidance for publicly traded companies, is considered non-authoritative. The Codification was effective on a prospective basis for interim and annual reporting periods ending after September 15, 2009. The adoption of the Codification changed our references to U.S. GAAP accounting standards, but did not impact our results of operations or financial position.

Business Combinations

In December 2007, the FASB issued revised guidance for the accounting for business combinations. The revised guidance, which is now part of ASC 805, Business Combinations, is effective for acquisitions during the fiscal years beginning after December 15, 2008, and early adoption is prohibited. This revised guidance establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquired entity. The revised guidance also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The adoption of this revised guidance on January 1, 2009 did not have an impact on our results of operations or financial

position. The future impact of the adoption of this revised guidance will depend upon the extent and magnitude of future acquisitions, if any.

Additional Fair Value Measurement Guidance

In April 2009, the FASB issued new guidance for determining when a transaction is not orderly and for estimating fair value when there has been a significant decrease in the volume and level of activity for an asset or liability. The new guidance, which is now part of ASC 820, Fair Value Measurements and Disclosures, is effective for periods ending after June 15, 2009 with early adoption permitted for periods ending after March 15, 2009. Retrospective application is not permitted. This new guidance requires disclosure of the inputs and valuation techniques used, as well as any changes in valuation techniques and inputs used during the period, to measure fair value in interim and annual periods. In addition, the presentation of the fair value hierarchy is required to be presented by major security type as described in ASC 320. The adoption of this new guidance on June 30, 2009 did not have a material impact on our results of operations or financial position.

Disclosure about Fair Value of Financial Instruments

In April 2009, the FASB issued new guidance related to the disclosure of the fair value of financial instruments. The new guidance, which is now part of ASC 825, Financial Instruments, was effective for periods ending after June 15, 2009 with early adoption permitted for periods ending after March 15, 2009. The new guidance requires disclosure of the fair value of financial instruments whenever a publicly traded company issues financial information in interim reporting periods in addition to the annual disclosure required at yearend. The adoption of this new guidance on June 30, 2009 did not have a material impact on our disclosures since all of our material financial instruments are carried at fair value.

Other-Than-Temporary Impairments

In April 2009, the FASB issued new guidance for the accounting for other-than-temporary impairments. The new guidance, which is now part of ASC 320, Investments — Debt and Equity Securities, was effective for periods ending after June 15, 2009 with early adoption permitted for periods ending after March 15, 2009. Under the new guidance, an other-than-temporary impairment is recognized when an entity has the intent to sell a debt security or when it is more likely than not that an entity will be required to sell the debt security before its anticipated recovery in value. The new guidance also changes the presentation and amount of other-than-temporary impairment losses recognized in the income statement for instances in which a company does not intend to sell a debt security, or it is more likely than not that a company will not be required to sell a debt security prior to the anticipated recovery of its remaining cost basis. We separate the credit loss component of the impairment from the amount related to all other factors and report the credit loss component in net realized investment gains (losses). The impairment related to all other factors is reported in accumulated other comprehensive income, net of deferred income taxes. In addition, the new guidance expands disclosures related to other-than-temporary impairments related to debt securities and requires such disclosures in both interim and annual periods. The adoption of the new guidance on June 30, 2009 did not have any impact on our results of operations or financial position.

Subsequent Events

In May 2009, the FASB issued new guidance for accounting for subsequent events. The new guidance, which is now part of ASC 855, Subsequent Events, was effective for interim and annual periods ending after June 15, 2009. The new guidance establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before the financial statements are issued or are available to be issued. Additionally, the new guidance requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. The adoption of the new guidance on June 30, 2009 did not have any impact on our results of operations or financial position.

Fair Value Measurement of Liabilities

In August 2009, the FASB issued new guidance for the accounting for the fair value measurement of liabilities. The new guidance, which is now part of ASC 820, Fair Value Measurements and Disclosures, is effective for interim and annual periods beginning after August 27, 2009. The new guidance provides clarification that in certain circumstances in which a quoted price in an active market for an identical liability is not available, an entity is required to measure fair value using one or more of the following valuation techniques: The quoted price of the identical when traded as an asset, the quoted price for similar liabilities or similar liabilities when traded as an asset or another valuation technique that is consistent with the principles of fair value measurements. We do not expect that the provisions of the new guidance will have a material effect on our results of operations or financial position.

Results of Operations

Our results of operations are discussed below in two parts. The first part discusses our consolidated results of operations. The second part discusses our results of operations by segment.

Consolidated Results of Operations

Nine Months Ended September 30, 2009 Compared to Nine Months Ended September 30, 2008

Overview of Operating Results. Net income for the nine months ended September 30, 2009 was $2.4 million compared to $600,000 for the comparable period in 2008. Income before income taxes for the nine months ended September 30, 2009 was $3.8 million compared to $383,000 for the comparable period in 2008. The increase in income before income taxes was principally the result of a 107% increase in insurance services income, a 3.6 percentage point decrease in net combined ratio and a $1.2 million increase in net realized gains on investments, partially offset by a 12% decrease in net premiums earned and a 38% increase in other operating expenses.

Gross Premiums Written. Gross premiums written were $96.0 million for the nine months ended September 30, 2009 compared to $94.9 million for the comparable period in 2008, an increase of $1.1 million or 1%. The increase was principally attributable to our assumption of approximately $7.8 million of premiums produced for our BPO client, beginning in the second quarter of 2009. This was partially offset by a $7.5 million decrease in traditional business direct premiums written. Gross premiums written by line of business were as follows:


	Nine Months Ended
	September 30,
	2009		2008
	In thousands

Direct business:
Alternative market	$	42,163	$	42,168
Traditional business		44,378		51,912

Total direct business		86,541		94,080

Assumed business
BPO client		7,824		—
NCCI National Workers’ Compensation Insurance Pool		1,607		798

Total assumed business		9,431		798

Total	$	95,972	$	94,878

Gross premiums written on alternative market business were $42.2 million for both the nine months ended September 30, 2009 and 2008. Increases in alternative market gross premiums written, primarily attributable to new agency captive business and the transfer or renewal of approximately $5.4 million of traditional business to alternative market agency captive business during the nine months ended September 30, 2008, were offset by the

January 1, 2009 non-renewal of our then largest alternative market policyholder, which represented approximately $15.5 million of gross premiums written upon renewal for the nine months ended September 30, 2008, together with lower payrolls associated with increases in overall unemployment.

Gross premiums written on traditional business were $44.4 million for the nine months ended September 30, 2009 compared to $51.9 million for the comparable period in 2008, a decrease of $7.5 million or 15%. The decrease in traditional business gross premiums written was generally attributable to lower payrolls associated with increases in overall unemployment, and also to the fact that approximately $5.4 million of traditional business was transferred to or renewed as alternative market agency captive business during the nine months ended September 30, 2009.

Net Premiums Written. Net premiums written were $39.4 million for the nine months ended September 30, 2009 compared to $42.0 million for the comparable period of 2008, a decrease of $2.6 million or 6%. The decrease in net premiums written was primarily attributable to a $3.6 million increase in ceded premiums written, partially offset by the $1.1 million increase in gross premiums written discussed above. We ceded approximately 58% and 44% of our traditional business for the nine months ended September 30, 2009 and 2008, respectively. For the nine months ended September 30, 2009, we had a 25% quota share reinsurance agreement on traditional business in all states and a 68% quota share reinsurance agreement in three states (Florida, New Jersey and Georgia), which business collectively comprised approximately 52% of our traditional direct premiums written. For the nine months ended September 30, 2008, we had a 50% quota share reinsurance agreement in all but three states. We ceded approximately 72% and 71% of our alternative market business for the nine months ended September 30, 2009 and 2008, respectively. In addition, the increase in ceded premiums written was attributable to a premium rate adjustment of approximately $1.3 million on an excess loss reinsurance agreement covering risks attaching from July 1, 2005 through June 30, 2006.

Insurance Services Income. Insurance services income was $9.8 million for the nine months ended September 30, 2009, compared to $4.7 million for the comparable period in 2008, an increase of $5.0 million or 107%. Insurance services income from nurse case management and cost containment services increased to $6.1 million for the nine months ended September 30, 2009 from $4.2 million for the comparable period in 2008, an increase of $1.9 million or 46%, due to the increase in exposures serviced by PRS. Additionally, PUI and PRS recognized approximately $3.5 million of fee income for the nine months ended September 30, 2009 related to the production, underwriting and administration of business on behalf of our BPO client pursuant to an agreement entered into during the second quarter of 2009. This increase was partially offset by a $406,000 decrease in fees for general agency services during the nine months ended September 30, 2008. The majority of these services were terminated in 2008.

Net Investment Income. Net investment income was $1.4 million for the nine months ended September 30, 2009, compared to $1.5 million for the comparable period in 2008, a decrease of $133,000 or 9%. The decrease in net investment income was attributable to a decrease in our average investment portfolio during the period, principally associated with the payment of reinsurance premiums in early 2009 associated with a quota share reinsurance agreement we entered into effective December 31, 2008, pursuant to which we ceded unearned premium reserves, net of ceding commissions, of approximately $8.1 million in order for Guarantee Insurance to satisfy certain regulatory leverage ratio requirements. Additionally, the book yield and taxable equivalent book yield on our portfolio at September 30, 2009 were 3.92% and 4.48%, respectively, compared to 4.16% and 4.77%, respectively, at September 30, 2008. The reduced yield on our portfolio of approximately 24 to 29 basis points reflects lower yields available in the fixed income securities market as our securities mature and new cash is deployed.

and mortgage-backed securities, the proceeds of which were used to pay net reinsurance premiums of approximately $8.1 million as discussed above.

Net Losses and Loss Adjustment Expenses. Net losses and loss adjustment expenses were $15.9 million for the nine months ended September 30, 2009, compared to $20.7 million for the comparable period in 2008, a decrease of $4.9 million or 23%. Our consolidated calendar period net loss ratio was 55.9% for the nine months ended September 30, 2009, compared to 64.2% for comparable period in 2008, a decrease of 8.3 percentage points. The decrease in the loss ratio was the result of favorable accident period loss experience for the nine months ended September 30, 2009 as well as lower adverse development on prior accident periods for the nine months ended September 30, 2009 versus the comparable period in 2008. For the nine months ended September 30, 2009, we recorded unfavorable development of approximately $1.5 million on our workers’ compensation business, primarily attributable to the 2007 accident year, and approximately $248,000 on our legacy asbestos and environmental exposures and commercial general liability exposures from prior accident years. For the nine months ended September 30, 2008, we recorded unfavorable development of approximately $2.2 million on our workers’ compensation business and approximately $745,000 on our legacy asbestos and environmental exposures and commercial general liability exposures from prior accident years.

Net Policy Acquisition and Underwriting Expenses. Net policy acquisition and underwriting expenses were $8.5 million for the nine months ended September 30, 2009, compared to $8.2 million for the comparable period in 2008, an increase of $322,000 or 4%. The increase was the net result in changes in our gross expense ratio and effective ceding commission ratio as described below.

Net policy acquisition and underwriting expenses are comprised of gross policy acquisition and underwriting expenses, which include agent commissions, premium taxes and assessments and general operating expenses associated with insurance operations, net of ceding commissions on ceded quota share reinsurance premiums on traditional and alternative market business, as follows:


	Nine Months Ended
	September 30,
	2009			2008
	Dollar amounts in thousands

Direct and assumed business:
Gross policy acquisition and underwriting expenses	$	23,548		$	21,963
Gross premiums earned		77,154			70,829

Gross policy acquisition and underwriting expense ratio		30.5	%		31.0	%

Alternative market and traditional business ceded on a quota share basis:
Ceding commissions		15,050			13,787
Ceded premiums earned		44,047			36,679

Effective ceding commission rate		34.2	%		37.6	%

Excess of loss reinsurance ceded premiums earned		4,738			1,874

Net business:
Net policy acquisition and underwriting expenses		8,498			8,176
Net premiums earned		28,369			32,276

Net policy acquisition and underwriting expense ratio		30.0	%		25.3	%

Gross policy acquisition and underwriting expenses were $23.5 million for the nine months ended September 30, 2009, compared to $22.0 million for the comparable period in 2008, an increase of $1.6 million or 7%. The increase in gross policy acquisition and underwriting expenses was generally consistent with the growth in gross premiums earned. Our gross expense ratio was 30.5% for the nine months ended September 30, 2009, compared to 31.0% for the comparable period in 2008. The decrease in our gross expense ratio was principally attributable to emerging economies of scale for the nine months ended September 30, 2009

compared to the comparable period in 2008, partially offset by an increase in net policy acquisition and underwriting expenses allocated from the holding company as discussed below.

Ceding commissions on alternative market and traditional business ceded on a quota share basis were $15.1 million for the nine months ended September 30, 2009 compared to $13.8 million for comparable period in 2008, an increase of $1.3 million or 9%. Our blended effective ceding commission rate on alternative market and traditional business quota share reinsurance was 34.2% for the nine months ended September 30, 2009, compared to 37.6% for the comparable period in 2008. The decrease in the blended effective ceding commission rate was principally attributable to a lower ceding commission rate on a traditional business quota share reinsurance treaty we entered into effective January 1, 2009. In addition, certain of our agency-owned captives have lower ceding commission rates than other captives. For the nine months ended September 30, 2009, 64% of the direct premiums written subject to segregated portfolio captive arrangements were derived from agency-owned captives, as compared to 13% for the comparable period in 2008.

Our net policy acquisition and underwriting expense ratio was 30.0% for the nine months ended September 30, 2009, compared to 25.3% for the comparable period in 2008. The increase in our net expense ratio was principally attributable to a lower ceding commission rate on a traditional business quota share reinsurance treaty entered into effective January 1, 2009 and an increase in the allocation of holding company expenses as discussed below.

Other Operating Expenses. Other operating expenses, which are primarily comprised of holding company expenses and expenses attributable to our insurance services operations, were $11.1 million for the nine months ended September 30, 2009, compared to $8.1 million for the comparable period in 2008, an increase of $3.0 million or 38%. Other operating expenses included approximately $9.4 million and $5.4 million associated with insurance services operations for the nine months ended September 30, 2009 and 2008, respectively, and $1.7 million and $2.7 million associated with holding company operations for the nine months ended September 30, 2009 and 2008, respectively. The $4.0 million increase in expenses associated with insurance services operations was attributable to infrastructure growth to support our expanding nurse case management and cost containment services, together with marketing, underwriting and policy administration costs incurred by PUI in connection with gross premiums produced for our BPO client.

The decrease in expenses associated with holding company operations was primarily attributable to an increase in the percentage of holding company expenses allocated to insurance and insurance services segments and a true-up of state income tax expenses for the nine months ended September 30, 2009, resulting in a state income tax benefit of approximately $220,000. Allocable holding company operating expenses, which include all expenses other than holding company stock compensation expense, state income taxes, loan guaranty fees, amortization of capitalized loan costs and certain legal fees associated with holding company matters, are incurred for the benefit of the holding company and our operating segments and allocated to each segment based on the proportion of such costs devoted to each segment. For the nine months ended September 30, 2009, approximately 67% of allocable holding company operating expenses were allocated to the insurance and insurance services segments. For the comparable period in 2008, approximately 38% of allocable holding company operating expenses were allocated to the insurance and insurance services segments. The increase in the portion of allocable holding company expenses allocated to insurance and insurance services segments was attributable to the decrease in holding company resources devoted to capital raising efforts and other holding company matters for the nine months ended September 30, 2009.

Interest Expense. Interest expense was $1.1 million for both the nine months ended September 30, 2009 and 2008. The aggregate principal balance of our notes payable was approximately $18.0 million and $15.4 million at September 30, 2009 and 2008, respectively. The increase in the principal balance was attributable to a $5.5 million loan made to us on December 31, 2008, partially reduced by monthly principal payments on all of our notes payable. Our debt generally bears interest at a fixed percentage above the Federal Reserve prime rate. The increase in interest expense associated with the increase in the principal balance of our notes payable was offset by the fact that the Federal Reserve prime rate was 3.25% for the nine months ended September 30, 2009, and ranged from 5.00% to 7.25% for the nine months ended September 30, 2008.

Income Tax Expense. Federal income tax expense was $1.4 million for the nine months ended September 30, 2009 compared to an income tax benefit of $217,000 for the comparable period in 2008. For the nine months ended September 30, 2009, our income tax expense at the statutory rate, which was approximately $1.3 million, was reduced by approximately $155,000 for tax exempt investment income and approximately $131,000 for a decrease in reserve for uncertain tax positions and increased by approximately $204,000 for a true-up of our prior year tax provision and approximately $213,000 for other items, net. For the nine months ended September 30, 2008, our income tax expense at the statutory rate, which was approximately $130,000, was reduced by approximately $178,000 and $290,000 for tax exempt investment income and a decrease in reserves for uncertain tax positions, respectively, and increased by approximately $121,000 for other items, net.

2008 Compared to 2007

Overview of Operating Results. Our net loss for 2008 was $124,000 compared to net income of approximately $2.4 million for 2007. Our loss before income taxes for 2008 was $767,000 compared to income before income taxes of $1.9 million for 2007. The $2.7 million decrease in income before income taxes was the result of the write-off of approximately $3.5 million of deferred equity offering costs in 2008 incurred in connection with our efforts to consummate an initial public offering and other-than-temporary impairment charges on our investment portfolio of approximately $1.2 million, together with a $1.7 million increase in holding company expenses in 2008, principally attributable to increased staffing and other internal costs in anticipation of an initial public offering and associated expanded business opportunities. These charges were partially offset by a 0.4 percentage point decrease in our combined ratio from insurance operations, together with a 100% increase in net premiums earned, and the recognition of approximately $1.5 million of other income in 2008 associated with gains on the commutation of certain alternative market segregated portfolio cell captive reinsurance treaties.

Gross Premiums Written. Gross premiums written were $117.6 million for 2008 compared to $85.8 million for 2007, an increase of $31.8 million or 37%. Gross premiums written by line of business were as follows:


	2008		2007
	In thousands

Direct business:
Alternative market	$	47,374	$	34,316
Traditional business		69,182		50,599

Total direct business		116,556		84,915
Assumed business(1)		1,007		895

Total	$	117,563	$	85,810


(1)		Represents premiums assumed as a result of our participation in the NCCI National Workers’ Compensation Insurance Pool.

Gross premiums written on alternative market business for 2008 were $47.4 million for 2008 compared to $34.3 million for 2007, an increase of $13.1 million or 38%. The increase in alternative market gross premiums written was primarily attributable to business with certain professional employer organizations and professional temporary staffing organizations on which we retain the risk. These plans may be converted to risk sharing arrangements in the future. The increase was also attributable to an increase in segregated portfolio cell captive reinsurance business and certain large deductible plans, the latter of which we began writing in 2008.

Gross premiums written on traditional business were $69.2 million for 2008, compared to $50.6 million for 2007, an increase of $18.6 million or 37%. The increase in traditional business gross premiums written was attributable to an increase in policy counts. Traditional business policy counts increased by 87%, to 5,538 at December 31, 2008 from 2,965 at December 31, 2007. The increase in policy counts was principally

attributable to our geographic expansion beyond Florida and the Midwest, together with the expansion of our traditional business pay-as-you-go plan. The increase in policy counts was partially offset by an 22% decrease in average annual in-force premium per policy, from approximately $15,800 at December 31, 2007 to approximately $12,400 at December 31, 2008. The decrease in average annual in-force premium per policy was principally attributable to mandatory rate decreases in the state of Florida, an administered pricing state where we wrote approximately 30% of our traditional business direct premiums written in 2008. The majority of the increase in gross premiums written on traditional business in 2008 came from New Jersey, where gross premiums written on traditional business were $9.7 million for 2008 compared to $2.4 million for 2007, an increase of $7.3 million or 307%.

Net Premiums Written. Net premiums written were $45.8 million for 2008, compared to $31.0 million for 2007, an increase of $14.9 million or 48%. The $31.8 million period-over-period increase in gross premiums written was partially offset by a $16.9 million increase in ceded premiums written. The increase in ceded premiums written was primarily attributable to (i) an increase in gross premiums written on traditional business (which was subject to a 50% quota share reinsurance treaty excluding certain states), (ii) an increase in premiums written on alternative market business ceded to segregated portfolio cell captives (which was generally subject to 50% to 90% quota share reinsurance treaties) and (iii) a quota share reinsurance agreement we entered into effective December 31, 2008 pursuant to which we ceded 37.83% of our gross unearned premium reserves, or approximately $12.9 million. These increases in ceded premiums written were partially offset by the commutation of certain alternative market segregated portfolio cell captive reinsurance agreements in 2008, which resulted in a reduction in ceded premiums written of approximately $8.2 million.

Net Premiums Earned. Net premiums earned were $49.2 million for 2008, compared to $24.6 million for 2007, an increase of $24.6 million or 100%. The increase was attributable to the increase in net premiums written, exclusive of the effects of the quota share reinsurance agreement we entered into effective December 31, 2008, for which no ceded premium was earned in 2008 because premiums are recognized as revenue on a pro rata basis over the terms of the policies written.

Insurance Services Income. Insurance services income earned by PRS was $5.7 million for 2008, compared to $7.0 million for 2007, a decrease of $1.4 million or 19%. Insurance services income in 2008 and 2007 was generated principally from nurse case management, cost containment and captive management services provided for the benefit of segregated portfolio captives and our quota share reinsurers. The decrease in insurance services income was attributable to lower fees associated with general agency services, which decreased to $361,000 in 2008 from $2.3 million in 2007 due to termination of these services effective January 1, 2008. This decrease was partially offset by an increase in insurance services income associated with nurse case management and cost containment services, which increased to $5.1 million in 2008 from $4.6 million in 2007 due to an increase in the number of claims subject to nurse case management and bill review. Insurance services income attributable to services provided to parties other than segregated portfolio captives and our quota share reinsurers increased to $241,000 in 2008 from $98,000 in 2007.

Net Investment Income. Net investment income was $2.0 million for 2008, compared to $1.3 million for 2007. Gross investment income was $2.5 million in both 2008 and 2007. The average of our beginning and ending investment portfolio, including cash and cash equivalents, increased to $62.6 million for 2008, compared to $56.1 million for 2007, an increase of $6.5 million, or 12%. The increase in our net investment income attributable to the increase in invested assets was partially offset by the fact that the tax adjusted yield on our debt portfolio fell to 4.99% at December 31, 2008 from 5.19% at December 31, 2007, due to prevailing market conditions in the debt securities market. The increase in our net investment income attributable to the increase in invested assets was also offset by a lower pre-tax yield on tax-exempt state and political subdivision debt securities, which we began to own in the second quarter of 2007. Investment expenses were $478,000 for 2008 compared to $1.2 million for 2007, a decrease of $714,000 or 60%. Investment expenses are principally comprised of interest expense credited to funds-held balances on alternative market segregated portfolio captive arrangements. Interest is credited to funds-held balances based on 3-month U.S. Treasury bill rates. The decrease in investment expenses was primarily attributable to a decrease in short term interest rates due to prevailing credit market conditions as well as a decrease in funds-held balances.

Net Realized Losses on Investments. Net realized losses on investments were approximately $1.0 million for 2008, compared to $5,000 for 2007. Net realized losses on investments in 2008 include an other-than-temporary impairment charge of approximately $875,000 related to investments in certain equity securities purchased in 2005 and approximately $350,000 on our investment of approximately $400,000 in certain bonds issued by Lehman Brothers Holdings, Inc., which filed for bankruptcy in September 2008.

Other Income. Other income was $1.5 million for 2008. We did not recognize other income for 2007. Other income for 2008 represents the recapture of funds held balances and other collateral pursuant to the commutation of six segregated portfolio cell captives in 2008.

Loss From Write-Off of Deferred Equity Offering Costs. In 2008, we recorded a loss from the write-off of deferred equity offering costs of approximately $3.5 million, principally representing legal and audit expenses incurred in 2007 and 2008 in connection with our efforts to consummate an initial public offering, which was suspended in the fourth quarter of 2008 due to market conditions.

Net Losses and Loss Adjustment Expenses. Net losses and loss adjustment expenses were $28.7 million for 2008 compared to $15.2 million for 2007, an increase of $13.5 million or 89%. The increase was attributable to a 100% increase in net premiums earned. Our calendar year net loss ratio was 58.3% for 2008 compared to 61.7% for 2007, a decrease of 3.4 percentage points. The decrease in the loss ratio was principally the result of favorable loss experience for accident year 2008, which was 55.7% compared to 75.7% for accident year 2007.

The favorable 2008 accident year loss ratio was partially offset by adverse development in 2008 on prior accident year net losses and loss adjustment expenses of approximately $584,000 and $710,000 on workers’ compensation and legacy commercial general liability, asbestos and environmental exposures, respectively. As a result of favorable development on prior accident year reserves, incurred losses and loss adjustment expenses decreased by approximately $3.5 million for the year ended December 31, 2007. The $3.5 million of favorable development reflects approximately $2.2 million of favorable development in 2007 on workers’ compensation reserves for prior accident years and $1.3 million of favorable development in 2007 on legacy asbestos and environmental exposures and commercial general liability exposures, the latter as discussed more fully below.

Net Policy Acquisition and Underwriting Expenses. Net policy acquisition and underwriting expenses were $13.5 million for 2008 compared to $6.0 million for 2007, an increase of $7.5 million.


	2008			2007
	Dollar amounts in thousands
Direct and assumed business:
Gross policy acquisition and underwriting expenses	$	31,499		$	22,644
Gross premiums earned		100,070			73,715

Gross policy acquisition and underwriting expense ratio		31.5	%		30.7	%

Alternative market and traditional business ceded on a quota share basis:
Ceding commissions		17,964			16,621
Ceded premiums earned		46,748			44,589

Effective ceding commission rate		38.4	%		37.3	%

Excess of loss reinsurance ceded premiums earned		4,102			4,513

Net business:
Net policy acquisition and underwriting expenses		13,535			6,023
Net premiums earned		49,220			24,613

Net policy acquisition and underwriting expense ratio		27.5	%		24.5	%

Gross policy acquisition and underwriting expenses were $31.5 million for 2008, compared with $22.6 million for 2007, an increase of $8.9 million or 39%. The increase in gross policy acquisition and underwriting expenses was generally consistent with the growth in gross premiums earned. Our gross expense ratio was 31.5% for 2008 compared to 30.7% for 2007. The increase in our gross expense ratio was principally attributable to incremental expenses for professional fees and additional compensation and compensation-related costs associated with the hiring of additional members of senior management as we positioned our company for growth and diversification as well as establishing infrastructure to support the requirements of being a publicly held company. These additional expenses were partially offset by (i) economies of scale as certain of our gross policy acquisition and underwriting expenses did not increase in proportion to gross premiums earned, (ii) a decrease in the portion of holding company expenses allocated to insurance operations as discussed more fully under Other Operating Expenses, and (iii) lower commission expenses in connection with the fact that, effective January 1, 2008, Guarantee Insurance began working directly with agents to market segregated portfolio captive insurance business and paying commissions directly to the producing agents rather than paying a higher general agency commission to PRS.

Ceding commissions on alternative market and traditional business ceded on a quota share basis were $18.0 million for 2008, compared to $16.6 million for 2007, an increase of $1.3 million or 8%. Our blended effective ceding commission rate on alternative market and traditional business quota share reinsurance was 38.4% for 2008 compared to 37.3% for 2007. The increase was principally attributable to the proportional increase in ceded quota share reinsurance premiums on our alternative market business, which have a higher effective ceding commission rate than ceded premiums on our traditional business.

Our net policy acquisition and underwriting expense ratio was 27.5% for 2008, compared to 24.5% for 2007. The ceding commission rates we earn on our alternative market business and traditional business quota share reinsurance are higher than our gross policy acquisition and underwriting expense ratio. Accordingly, if we cede more business on a quota share basis, our net policy acquisition and underwriting expense ratio decreases, and if we cede less business on a quota share basis, our net policy acquisition and underwriting expense ratio increases. The increase in our net expense ratio was principally the result of the fact that a smaller portion of our gross premiums were ceded on a quota share basis in 2008. To a lesser extent, the increase in our net expense ratio was due to the increase in our gross expense ratio.

Other Operating Expenses. Other operating expenses, which are primarily comprised of holding company expenses and expenses attributable to our insurance services operations, were $10.9 million for 2008, compared to $8.5 million for 2007, an increase of $2.4 million or 28%. Other operating expenses included approximately $7.8 million and $7.1 million associated with insurance services operations for 2008 and 2007, respectively, and $3.1 million and $1.4 million associated with holding company operations for 2008 and 2007, respectively. The increase in expenses associated with insurance services operations was attributable to the increase in insurance services income associated with nurse case management and cost containment services. The increase was also attributable to a higher allocation of holding company expenses to our insurance services operations.

The increase in expenses associated with holding company operations reflects a substantial reduction in the proportion of holding company expenses allocated to the insurance segment, partially offset by an increase in the proportion of holding company expenses allocated to the insurance services segment. Allocable holding company operating expenses, which include all expenses other than holding company stock compensation expense, loan guaranty fees and amortization of capitalized loan costs, are incurred for the benefit of the holding company and our operating segments and allocated to each segment based on the proportion of such costs devoted to each segment. For 2008, approximately 30% of allocable holding company operating expenses were allocated to the insurance segment, approximately 30% were allocated to the insurance services segment and approximately 40% were retained by the holding company based on our estimate of costs devoted to the insurance segment, insurance services segment and holding company matters. These allocations principally reflect the time and effort devoted to our planned initial public offering during 2008. For 2007, approximately 80% of allocable holding company operating expenses were allocated to the insurance segment, approximately 8% were allocated to the insurance services segment and approximately 12% were retained by the holding

company, as we determined that a higher proportion of holding company costs were devoted to insurance operations.

Interest Expense. Interest expense was $1.4 million for 2008, compared to $1.3 million for 2007, an increase of $147,000 or 11%. The increase was attributable to the fact that we borrowed an additional $5.7 million in September 2007 and another $1.5 million from Mr. Mariano, our Chairman and Chief Executive Officer and the beneficial owner of a majority of our outstanding shares, in June 2008. Interest expense associated with these additional borrowings was substantially offset by a decrease in the effective interest rate on the debt, which is based on the Federal Reserve prime rate.

Income Tax Expense. We recognized an income tax benefit of approximately $643,000 for 2008, compared to $432,000 for 2007. For 2008, our income tax benefit at the statutory rate, which was approximately $261,000, was increased by approximately $238,000 related to tax exempt investment income and a $290,000 reduction in the reserve for uncertain tax positions, partially offset by the tax effect of other permanent tax differences of approximately $146,000.

For 2007, our income tax expense at the statutory rate, which was approximately $662,000, was reduced by approximately $1.9 million attributable to a change in the valuation allowance related to the deferred tax asset arising from Tarheel net operating loss carry forwards. For the three months ended March 31, 2007 and the years ended December 31, 2006 and 2005, management did not consider it more likely than not that Tarheel would generate future taxable income against which Tarheel net operating loss carry forwards could be utilized and, accordingly, maintained a 100% valuation allowance on the deferred tax asset attributable to Tarheel net operating loss carry forwards. On April 1, 2007, Mr. Mariano, our Chairman, President and Chief Executive Officer and the beneficial owner of a majority of our outstanding shares, contributed all the outstanding capital stock of Tarheel to Patriot Risk Management with the result that Tarheel and its subsidiary, TIMCO, became wholly-owned indirect subsidiaries of Patriot Risk Management. In conjunction with the business contribution, management deemed the prospects for Tarheel business to generate future taxable income and utilize Tarheel net operating loss carry forwards, subject to annual limitations, to be more likely than not and, accordingly, eliminated the valuation allowance on the deferred tax asset associated with Tarheel net operating losses.

Additionally, our income tax expense at the statutory rate for 2007 was reduced by approximately $85,000 related to tax exempt investment income and increased by approximately $711,000 in connection with the increase in the reserve for uncertain tax positions and approximately $192,000 of other net permanent tax differences.

2007 Compared to 2006

Overview of Operating Results. Net income for 2007 was $2.4 million compared to $1.6 million for 2006. The $769,000 increase in net income is comprised of a $1.2 million decrease in pre-tax net income and a $1.9 million decrease in income tax expense. The $1.1 million decrease in pre-tax net income is comprised principally of a $7.4 million decrease in pre-tax net income related to the 2006 gain on early extinguishment of debt and associated other income, which represents the forgiveness of accrued interest on the extinguished debt, partially offset by an increase in pre-tax net income related to (i) a 16.7 percentage point decrease in our combined ratio from insurance operations, (ii) a $437,000 increase in pre-tax net income from insurance services operations and (iii) a decrease in net realized losses of $1.3 million.

The $1.9 million decrease in income tax expense is principally attributable to the fact that we maintained a valuation allowance equal to 100% of the deferred tax assets associated with net operating loss carry forwards attributable to Tarheel operations until April 2007, at which time we reversed the valuation allowance, as discussed more fully below.

Gross Premiums Written. Gross premiums written for 2007 were $85.8 million compared to $62.4 million for 2006, an increase of $23.4 million or 38%. Gross premiums written by line of business were as follows:


	2007		2006
	In thousands

Direct business:
Alternative market	$	34,316	$	33,921
Traditional business		50,599		26,636

Total direct business		84,915		60,557
Assumed business(1)		895		1,815

Total	$	85,810	$	62,372


(1)		Represents premiums assumed as a result of our participation in the NCCI National Workers’ Compensation Insurance Pool.

Gross premiums written on alternative market business for 2007 were $34.3 million compared to $33.9 million for 2006, an increase of $395,000 or 1%.

The increase was attributable to traditional business, for which gross premiums written for 2007 were $50.6 million compared to $26.6 million for 2006, an increase of $24.0 million or 90%. The increase in traditional business gross premiums written was attributable to an increase in policy counts. Traditional business policy counts increased by 126%, from 1,340 at December 31, 2006 to 3,034 at December 31, 2007. The increase in policy counts was principally attributable to the expansion of the traditional business pay-as-you-go plan. The increase in policy counts was partially offset by an 11% decrease in average annual in-force premium per policy, from approximately $18,500 at December 31, 2006 to approximately $16,400 at December 31, 2007. The decrease in average annual in-force premium per policy was principally attributable to mandatory rate decreases in the state of Florida, an administered pricing state where we wrote approximately 41% of our traditional business direct premiums written in 2007. The majority of the increase in gross premiums written on traditional business came from Florida, where gross premiums written on traditional business were $20.8 million for 2007 compared to $7.1 million for 2006, an increase of $13.7 million or 193%.

Net Premiums Written. Net premiums written for 2007 were $31.0 million compared to $19.4 million for 2006, an increase of $11.6 million or 60%. The $23.4 million period-over-period increase in gross premiums written was partially offset by a $11.9 million increase in ceded premiums written. The increase in ceded premiums written was primarily attributable to the increase in gross premiums written on traditional business, which was subject to a 50% quota share reinsurance treaty (excluding certain states) for the full year 2007, but only the second half of 2006.

Net Premiums Earned. Net premiums earned for 2007 were $24.6 million compared to $21.1 million for 2006, an increase of $3.6 million or 17%. The increase was attributable to the increase in net premiums written, recognized as revenue on a pro rata basis over the terms of the policies written.

Insurance Services Income. Insurance services income by PRS for 2007 was $7.0 million compared to $7.2 million for 2006, a decrease of $148,000 or 2%. Insurance services income in 2007 and 2006 was generated principally from nurse case management and cost containment services provided for the benefit of segregated portfolio captives and our quota share reinsurers. In addition, as consideration for providing insurance services, segregated portfolio captives and our quota share reinsurers paid PRS general agency commission compensation, a portion of which was retained by PRS and a portion of which was paid by PRS as commission compensation to the producing agents.

The decrease in insurance services income was attributable to lower fees associated with general agency services, which decreased to $2.3 million in 2007 from $3.0 million in 2006 due to lower earned premiums subject to general agency services. Additionally, insurance services income attributable to services provided to parties other than segregated portfolio captives and our quota share reinsurers decreased to $160,000 in 2007

from $373,000 in 2006, primarily as a result of the termination or sale of service relationships that Tarheel had with other third parties. These decreases were partially offset by an increase in insurance services income associated with nurse case management and cost containment services, which increased to $4.6 million in 2007 from $3.6 million in 2006 due to an increase in the number of claims subject to nurse case management and bill review and a larger portion of the insurance risk assumed by our quota share reinsurers.

Net Investment Income. Net investment income for 2007 and 2006 was $1.3 million. Gross investment income for 2007 was $2.5 million compared to $2.1 million for 2006, an increase of $465,000 or 23%. The increase is a reflection of a higher weighted average invested asset base, the result of growth in net premiums written and the corresponding lag between the collection of premiums and the payment of claims. The increase in gross investment income attributable to a higher invested asset base was somewhat offset by the fact that a portion of our fixed maturity securities at December 31, 2007 were tax-exempt state and political subdivision debt securities, which generate lower pre-tax yields. We had no tax-exempt state and political subdivision debt securities at December 31, 2006. Investment expenses for 2007 were $1.2 million compared to $732,000 for 2006, an increase of $460,000 or 63%. Investment expenses are principally comprised of interest expense credited to funds-held balances related to alternative market segregated portfolio captive arrangements. The increase in investment expenses was attributable to an increase in funds-held balances from December 31, 2006 to December 31, 2007.

Net Realized Losses on Investments. Net realized losses on investments for 2007 were $5,000 compared to $1.3 million for 2006. In 2007, we did not recognize any other-than-temporary impairments. In 2006, we recognized realized losses of approximately $1.7 million in connection with Tarheel’s investment in Foundation, which was deemed to be other-than-temporarily impaired. This was partially offset by realized gains on the sales of equity securities.

Other Income. We did not recognize any other income for 2007. For 2006, we recognized $796,000 of other income in connection with the forgiveness of accrued interest associated with the early extinguishment of debt.

Net Losses and Loss Adjustment Expenses. Net losses and loss adjustment expenses were $15.2 million for 2007 compared to $17.8 million for 2006, a decrease of $2.7 million or 15%, despite an increase in net premiums earned. The decrease was attributable to a lower calendar year net loss ratio which was 61.7% for 2007 compared to 84.7% for 2006, a decrease of 23.0 percentage points. The decrease in the loss ratio was principally the result of favorable development in 2007 on both workers’ compensation and legacy reserves associated with prior accident years, combined with unfavorable development in 2006 on both workers’ compensation and legacy reserves associated with prior accident years. Our net loss ratio was 75.7% for accident year 2007 compared to 72.8% for accident year 2006, an increase of 2.9 percentage points.

As a result of favorable development on prior accident year reserves, incurred losses and loss adjustment expenses decreased by approximately $3.5 million for the year ended December 31, 2007. The $3.5 million of favorable development reflects approximately $2.2 million of favorable development in 2007 on workers’ compensation reserves for prior accident years and $1.3 million of favorable development in 2007 on legacy asbestos and environmental exposures and commercial general liability exposures.

As a result of adverse development on prior accident year reserves, incurred losses and loss adjustment expenses increased by approximately $2.5 million for the year ended December 31, 2006. The $2.5 million of adverse development in 2006 reflects approximately $2.0 million of adverse development in 2006 on workers’ compensation reserves for prior accident years. Of the $2.0 million, approximately $1.3 million was subsequently reduced in 2007 and included in the $3.5 million of total favorable development in 2007 as discussed above. The $2.5 million of adverse development in 2006 also reflects approximately $516,000 of adverse development in 2006 on legacy asbestos and environmental exposures and commercial general liability exposures, the latter as discussed more fully below. The $516,000, together with an additional amount totaling approximately $1.7 million, was subsequently reduced in 2007 and included in the $3.5 million of total favorable development in 2007 as discussed above.

Net Policy Acquisition and Underwriting Expenses. Net policy acquisition and underwriting expenses were $6.0 million for 2007 compared to $3.8 million for 2006, an increase of $2.2 million or 57%.


	2007			2006
	Dollar amounts in thousands

Direct and assumed business:
Gross policy acquisition and underwriting expenses	$	22,644		$	18,622
Gross premiums earned		73,715			60,672

Gross policy acquisition and underwriting expense ratio		30.7	%		30.7	%

Alternative market and traditional business ceded on a quota share basis:
Ceding commissions		16,621			14,788
Ceded premiums earned		44,589			37,391

Effective ceding commission rate		37.3	%		39.5	%

Excess of loss reinsurance ceded premiums earned		4,513			2,228

Net business:
Net policy acquisition and underwriting expenses		6,023			3,834
Net premiums earned		24,613			21,053

Net policy acquisition and underwriting expense ratio		24.5	%		18.2	%

Gross policy acquisition and underwriting expenses were $22.6 million for 2007 compared with $18.6 million for 2006, an increase of $4.0 million or 22%. The increase in gross policy acquisition and underwriting expenses was generally consistent with the growth in gross premiums earned. Our gross expense ratio was 30.7% for both 2007 and 2006.

Ceding commissions on alternative market and traditional business ceded on a quota share basis were $16.6 million for 2007 compared to $14.8 million for 2006, an increase of $1.8 million or 12%. Our blended effective ceding commission rate on alternative market and traditional business quota share reinsurance was 37.3% for 2007 compared to 39.5% for 2006. The decrease was principally attributable to the proportional increase in ceded quota share reinsurance premiums on our traditional business, which have a lower effective ceding commission rate than ceded premiums on our alternative market business.

Our net policy acquisition and underwriting expense ratio was 24.5% for 2007 compared to 18.2% for 2006. The ceding commission rates we earn on our alternative market business and traditional business quota share reinsurance are higher than our gross policy acquisition and underwriting expense ratio. Accordingly, if we cede more business on a quota share basis, our net policy acquisition and underwriting expense ratio decreases, and if we cede less business on a quota share basis, our net policy acquisition and underwriting expense ratio increases. In addition, on our alternative market business quota share reinsurance, we recoup a portion our excess of loss reinsurance costs from the segregated portfolio captives. Accordingly, our excess of loss reinsurance costs are lower, in proportion to gross earned premium, on our alternative market business. The increase in our net expense ratio was principally the result of an increase in excess of loss ceded earned premium associated with the increase in our traditional business and, to a lesser extent, the fact that a smaller portion of our gross premiums were ceded on a quota share basis in 2007 at a lower blended effective ceding commission rate.

included approximately $7.1 million associated with insurance services operations and $1.4 million associated with holding company operations. For 2006, other operating expenses included approximately $6.4 million associated with insurance services operations and $3.3 million associated with holding company operations. The decrease in other operating expenses was primarily attributable to a higher allocation of holding company expenses to insurance operations in 2007 compared to 2006, resulting in an increase in net policy acquisition and underwriting expenses and a corresponding decrease in other operating expenses.

Interest Expense. Interest expense for 2007 was $1.3 million compared to $1.1 million for 2006, an increase of $181,000 or 16%. The increase was attributable to the fact that we borrowed an additional $5.7 million in September 2007 at an interest rate equal to the Federal Reserve prime rate plus 4.5%.

Income Tax Expense. We recognized an income tax benefit of $432,000 for 2007 compared to an income tax expense of $1.5 million for 2006. The decrease in income tax expense was principally the result of changes in the valuation allowance related to the deferred tax asset arising from Tarheel net operating loss carry forwards. For the three months ended March 31, 2007 and the years ended December 31, 2006 and 2005, management did not consider it more likely than not that Tarheel would generate future taxable income against which Tarheel net operating loss carry forwards could be utilized and, accordingly, maintained a 100% valuation allowance on the deferred tax asset attributable to Tarheel net operating loss carry forwards. On April 1, 2007, Mr. Mariano, our Chairman, President and Chief Executive Officer and the beneficial owner of a majority of our outstanding shares, contributed all the outstanding capital stock of Tarheel to Patriot Risk Management with the result that Tarheel and its subsidiary, TIMCO, became wholly-owned indirect subsidiaries of Patriot Risk Management. In conjunction with the business contribution, management deemed the prospects for Tarheel business to generate future taxable income and utilize Tarheel net operating loss carry forwards, subject to annual limitations, to be more likely than not and, accordingly, eliminated the valuation allowance on the deferred tax asset associated with Tarheel net operating losses.

In June 2006, the FASB issued guidance clarifying the accounting and financial reporting for uncertain tax positions. The new guidance prescribes a recognition threshold and measurement attributes for the financial statement recognition, measurement and presentation of uncertain tax positions taken or expected to be taken in an income tax return. We adopted this new guidance effective January 1, 2007. Reserves for uncertain tax positions associated with such new guidance were approximately $421,000 and $711,000 at December 31, 2008 and 2007, respectively. We had no accrued interest or penalties related to uncertain tax positions as of December 31, 2008 or 2007.

Excluding changes in the valuation allowance and excluding the effect of changes in reserve for uncertain tax positions in accordance with FIN 48, our effective tax rate was approximately 39% for 2007 compared to 33% for 2006. The increase in effective tax rate, exclusive of changes in the valuation allowance and reserve for uncertain tax positions, was primarily attributable to Tarheel pre-tax net losses in the first quarter of 2007 for which no tax benefit was recognized due to the then uncertainty of ultimate recoverability.

Segment Information

We manage our operations through two business segments: insurance services and insurance. The insurance services segment provides workers’ compensation claims services and agency and underwriting services. Workers compensation claims services include nurse case management, cost containment services and claims administration and adjudication services. Cost containment services refer to workers’ compensation bill review and re-pricing services. Workers’ compensation agency and underwriting services include general agency services and specialty underwriting, policy administration and captive management services. We currently provide the services principally to Guarantee Insurance, segregated portfolio captives and Guarantee Insurance’s quota share reinsurers. In the insurance segment, we provide workers’ compensation policies to businesses. These products include both alternative market products and traditional insurance. The products offered in our insurance segment encompass a variety of options designed to fit the needs of our policyholders and employer groups.

We consider many factors in determining reportable segments including economic characteristics, production sources, products or services offered and regulatory environment. Certain items are not allocated to

segments, including gains on the early extinguishment of debt, holding company expenses and interest expense. The accounting policies of the segments are the same as those described in the summary of significant accounting policies contained in the notes to our consolidated financial statements. We manage our segments on the basis of both pre-tax and after-tax net income, and, accordingly, our business segment results are shown for all periods to include pre-tax net income (losses), income tax expenses (benefits) and net income (losses). Business segment results are as follows:


	Nine Months
	Ended September 30,					Year Ended December 31,
	2009		2008			2008			2007			2006			2005
						In thousands

Insurance Services Segment
Revenues — insurance services income	$	14,448	$	9,031		$	12,308		$	11,325		$	10,208		$	6,552

Pre-tax net income	$	5,041	$	3,666		$	4,452		$	4,201		$	3,764		$	2,358
Income tax expense (benefit)		1,713		1,246			1,513			(481	)		1,744			938

Net income	$	3,328	$	2,420		$	2,939		$	4,682		$	2,020		$	1,420

Insurance Segment
Revenues:
Premiums earned, net	$	28,369	$	32,276		$	49,220		$	24,613		$	21,053		$	21,336
Investment income, net		1,354		1,487			2,028			1,326			1,321			1,077
Net realized gains (losses) on investments		903		(253	)		(1,037	)		(5	)		393			(1,348	)

Total revenues	$	30,626	$	33,510		$	50,211		$	25,934		$	22,767		$	21,065

Pre-tax net income (loss)	$	1,568	$	509		$	2,773		$	431		$	(1,939	)	$	3,692
Income tax expense (benefit)		751		(174	)		495			951			(689	)		1,198

Net income (loss)	$	817	$	683		$	2,278		$	(520	)	$	(1,250	)	$	2,494

Insurance Services Segment Results of Operations

Nine Months Ended September 30, 2009 Compared to Nine Months Ended September 30, 2008

Insurance Services Income. Insurance services segment income consists of both income for services provided to Guarantee Insurance, which is eliminated in consolidation, and income for services provided to unaffiliated clients, which, on a consolidated basis, represents our insurance services income. For the nine months ended September 30, 2009 and 2008, insurance services segment income and insurance services income were as follows:


	Nine Months Ended
	September 30,
	2009		2008
	In thousands

Insurance services income	$	9,753	$	4,706
Insurance services income for services provided to Guarantee Insurance, eliminated in consolidation		4,695		4,325

Insurance services segment income	$	14,448	$	9,031

Insurance services segment income was $14.4 million for the nine months ended September 30, 2009, compared to $9.0 million for the comparable period in 2008, an increase of $5.4 million or 60%. Insurance services segment income from nurse case management and cost containment services increased to $10.6 million for the nine months ended September 30, 2009 from $7.9 million for the comparable period in 2008, an increase of $2.6 million or 33%, due to the increase in Guarantee Insurance exposures serviced by PRS.

Additionally, PUI recognized approximately $3.5 million of fee income for the nine months ended September 30, 2009 related to the production, underwriting and administration of business on behalf of our BPO client pursuant to an agreement entered into during the second quarter of 2009. This was partially offset by a $776,000 decrease in fees for general agency and reinsurance brokerage services provided to Guarantee Insurance during the nine months ended September 30, 2008. The majority of these services were terminated in 2008.

Pre-Tax Net Income. Pre-tax net income for the insurance services segment was $5.0 million for the nine months ended September 30, 2009, compared to $3.7 million for the comparable period in 2008, an increase of $1.4 million or 38%. The increase in pre-tax net income was attributable to the increase in insurance services segment income, partially offset by an increase in insurance services segment operating expenses to $9.4 million for the nine months ended September 30, 2009 from $5.4 million for the comparable period in 2008. The increase in expenses associated with insurance services segment operations was primarily attributable to marketing, underwriting and policy administration costs incurred by PUI in connection with gross premiums produced for our BPO client, for which we provide general agency, underwriting and captive management services and claims services.

Income Tax Expense. Income tax expense for the insurance services segment was $1.7 million for the nine months ended September 30, 2009, compared to $1.2 million for the comparable period in 2008. The effective tax rate for the insurance services segment was approximately 34% for both the nine months ended September 30, 2009 and 2008.

Net Income. Net income for the insurance services segment was $3.3 million for the nine months ended September 30, 2009, compared to $2.4 million for the comparable period in 2008. The increase in net income was attributable to the increase in pre-tax net income as discussed above, partially offset by the increase in operating expenses and income tax expense.

2008 Compared to 2007

Insurance Services Income. Insurance services segment income consists of both income for services provided to Guarantee Insurance, which is eliminated in consolidation, and income for services provided to unaffiliated clients, which, on a consolidated basis, represents our insurance services income. For 2008 and 2007, insurance services segment income and insurance services income were as follows:


	Year Ended December 31,
	2008		2007
	In thousands

Insurance services income	$	5,657	$	7,027
Insurance services income for services provided to Guarantee Insurance, eliminated in consolidation		6,651		4,298

Insurance services segment income	$	12,308	$	11,325

Insurance services segment income was $12.3 million for 2008, compared to $11.3 million for 2007, an increase of $1.0 million or 9%. Insurance services segment income for both years was comprised of nurse case management and cost containment services provided to Guarantee Insurance, for our benefit and for the benefit of segregated portfolio captives and our quota share reinsurers. Insurance services segment income from nurse case management and cost containment services increased to $11.0 million for 2008, compared to $7.2 million for 2007, due to an increase in the number of claims subject to nurse case management and medical bill review.

Insurance services segment income in 2007 was also generated from general agency services on Guarantee Insurance business, pursuant to which Guarantee Insurance paid PRS general agency commission compensation, a portion of which was retained by PRS and a portion of which was paid by PRS as commission compensation to the producing agents. Effective January 1, 2008, Guarantee Insurance began working directly with agents to market segregated portfolio captive business and paying commissions directly

to the producing agents. As a result, PRS ceased earning general agency commissions and ceased paying commissions to the producing agents on Guarantee Insurance business. Insurance services segment income from general agency services was $361,000 for 2008, which was attributable to premiums earned in 2008 but written prior to January 1, 2008, compared to $3.1 million for 2007.

Insurance services segment income from reinsurance brokerage services was $685,000 for 2008, compared to $967,000 for 2007, a decrease of $282,000 or 29%. The decrease in insurance services segment income from reinsurance brokerage services was attributable to the fact that we appointed a third-party reinsurance broker of record in 2008, from whom we were paid a portion of the reinsurance commissions pursuant to a commission sharing agreement. Insurance services segment income attributable to services provided to parties other than segregated portfolio captives and our quota share reinsurers increased to $241,000 in 2008 from $98,000 in 2007.

Pre-Tax Net Income. Pre-tax net income for the insurance services segment was $4.5 million for 2008, compared to $4.2 million for 2007, an increase of $251,000 or 6%. The increase in pre-tax net income was generally commensurate with an increase in insurance services segment income to $12.3 million for 2008 compared to $11.3 million for 2007. Expenses associated with the insurance services segment, which include general expenses for nurse case managers, bill review administrators and all associated activities and infrastructure, network access fees and commissions, increased at a lower rate than the increase in insurance services segment income due to improved economies of scale. This was partially offset by an increase in expenses allocated from the holding company to the insurance services segment, which are allocated based on the proportion of such costs devoted to the segment. For 2008 and 2007, approximately 28% and 9% of holding company expenses were allocated to the insurance services segment, respectively.

Income Tax Expense. Income tax expense for the insurance services segment was $1.5 million for 2008, compared to an income tax benefit of $481,000 for 2007. In 2007, we recorded a $1.9 million decrease in the valuation allowance related to the deferred tax asset arising from net operating loss carryforwards on the insurance services operations of Tarheel. On April 1, 2007, Mr. Mariano, our Chairman, President and Chief Executive Officer and the beneficial owner of a majority of our outstanding shares, contributed all the outstanding capital stock of Tarheel to us with the result that Tarheel and its subsidiary, TIMCO, became our wholly-owned indirect subsidiaries. In conjunction with the business contribution, management deemed the prospects for Tarheel business to generate future taxable income and utilize Tarheel net operating loss carryforwards, subject to annual limitations, to be more likely than not and, accordingly, eliminated the valuation allowance on the deferred tax asset associated with Tarheel net operating losses. The effective tax rate for the insurance services segment, excluding the decrease in the valuation allowance for 2007, was approximately 34% for both 2008 and 2007.

Net Income. Net income for the insurance services segment was $2.9 million for 2008 compared to $4.7 million for 2007. The decrease in net income was attributable to the decrease in the valuation allowance on the deferred tax asset associated with Tarheel net operating losses for 2007, partially offset by the increase in pre-tax net income as discussed above.

2007 Compared to 2006

Insurance Services Income. Insurance services segment income both income consists of both income for services provided to Guarantee Insurance, which is eliminated in consolidation, and income for services

provided to unaffiliated clients, which, on a consolidated basis, represents our insurance services income. For 2007 and 2006, insurance services segment income and insurance services income were as follows:


	Year Ended December 31,
	2007		2006
	In thousands

Insurance services income	$	7,027	$	7,175
Insurance services income for services provided to Guarantee Insurance, eliminated in consolidation		4,298		3,033

Insurance services segment income	$	11,325	$	10,208

Insurance services segment income for 2007 was $11.3 million compared to $10.2 million for 2006, an increase of $1.1 million or 11%. The increase in insurance services segment income was principally attributable to nurse case management and cost containment services, which increased to $7.2 million in 2007 from $4.8 million in 2006 due to an increase in the number of claims subject to nurse case management and cost containment. Additionally, insurance services segment income attributable to reinsurance brokerage fees from Guarantee Insurance increased to $967,000 for 2007 compared to $625,000 for 2006. These increases were partially offset by a $1.6 million decrease in commissions associated with general agency services, which decreased to $3.2 million in 2007 from $4.8 million in 2006 due to lower earned premium associated with segregated portfolio cell captives serviced by PRS.

Pre-Tax Net Income. Pre-tax net income for 2007 for the insurance services segment was $4.2 million compared to $3.8 million for 2006, an increase of $437,000 or 12%. The increase was generally commensurate with an increase in insurance services segment income to $11.3 million for 2007 compared to $10.2 million for 2006.

Income Tax Expense (Benefit). Income tax benefit for the insurance services segment was $481,000 for 2007, compared to income tax expense of $1.7 million for 2006. In 2007, we recorded a $1.9 million decrease in the valuation allowance related to the deferred tax asset arising from Tarheel net operating loss carryforwards as discussed above. Excluding changes in the valuation allowance, the effective tax rate for the insurance services segment was approximately 34% for both 2007 and 2006.

Net Income. Net income for the insurance services segment was $4.7 million for 2007, compared to $2.0 million for 2006. The increase in net income was commensurate with the increase in pre-tax net income and the changes in the valuation allowance on the deferred tax asset associated with Tarheel net operating losses discussed above.

Insurance Segment Results of Operations

Nine Months Ended September 30, 2009 Compared to Nine Months Ended September 30, 2008

Net Premiums Earned. Net premiums earned were $28.4 million for the nine months ended September 30, 2009, compared to $32.3 million for the comparable period in 2008, a decrease of $3.9 million or 12%. The decrease was generally commensurate with the decrease in net premiums written, which was attributable to an increase in ceded premiums written, partially offset by an increase in gross premiums written, as discussed above.

Net Investment Income. Net investment income was $1.4 million for the nine months ended September 30, 2009, compared to $1.5 million for the comparable period in 2008, a decrease of $133,000 or 9%. The decrease in net investment income was attributable to a decrease in our average investment portfolio during the period, principally associated with the payment of reinsurance premiums in early 2009 associated with a quota-share reinsurance agreement we entered into effective December 31, 2008, pursuant to which we ceded unearned premiums reserves, net of ceding commissions, of approximately $8.1 million in order for Guarantee Insurance to satisfy certain regulatory leverage ratio requirements. Additionally, the book yield and taxable equivalent book yield on our portfolio at September 30, 2009 were 3.92% and 4.48%, respectively, compared to 4.16% and 4.77%, respectively, at September 30, 2008. The reduced yield on our portfolio of approximately

24 to 29 basis points reflects lower yields available in the fixed income securities market as our securities mature and new cash is deployed.

Net Realized Gains on Investments. Net realized gains on investments were $903,000 for the nine months ended September 30, 2009, compared to net realized losses of $253,000 for the comparable period of 2008, an increase of $1.2 million. The increase was principally attributable to the sale of certain asset-backed and mortgage-backed securities, the proceeds of which were used to pay net reinsurance premiums of approximately $8.1 million, as discussed above.

Pre-Tax Net Income. Pre-tax net income for the insurance segment was $1.6 million for the nine months ended September 30, 2009, compared to $509,000 for the comparable period in 2008, an increase of $1.1 million. The increase was attributable to the increase in net realized gains on investments and a decrease in our loss and loss adjustment expense ratio to 55.9% for the nine months ended September 30, 2009 from 64.2% for the comparable period in 2008, partially offset by a premium rate adjustment of approximately $1.3 million on an excess loss reinsurance agreement covering risks attaching from July 1, 2005 through June 30, 2006.

Income Tax Expense. Income tax expense for the insurance segment was $751,000 for the nine months ended September 30, 2009, compared to an income tax benefit of $174,000 for the comparable period in 2008. The effective tax rate for the insurance segment was approximately 48% for the nine months ended September 30, 2009, 14 percentage points above the 34% statutory rate, primarily attributable to a true up of the prior year tax provision. For the nine months ended September 30, 2008, our insurance segment recognized a decrease in reserves for uncertain tax positions of approximately $290,000, resulting in an effective income tax benefit rate for the period of 34%.

Net Income. Net income for the insurance segment was $817,000 for the nine months ended September 30, 2009, compared to $683,000 for the comparable period in 2008, an increase of $134,000 or 20%. The increase in net income was the result of an increase in pre-tax net income, partially offset by an increase in income tax expense, as discussed above.

2008 Compared to 2007

Net Premiums Earned. Net premiums earned were $49.2 million for 2008, compared to $24.6 million for 2007, an increase of $24.6 million or 100%. The increase was attributable to the increase in net premiums written, exclusive of the effects of the quota share reinsurance agreement we entered into effective December 31, 2008 for which no ceded premium was earned in 2008, recognized as revenue on a pro rata basis over the terms of the policies written.

Net Investment Income. Net investment income was $2.0 million for 2008, compared to $1.3 million for 2007. Gross investment income was $2.5 million for both 2008 and 2007. The average of our beginning and ending investment portfolio, including cash and cash equivalents, increased to $62.6 million for 2008 compared to $56.1 million for 2007, an increase of $6.5 million, or 12%. The increase in our invested asset base was partially offset by the fact that the tax adjusted yield on our debt portfolio fell to 4.99% at December 31, 2008 from 5.19% at December 31, 2007 due to prevailing market conditions in the debt securities market. The increase in our invested asset base was also offset by lower pre-tax yield tax-exempt state and political subdivision debt securities, which we began to own in the second quarter of 2007. Investment expenses were $478,000 for 2008 compared to $1.2 million for 2007, a decrease of $714,000 or 60%. Investment expenses are principally comprised of interest expense credited to funds-held balances on alternative market segregated portfolio captive arrangements. Interest is credited to funds-held balances based on 3-month U.S. Treasury Bill rates. The decrease in investment expenses was primarily attributable to a decrease in short term interest rates due to prevailing credit market conditions.

approximately $350,000 on investment of approximately $400,000 in certain Lehman Brothers Holdings, Inc. bonds, as a result of Lehman Brothers’ bankruptcy filing.

Pre-Tax Income. Pre-tax net income for the insurance segment was approximately $2.8 million for 2008, compared to $431,000 for 2007. The increase in pre-tax net income was primarily attributable to an increase in underwriting income attributable to a $24.6 million, or 100%, increase in net earned premiums and, to a lesser extent, a decrease in the portion of holding company expenses allocated to the segment and an increase in net investment income. These factors were partially offset by other-than-temporary impairment charges of approximately $1.0 million and lower commission expenses in connection with the fact that, effective January 1, 2008, Guarantee Insurance began working directly with agents to market segregated portfolio captive insurance business and paying commissions directly to the producing agents rather than paying a higher general agency commission to PRS. Holding company expenses are allocated to the insurance segment based on the proportion of such costs devoted to the segment. For 2008 and 2007, approximately 30% and 80% of holding company expenses were allocated to the insurance services segment, respectively.

Income Tax Expense. Income tax expense for the insurance segment was approximately $495,000 for 2008, compared to $951,000 for 2007. For 2008, the income tax expense for the insurance segment at the statutory rate, which was approximately $943,000, was reduced by approximately $238,000 related to tax exempt investment income and $290,000 related to the reduction in reserve for uncertain tax positions. For 2007, the income tax expense for the insurance segment at the statutory rate, which was approximately $146,000, was increased by approximately $711,000 in connection with the increase in reserve for uncertain tax positions, together with other net permanent tax differences.

Net Income. Net income for the insurance segment was approximately $2.3 million for 2008, compared to a net loss of $520,000 for 2007. The increase in net income was attributable to the increase in pre-tax net income and changes in the reserve for uncertain tax positions as discussed above.

2007 Compared to 2006

Net Premiums Earned. Net premiums earned were $24.6 million for 2007, compared to $21.1 million for 2006, an increase of $3.5 million or 17%. The increase was attributable to the increase in net premiums written, as discussed above, recognized as revenue on a pro rata basis over the terms of the policies written.

Net Investment Income. Net investment income for 2007 and 2006 was $1.3 million. Gross investment income was $2.5 million for 2007, compared to $2.1 million for 2006, an increase of $465,000 or 23%. The increase is a reflection of a higher weighted average invested asset base, the result of growth in net premiums written and the lag between the collection of premiums and the payment of claims. The increase in gross investment income attributable to a higher invested asset base was somewhat offset by the fact that a portion of our fixed maturity securities at December 31, 2007 were tax-exempt state and political subdivision debt securities, which generate lower pre-tax yields. We had no tax-exempt state and political subdivision debt securities at December 31, 2006. Investment expenses were $1.2 million for 2007 compared to $732,000 for 2006, an increase of $461,000 or 63%. Investment expenses are principally comprised of interest expense credited to funds held balances related to our alternative market segregated portfolio captive reinsurers. The increase in investment expenses was attributable to an increase in funds held balances from December 31, 2006 to December 31, 2007.

Net Realized Gains (Losses) on Investments. Our insurance segment had $5,000 of net realized losses on investments for 2007, compared to $393,000 of net realized gains on investments for 2006. Realized gains and losses on investments occur from time to time in connection with the sale of debt securities prior to their maturity and equity securities.

Pre-Tax Net Income (Loss). Pre-tax net income for the insurance segment was $431,000 for 2007, compared to a pre-tax loss of $1.9 million for 2006. The increase in pre-tax net income primarily reflects a lower calendar year loss ratio in 2007 as discussed above.

Income Tax Expense (Benefit). Income tax expense for the insurance segment was $951,000 for 2007, compared to an income tax benefit of $689,000 for 2006. For 2007, the income tax expense for the insurance

segment at the statutory rate, which was approximately $146,000, was increased by approximately $711,000 in connection with the increase in reserve for uncertain tax positions, together with other net permanent tax differences. For 2006, the income tax benefit for the insurance segment was approximately 36% of the insurance segment’s pre-tax net loss.

Net Income (Loss). Net loss for the insurance segment was $520,000 for 2007 compared to a net loss of $1.3 million for 2006. The reduction in the net loss was commensurate with the increase in pre-tax net income, partially offset by the increase in income tax expense.

Liquidity and Capital Resources

Sources and Uses of Funds

Patriot Risk Management is organized as a holding company with two principal operating units — insurance services through PRS and PUI, and insurance through Patriot National Insurance Group, Inc. Patriot Risk Management’s principal liquidity needs include debt service, payments of income taxes, payment of certain holding company costs not attributable to subsidiary operations and, in the future, may include stockholder dividends.

Historically, Patriot Risk Management’s principal source of liquidity has been, and we expect will continue to be, dividends from PRS, as well as financing through borrowings, issuances of our securities and fees received under intercompany agreements as described below. In addition, we expect to retain approximately $5.3 million, or $4.1 million if we acquire PF&C, of the net proceeds from this offering and the concurrent private placement at the holding company for general corporate purposes.

At the time we acquired Guarantee Insurance, it had a large statutory unassigned deficit. As of September 30, 2009, Guarantee Insurance’s statutory unassigned deficit was $94.7 million. Pursuant to a consent order issued by the Florida OIR on December 29, 2006 in connection with the redomestication of Guarantee Insurance from South Carolina to Florida, Guarantee Insurance was prohibited from paying dividends, without Florida OIR approval, until December 29, 2009. Moreover, under Florida law, insurance companies may only pay dividends out of available and accumulated surplus funds derived from realized net operating profits on their business and net realized capital gains, except under limited circumstances with the prior approval of the Florida OIR. Therefore, it is unlikely that Guarantee Insurance will be able to pay dividends for the foreseeable future without the prior approval of the Florida OIR. Currently, Guarantee Insurance does not plan to pay cash dividends on its common stock.

We presently expect that the net proceeds that the holding company retains from this offering and the concurrent private placement, projected cash flows from dividends from our insurance and insurance services operating companies, and cash flows from intercompany agreements with our insurance and insurance services companies will provide Patriot Risk Management with sufficient liquidity to repay our debt, pay income taxes on behalf of Patriot and fund holding company operating expenses not attributable to subsidiary operations for the next two years.

We plan to contribute approximately $155.0 million of the net proceeds from this offering and the concurrent private placement to Guarantee Insurance to support its premium writings. As described elsewhere in this prospectus, we have entered into a stock purchase agreement to acquire PF&C, a shell property and casualty insurance company. Our acquisition of PF&C is subject to various regulatory approvals. If we obtain these regulatory approvals and consummate the acquisition on or prior to March 31, 2010, we plan instead to use approximately $16.7 million of the net proceeds from this offering and the concurrent private placement to pay the purchase price for PF&C (of which approximately $15.5 million represents the capital and surplus of PF&C), to contribute approximately $119.5 million to PF&C to support its premium writings (thereby increasing PF&C’s capital and surplus to $135 million), and to contribute approximately $20.0 million to Guarantee Insurance to support its premium writings.

acquisitions, although we have no current understandings or agreements regarding any such acquisitions (other than PF&C).

If the underwriters exercise all or any portion of their over-allotment option, we intend to use all or a substantial portion of the net proceeds from any such exercise to pay down the balance of our credit facilities with Brooke and ULLICO. If the over-allotment option is exercised in full, we intend to use approximately $16.0 million of the net proceeds to pay off these credit facilities and the remaining $13.0 million, or $11.8 million if we acquire PF&C, for general corporate purposes.

Pursuant to a tax allocation agreement by and among Patriot Risk Management and its subsidiaries, Patriot Risk Management computes and pays federal income taxes on a consolidated basis. At the end of each consolidated return year, each subsidiary computes and pays to Patriot Risk Management its respective share of the federal income tax liability primarily based on separate return calculations. During the nine months ended September 30, 2009, Guarantee Insurance paid approximately $300,000 to Patriot Risk Management under this agreement.

Pursuant to a Management Services Agreement dated as of January 1, 2004 between Patriot Risk Management and Guarantee Insurance, Patriot Risk Management provides Guarantee Insurance with strategic planning and capital raising, prospective acquisition management, human resources and benefits administration and certain other management services. Patriot Risk Management bills Guarantee Insurance for its share of the actual costs of such services on a monthly basis. During the nine months ended September 30, 2009, Patriot Risk Management recouped approximately $1.1 million from Guarantee Insurance under this agreement. Additionally, Patriot Risk Management bills PRS for a portion of the actual costs for such services. During the nine months ended September 30, 2009, Patriot Risk Management recouped approximately $1.1 million from PRS for its share of such services.

Pursuant to a Managed Care Services Agreement between Guarantee Insurance and Patriot Risk Services, dated as of January 1, 2006, Patriot Risk Services provides nurse case management and cost containment services for Guarantee Insurance’s benefit and for the benefit of segregated portfolio captives and our quota share reinsurers. During the nine months ended September 30, 2009, Patriot Risk Services earned a total of $14.4 million under this agreement, $4.6 million of which represented consideration for services performed for the benefit of Guarantee Insurance and are eliminated in consolidation. The remaining $9.8 million earned by Patriot Risk Services under this agreement represents income derived from segregated portfolio captives, our quota share reinsurers and our BPO client for services performed on their behalf and is reflected as insurance services income on our consolidated income statement.

Pursuant to a Subrogation Services Agreement and an Investigation Services Agreement, each dated as of January 1, 2009, between Guarantee Insurance and Patriot Recovery, Inc., Patriot Recovery, Inc. provides subrogation recovery services and investigative services to Guarantee Insurance. During the nine months ended September 30, 2009, Patriot Recovery, Inc. earned approximately $6,000 of fee income under these agreements.

Pursuant to an Expense Reimbursement Agreement effective April 1, 2009 between Guarantee Insurance and PUI, Guarantee Insurance pays salaries and certain other expenses on behalf of PUI. Guarantee Insurance bills PUI for these salaries and certain other expenses on a monthly basis. During the nine months ended September 30, 2009, Guarantee Insurance recouped approximately $1.9 million from PUI under this agreement.

Operating Activities

In our insurance services operations, our principal source of operating funds is insurance services income generated by PRS and PUI. PRS currently provides a range of insurance services primarily to Guarantee Insurance, for its benefit and for the benefit of segregated portfolio captives and our quota share reinsurers. PRS and PUI also provide insurance services to our BPO client. Our primary use of operating funds in our insurance services operations is for the payment of operating expenses.

In our insurance operations, our principal sources of operating funds are premium collections and investment income. Premiums are generally collected over the terms of the policies. Installments booked but

deferred and not yet due represent estimated future premium amounts to be paid ratably over the terms of in-force policies based upon established payment arrangements.

Our primary uses of operating funds in our insurance operations include payments of claims, reinsurance premiums and operating expenses. Currently, we pay claims using cash flow from operations and invest our excess cash in debt securities. We forecast claim payments based on our historical trends as well as loss development factors from the NCCI. We seek to manage the funding of claim payments by actively managing available cash and forecasting cash flows on a short- and long-term basis. Claims paid, net of reinsurance, were $18.2 million, $13.5 million and $10.4 million for 2008, 2007 and 2006, respectively. Since our inception in 2004, we generally have funded claim payments from cash flow from operations, principally premiums, net of amounts ceded to our reinsurers, and net investment income. With the proceeds of this offering and the concurrent private placement, we presently expect to maintain sufficient cash flows from operations to meet our anticipated claim obligations and operating needs for the next two years. However, depending on our level of premium writings, retention and acquisition activity, we may need to raise more capital over time to support our operations.

Other factors may also influence our need to raise additional capital. As of September 30, 2009, Guarantee Insurance had approximately $2.7 million of intercompany receivables, $975,000 of which had been outstanding for more than 90 days (although subsequent to September 30, 2009, all intercompany receivables that had been outstanding for more than 30 days were repaid). Under statutory accounting rules, Guarantee Insurance is required to record the amount of any intercompany receivables that have been outstanding for more than 90 days as a non-admitted asset. Therefore, to the extent that any intercompany receivables have been outstanding for more than 90 days, Guarantee Insurance will be required to non-admit the amount of such receivables, which will result in a corresponding decrease in the surplus of Guarantee Insurance. At year end, if the amount of our premium writings relative to the amount of our surplus causes Guarantee Insurance to be out of compliance with certain statutory leverage ratios, we may need to obtain additional reinsurance, reduce our insurance writings or raise additional capital before year end to contribute to Guarantee Insurance in order to satisfy regulatory leverage ratio requirements. See “Risk Factors — Risks Related to Our Business — We are subject to extensive state regulation; regulatory and legislative changes may adversely impact our business.”

We purchase reinsurance to help protect us against severe claims and catastrophic events and to help maintain desired capital ratios. Based on our estimates of future claims, we believe we are sufficiently capitalized to satisfy the deductibles, retentions and aggregate limits in our annual reinsurance program effective July 1, 2009. We reevaluate our reinsurance program at least annually, taking into consideration a number of factors, including cost of reinsurance, liquidity requirements, operating leverage and coverage terms. If we decrease our retention levels, or maintain our current retention levels and the cost of reinsurance increases, assuming no material change in our loss ratio, our cash flows from operations would decrease because we would cede a greater portion of our premiums written to our reinsurers. Conversely, if we increase our retention levels, or maintain our current retention levels and the cost of reinsurance declines, assuming no material change in our loss ratio, our cash flow from operations would increase. We do not have any immediate plans to materially increase or reduce our retention levels subsequent to this offering.

Investment Activities

Our investment portfolio, including cash and cash equivalents, was approximately $54.5 million at September 30, 2009. The first priority of our investment strategy is capital preservation, with a secondary focus on achieving an appropriate risk adjusted return. We seek to manage our investment portfolio such that the security maturities provide adequate liquidity relative to our expected claims payout pattern. We expect to maintain sufficient liquidity from funds generated from operations to meet our anticipated insurance obligations and operating and capital expenditure needs, with excess funds invested in accordance with our investment guidelines. We anticipate that all of our debt securities would be available to be sold in response to changes in interest rates or changes in the availability of and yields on alternative investments. Accordingly, our debt securities are classified as available for sale and stated at fair value, with net unrealized gains and losses included in accumulated other comprehensive income net of deferred income taxes.

Financing Activities

We had a note payable to the former owner of Guarantee Insurance, with a principal balance of $8.8 million as of March 30, 2006. On that date, we entered into a settlement and termination agreement with the former owner of Guarantee Insurance that allowed for the early extinguishment of the $8.8 million note payable for $2.2 million in cash and release of the indemnification agreement previously entered into by the parties. We recognized an associated gain on the early extinguishment of debt of $6.6 million in 2006.

Effective March 30, 2006, we entered into a loan agreement for $8.7 million with an interest rate equal to the Federal Reserve prime rate plus 4.5% (7.75% at September 30, 2009). The loan was originally entered into with Brooke and is currently syndicated among 22 banks. This loan, which we refer to as the Original Brooke loan, is, now administered by Quivira Capital, LLC. The proceeds of the Original Brooke loan, net of loan and guaranty fee costs, totaled approximately $7.2 million and were used to provide $3.0 million of additional surplus to Guarantee Insurance, pay the $2.2 million early extinguishment of debt noted above, provide $750,000 to Tarheel to settle certain liabilities of Foundation Insurance Company, redeem common stock for approximately $1.0 million and for general corporate purposes. In September 2007, we borrowed an additional $5.7 million from the same lender under the same interest rate terms as the Original Brooke loan, and we refer to this loan together with the Original Brooke loan as the Brooke loans. The proceeds of the additional loan, net of loan and guaranty fee costs, totaled approximately $4.9 million and were used to provide $3.0 million of additional surplus to Guarantee Insurance and to pay federal income taxes of approximately $1.9 million on our 2006 gain on early extinguishment of debt. The principal balance and accrued interest associated with this loan at September 30, 2009 were approximately $11.4 million and $36,000, respectively. Principal and interest payments, based on the prevailing Federal Reserve prime rate at September 30, 2009, were approximately $186,000 per month. Due to the variable rate, payment amounts may change.

On December 31, 2008, we borrowed approximately $5.5 million from ULLICO under the same terms as the Brooke loans. The proceeds of this loan, which we refer to as the ULLICO loan, net of loan and guaranty fee costs, totaled approximately $5.0 million and were used to provide additional surplus to Guarantee Insurance. The principal balance and accrued interest associated with the ULLICO loan at September 30, 2009 were approximately $5.0 million and $16,000, respectively. Principal and interest payments, based on the prevailing Federal Reserve prime rate at September 30, 2009, are approximately $81,000 per month. Due to the variable rate, payment amounts may change.

The Brooke loans and the ULLICO loan are guaranteed by Mr. Mariano, our Chairman, President and Chief Executive Officer and the beneficial owner of a majority of our outstanding shares. Mr. Mariano has pledged all of the shares of our capital stock beneficially owned by him, and which may be acquired by him in the future, as security for his guarantee of the ULLICO loan. In January 2010, the lenders under the Brooke loan and the ULLICO loan agreed to release 500,000 shares of our capital stock beneficially owned by Mr. Mariano so that Mr. Mariano could pledge those shares pursuant to the indemnification and pledge agreement relating to the PES litigation. See “Certain Relationships and Related Transactions — Westwind Holding Company, LLC and Progressive Employer Services.” We pay a guaranty fee of 4% of the principal balance on these loans to Mr. Mariano each year.

The Brooke loans and the ULLICO loan are secured by a first lien on all the assets of Patriot Risk Management, PRS Group, Inc., Patriot National Insurance Group, Inc., Patriot Risk Services, Inc., Patriot Underwriters, Inc. and Patriot Risk Management of Florida, Inc. (each a “borrower”). In connection with the ULLICO loan, the lenders under the Brooke loan and ULLICO entered into an intercreditor agreement under which the parties agreed that repayment and collateral security for the Brooke loan and the ULLICO loan will be on a pari passu basis. The loan agreements, as amended, contain covenants including, among other things, a prohibition on the sale, transfer or conveyance of the assets securing the loans that are not in the ordinary course of business by a borrower without the lender’s consent, certain limitations on the incurrence of future indebtedness, financial covenants requiring us to maintain consolidated stockholders’ equity exceeding $5.5 million on a GAAP basis and Guarantee Insurance to maintain policyholders’ surplus exceeding $14.5 million on a GAAP basis, limitations on certain changes in management and the board of directors without the lender’s consent and a prohibition on making material changes to agency relationships or business

operations without each lender’s consent. Additionally, none of the borrowers may pay dividends on its capital stock without each lender’s consent at any time when Patriot Risk Management’s consolidated stockholders’ equity is less than $50 million.

The lenders may declare outstanding amounts under the loan agreements to be due and payable immediately by us if any borrower defaults. Additionally, certain affiliates of the borrowers are prohibited from soliciting, writing, processing or servicing insurance policies of our customers for a period of five years if there has been a default. Events of default include among others, the following:


	•	non-payment of principal or interest within ten days of the payment due date or any other material nonperformance;

	•	failure to maintain an employment agreement with Steven M. Mariano or find a suitable replacement for him if he should die or become legally incapacitated;

	•	insolvency of any borrower or Guarantee Insurance;

	•	cessation of Steven M. Mariano’s direct or indirect 51% or more ownership and/or profit interest in us or 51% or more voting control of Patriot Risk Management except as a result of the issuance of additional shares of our common stock in this offering;

	•	transfer of direct or indirect ownership of the other borrowers;

	•	regulatory supervision, control or rehabilitation of Guarantee Insurance, failure of Guarantee Insurance to meet certain risk based capital ratios, or revocation or suspension of Guarantee Insurance’s certificate of authority by the state of Florida or any other regulatory body having authority over it;

	•	material impairment of the value of collateral;

	•	deviation by Guarantee Insurance from certain underwriting guidelines without the prior written consent of the lenders;

	•	entry by Guarantee Insurance into any contract that involves the payment of expenses in excess of 10% of the borrowers’ combined annual revenues without the prior written consent of the lenders;

	•	failure of Guarantee Insurance to perform its business obligations under material contracts; and

	•	attempts by other creditors of a borrower to collect any debt any borrower owes through a court proceeding.

At September 30, 2009, we were in compliance with the financial covenants of these loans. Although we were not in compliance with certain non-financial covenants, we have obtained a waiver from the lenders regarding these covenants.

On June 26, 2008, we borrowed $1.5 million from our Chairman, President, Chief Executive Officer and the beneficial owner of a majority of our outstanding shares, pursuant to a promissory note that bears interest at the rate equal to the Federal Reserve prime rate plus 3% (6.25% at September 30, 2009). The net proceeds of the loan totaled approximately $1.3 million and were contributed to the surplus of Guarantee Insurance to support its premium writings. Concurrently with the loan, Mr. Mariano personally borrowed $1.5 million to fund his loan to us. The loan to Mr. Mariano contains terms similar to the terms contained in the note between Mr. Mariano and us. Because Mr. Mariano personally obtained this loan for our benefit, we paid him a loan origination fee of $187,000. The principal balance of the loan, which is payable on demand by the lender subject to the cash flow requirements of Patriot, was approximately $363,000 at September 30, 2009. There was no accrued interest on the loan at September 30, 2009. Subsequent to September 30, 2009, the loan was repaid in full.

In connection with the Brooke loans, the loan from Mr. Mariano and the ULLICO loan, we incurred approximately $2.5 million in issuance costs, which have been capitalized and are being amortized over the estimated terms of the debt. Unamortized debt issuance costs of approximately $1.8 million are included in other assets on the unaudited consolidated balance sheet as of September 30, 2009.

Between July and August 2004, Guarantee Insurance issued five fully subordinated surplus notes in the aggregate amount of $1.3 million to certain policyholders. The aggregate principal balance and accrued

interest associated with these notes at September 30, 2009 were approximately $1.2 million and $190,000, respectively. The notes are unsecured, are subordinated to all general liabilities and claims of policyholders and creditors of Guarantee Insurance, have stated maturities of five years and an interest rate of 3%. The principal and interest due under the subordinated surplus notes are not carried as a legal liability of Guarantee Insurance, but are considered to be a special surplus on Guarantee Insurance’s statutory financial statements. No payments of interest or principal may be made on these subordinated notes unless either (i) the total adjusted capital and surplus of Guarantee Insurance exceeds 400% of the authorized control level risk-based capital (calculated in accordance with the rules promulgated by the NAIC) stated in Guarantee Insurance’s most recent annual statement filed with the appropriate state regulators, or (ii) Guarantee Insurance obtains regulatory approval to make such payments.

Between May and August 2005, we issued subordinated debentures totaling approximately $2.0 million. The debentures had an initial 3-year term, subject to renewal at the end of the term, generally for an additional 3-year term. Certain of the subordinated debentures are subject to renewal for up to two additional 1-year terms. The debentures bear interest at the rate of 3%. The principal balance and accrued interest on these debentures as of September 30, 2009 were approximately $1.6 million and $211,000, respectively.

The following table summarizes our outstanding notes payable, surplus notes payable and subordinated debentures, including accrued interest thereon, as of September 30, 2009:


					Interest			Principal
					Rate at			and
Year of				Interest Rate	September 30,			Accrued
Issuance	Description	Years Due		Terms	2009			Interest
								In thousands

2006/2007	Brooke loans		2009 — 2016	Federal Reserve prime rate plus 4.5%		7.75	%	$	11,481
2008	ULLICO loan		2009 — 2016	Federal Reserve prime rate plus 4.5%		7.75			5,023
2008	Steven Mariano loan		2009	Federal Reserve prime rate plus 3.0%		6.25			363
2004	Surplus notes payable		2009	3.0%		3.00			1,377

									18,244
2005	Subordinated debentures		2011	3.0%		3.00			1,845

								$	20,089

Issuance of Series A Convertible Preferred Stock

Our December 2008 loan agreement with ULLICO required us to raise an additional $1 million in equity financing. To satisfy such obligation, we issued 1,000 shares of Series A convertible preferred stock in December 2008, at a price of $1,000 per share, to five investors, including Mr. Mariano, our Chairman, President, Chief Executive Officer and the beneficial owner of a majority of our outstanding shares, and three of our directors. See “Certain Relationships and Related Transactions — Issuance of Series A Convertible Preferred Stock.” The original terms of the Series A convertible preferred stock provided that upon the consummation of a qualified offering, each outstanding share of Series A convertible preferred stock would automatically convert into that number of shares of our common stock determined by dividing the sum of $1,000 plus any accrued but unpaid dividends on the date of conversion by the price per share of common stock sold in such offering. In January 2010, we amended the conversion terms of the Series A convertible preferred stock so that, upon the consummation of a qualified offering (which includes this offering), each outstanding share of Series A convertible preferred stock will automatically convert into that number of shares of our common stock determined by dividing (1) the sum of (A) $1,000 times 1.5 plus (B) any accrued but unpaid dividends on the date of conversion by (2) the price per share of common stock sold in such offering. The amendment also eliminated the minimum price per share required for an offering to constitute a “qualified offering.”

As a result of this amendment to the conversion terms of our Series A convertible preferred stock, upon completion of this offering and the conversion of the Series A convertible preferred stock, we expect to recognize approximately $500,000 for the intrinsic value of the beneficial conversion feature as of the commitment date. This beneficial conversion amount will be reflected as a deemed dividend to the preferred stockholders, resulting in a $500,000 decrease in income available to common stockholders, a $500,000 reduction in retained earnings and a corresponding $500,000 increase in additional paid in capital.

Nine Months Ended September 30, 2009 Compared to Nine Months Ended September 30, 2008

Net cash used in operating activities was $8.1 million for the nine months ended September 30, 2009, compared to $4.5 million for the comparable period in 2008, an increase of $3.5 million. The increase in net cash used in operating activities was primarily attributable to the payment of reinsurance premiums associated with a quota share reinsurance agreement we entered into effective December 31, 2008, pursuant to which we ceded unearned premium reserves, net of ceding commissions, of approximately $8.1 million. The components of net cash used in operating activities are as follows:


	Nine Months Ended
	September 30,
	2009			2008
	In thousands

Net income	$	2,376		$	600
Non-cash decreases in net income		1,365			837
Changes in balances generally reflecting growth in net premiums written(1)		(4,687	)		(11,614	)
Changes in balances generally reflecting claim payment patterns(2)		(7,534	)		7,823
Other items(3)		424			(2,171	)

	$	(8,056	)	$	(4,525	)


(1)		Includes premiums receivable, unearned and advanced premium reserves, reinsurance funds withheld and balances payable, prepaid reinsurance premiums and funds held by ceding companies and other amounts due from reinsurers

(2)		Includes reserves for losses and loss adjustment expenses and reinsurance recoverable balances on paid and unpaid losses and loss adjustment expenses

(3)		Principally changes in other assets and accounts payable and accrued expenses

Net cash provided by investing activities was $9.2 million for the nine months ended September 30, 2009 compared to net cash used in investment activities of $960,000 for the comparable period in 2008, an increase of $10.2 million. For the nine months ended September 30, 2009, the principal components of net cash provided by investing activities included sales and maturities of debt securities of $20.5 million and sales of equity securities of $329,000, partially offset by purchases of debt securities of $10.8 million, net purchases of short-term investments of $427,000 and purchases of fixed assets of $407,000. For the nine months ended September 30, 2008, the principal components of net cash used in investing activities included purchases of debt securities of $15.7 million, net purchases of short-term investments of $144,000 and purchases of fixed assets of $87,000, partially offset by sales and maturities of debt securities of $15.0 million.

Net cash used in financing activities was $2.1 million for the nine months ended September 30, 2009 compared to net cash provided by financing activities of $739,000 for the comparable period in 2008. For the nine months ended September 30, 2009, net cash used in financing activities included repayment of notes payable of $2.6 million, partially offset by the payment of a receivable from a related party for Series A convertible preferred stock of $500,000. For the nine months ended September 30, 2008, net cash provided by financing activities included proceeds from notes payable of $1.5 million, partially offset by repayment of notes payable of $761,000.

2008 Compared to 2007

Net cash used in operating activities was $4.4 million for 2008 compared to net cash provided by operating activities of $7.1 million for 2007, a decrease of $11.5 million. The components of net cash provided by (used in) operating activities are as follows:


	2008			2007
	In thousands

Net income (loss)	$	(124	)	$	2,379
Non-cash decreases in net income		688			202
Changes in balances generally reflecting growth in net premiums written(1)		(21,974	)		5,877
Changes in balances generally reflecting claim payment patterns(2)		10,054			(2,060	)
Other items(3)		6,971			729

	$	(4,385	)	$	7,127


(1)		Includes premiums receivable, unearned and advanced premium reserves, reinsurance funds withheld and balances payable, prepaid reinsurance premiums and funds held by ceding companies and other amounts due to reinsurers

(2)		Includes reserves for losses and loss adjustment expenses and reinsurance recoverable balances on paid and unpaid losses and loss adjustment expenses

(3)		Principally changes in accounts payable and accrued expenses

Net cash provided by investing activities was $1.4 million for 2008 compared to net cash used in investing activities of $25.0 million for 2007, an increase of $26.4 million. For 2008, the components of net cash provided by investing activities included proceeds from sales and maturities of debt securities of $19.1 million, partially offset by purchases of debt securities, net purchases of short-term investments and purchases of fixed assets totaling $17.6 million. For 2007, the components of net cash used by investing activities included purchases of debt securities and fixed assets and net purchases of short-term investments $46.1 million, partially offset by proceeds from sales and maturities of debt and equity securities totaling $21.1 million.

Net cash provided by financing activities was $6.3 million for 2008 compared to $5.0 million for 2007, an increase of $1.3 million. For 2008, net cash provided by financing activities included proceeds from notes payable of approximately $6.9 million and proceeds from the issuance of preferred stock, net of receivable from related party, of $500,000. These factors were partially offset by the repayment of notes payable of approximately $1.1 million. For 2007, net cash used by financing activities include proceeds from notes payable to Brooke of $5.7 million, partially offset by repayment of notes payable of $586,000 and net disbursements for the redemption of common stock of $100,000.

2007 Compared to 2006

Net cash provided by operating activities was $7.1 million in 2007 compared to $5.0 million in 2006, an increase of $2.1 million. The components of net cash provided by operating activities are as follows:


	2007			2006
	In thousands

Net income	$	2,379		$	1,610
Non-cash income derived from early extinguishment of debt and related other income		—			(7,382	)
Non-cash charges related to net realized investment losses		5			1,346
Other non-cash decreases (increases) in net income		197			1,081
Changes in balances typically reflecting growth in net premiums written(1)		5,877			3,414
Changes in balances typically reflecting claim payment patterns(2)		(2,060	)		7,899
Other items(3)		729			(2,979	)

	$	7,127		$	4,989


(1)		Includes premiums receivable, unearned and advanced premium reserves, reinsurance funds withheld and balances payable, prepaid reinsurance premiums and funds held by ceding companies and other amounts due to reinsurers

(2)		Includes reserves for losses and loss adjustment expenses and reinsurance recoverable balances on paid and unpaid losses and loss adjustment expenses

(3)		Principally changes in accounts payable and accrued expenses

Net cash used in investing activities was $25.0 million in 2007 compared to $13.7 million in 2006, an increase of $11.3 million. In 2007, the primary components of net cash used in investing activities included purchases of debt securities, short-term investments and fixed assets totaling $46.1 million, offset by proceeds from sales and maturities of debt and equity securities totaling $21.1 million. In 2006, the primary components of net cash used in investing activities included purchases of debt securities and, to a much lesser extent, equity securities and fixed assets totaling $25.2 million, offset by proceeds from sales and maturities of debt and equity securities and short-term investments totaling $11.5 million. The increase in net cash used in investing activities in 2007 over 2006 was attributable to increased cash flows from higher premium volume, together with the deployment of $5.7 million of additional proceeds from notes payable as discussed below.

Net cash provided by financing activities was $5.0 million in 2007 compared to $6.1 million in 2006, a decrease of $1.1 million. In 2007, we received $5.7 million of proceeds from notes payable, redeemed common stock for $100,000 and made interest and principal payments on notes payable totaling $586,000. In 2006, we received $8.7 million of proceeds from notes payable, issued common stock for $1.4 million, redeemed common stock for $1.0 million, made interest and principal payments on notes payable totaling $2.3 million and paid dividends of $600,000.

Investment Portfolio

Our primary investment objective is capital preservation. Our secondary objectives are to achieve an appropriate risk-adjusted return and maintain an appropriate match between the duration of our investment portfolio and the duration of the claims obligations in our insurance operations.

At December 31, 2006, we did not anticipate that our fixed maturity securities would be available to be sold in response to changes in interest rates or changes in the availability of and yields on alternative investments and, accordingly, these securities were classified as held to maturity and stated at amortized cost.

In 2007, we purchased state and political subdivision debt securities with the intent that such securities would be available to be sold in response to changes in interest rates or changes in the availability of and yields on alternative investments. Accordingly, we classified these state and political subdivision debt securities

as available for sale and stated them at fair value, with net unrealized gains and losses included in accumulated other comprehensive income net of deferred income taxes.

At December 31, 2007, the increased volatility in the debt securities market substantially increased the likelihood that we would, on a routine basis, desire to sell our debt securities and redeploy the proceeds into alternative asset classes or into alternative securities with better yields or lower exposure to decreases in fair value. We anticipated that all of our debt securities would be available to be sold in response to changes in interest rates or changes in the availability of and yields on alternative investments. Accordingly, we transferred all of our debt securities that were not already classified as available for sale from held to maturity to available for sale. All of our debt securities at December 31, 2008 and 2007 were stated at fair value, with net unrealized gains and losses included in accumulated other comprehensive income net of deferred income taxes. In connection with the transfer of debt securities from held to maturity to available for sale, we recognized a net unrealized gain of approximately $215,000, which is included in other comprehensive income for the year ended December 31, 2007.

Our fixed maturity securities, which are classified as available-for-sale, and certain cash equivalent investments are managed by Gen Re — New England Asset Managers (a subsidiary of Berkshire Hathaway, Inc.), an independent asset manager that operates under investment guidelines approved by our board of directors. Cash and cash equivalents include cash on deposit, commercial paper, short-term municipal securities, pooled short-term money market funds and certificates of deposit. Our fixed maturity securities available for sale include obligations of the U.S. Treasury or U.S. agencies, obligations of states and their subdivisions, long-term certificates of deposit, U.S. dollar-denominated obligations of U.S. corporations, mortgage-backed securities, collateralized mortgage obligations, mortgages guaranteed by the Federal National Mortgage Association and the Government National Mortgage Association, and asset-backed securities. We did not have any equity securities at September 30, 2009. Our real estate portfolio consists of one residential property in Florida. See “Business — Investments.”

We manage our investment credit risk through a diversification strategy that reduces our exposure to any business sector or security. See “Business — Investments” for additional information. Our investment portfolio, including cash and cash equivalents, had a carrying value of $54.5 million at September 30, 2009, and is summarized below:


			Percentage of
	Fair Value		Portfolio
	(In thousands)

Debt securities available for sale:
U.S. government securities	$	3,599		6.6	%
U.S. government agencies		308		0.6
Asset-backed and mortgage-backed securities		13,887		25.4
State and political subdivisions		16,376		30.0
Corporate securities		11,964		22.0

Total fixed maturity securities		46,134		84.6
Short-term investments		671		1.2
Real estate		246		0.5
Cash and cash equivalents		7,452		13.7

Total investments, including cash and cash equivalents	$	54,503		100.0	%

At September 30, 2009, 99.8% of our debt securities available for sale were rated “investment grade” (credit rating of AAA to BBB- by Standard & Poor’s Corporation, or S&P) and 96.8% of our debt securities available for sale were rated A or better by Standard & Poor’s Corporation. The following table shows the

distribution of our fixed maturity securities available for sale as of September 30, 2009 as rated by S&P. Actual ratings do not differ from ratings exclusive of guarantees by third parties as of September 30, 2009.


S&P Credit Rating

AAA	50.9	%
AA	24.5
A	21.4
BBB	3.0
Below BBB	0.2

Total	100.0	%

Approximately 44% of the fair value of our state and political subdivision debt securities were guaranteed by third parties as of September 30, 2009 as follows. We have no direct investments in these financial guarantee companies.


			Percentage of Total
			State and Political
			Subdivision
Guarantor	Fair Value		Securities
	(In thousands)

Ambac Assurance Corporation	$	1,676		10.2	%
Financial Guaranty Insurance Company		2,682		16.4
Financial Security Assurance, Inc.		1,675		10.2
MBIA, Inc.		1,146		7.0

Total	$	7,179		43.8	%

We seek to manage our investment portfolio such that the security maturities provide adequate liquidity relative to our expected claims payout pattern. A summary of the carrying value of our fixed maturity securities available for sale as of September 30, 2009, by contractual maturity, is as follows:


	Fair		Percentage of
	Value		Portfolio
	(In thousands)

Due in one year or less	$	5,171		11.2	%
Due after one year through five years		15,312		33.2
Due after five years		11,764		25.5

		32,247		69.9
Asset-backed and mortgage-backed securities		13,887		30.1

Total	$	46,134		100.0	%

We regularly review our investment portfolio to identify other-than-temporary impairments in the fair values of our securities. We consider various factors in determining whether a decline in the fair value of a security is other-than-temporary, including:


	•	how long and by how much the fair value of the security has been below its cost;

	•	the financial condition and near-term prospects of the issuer of the security, including any specific events that may affect our operations or earnings;

	•	our intent and ability to keep the security for a sufficient time period for us to recover our value;

	•	any downgrades of the security by a rating agency; and

	•	any reduction or elimination of dividends, or nonpayment of scheduled interest payments.

For the nine months ended September 30, 2009, we did not recognize any other-than-temporary impairments. For 2008, we recognized an other-than-temporary impairment charge of approximately $875,000 related to investments in certain equity securities. Additionally, during 2008, we recognized an other-than-temporary-impairment charge of approximately $350,000 on our approximately $400,000 investment in certain Lehman Brothers Holdings, Inc. bonds. We do not believe that our investment portfolio contains any material exposure to subprime mortgage securities.

Effective January 1, 2008, we adopted FASB guidance, now part of ASC 820, Fair Value Measurements and Disclosure, which establishes a three-level hierarchy for fair value measurements that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (Observable Units) and the reporting entity’s own assumptions about market participants’ assumptions (Unobservable Units). The hierarchy level assigned to each security in our available-for-sale debt and equity securities portfolio is based upon our assessment of the transparency and reliability of the inputs used in the valuation as of the measurement date. The three hierarchy levels are as follows:


		Definition

Level 1		Observable unadjusted quoted prices in active markets for identical securities
Level 2		Observable inputs other than quoted prices in active markets for identical securities, including:
		(i) quoted prices in active markets for similar securities,
		(ii) quoted prices for identical or similar securities in markets that are not active,
		(iii) inputs other than quoted prices that are observable for the security (e.g. interest rates, yield curves observable at commonly quoted intervals, volatilities, prepayment speeds, credit risks and default rates, and
		(iv) inputs derived from or corroborated by observable market data by correlation or other means
Level 3		Unobservable inputs, including the reporting entity’s own data, as long as there is no contrary data indicating market participants would use different assumptions

At December 31, 2008, all of our debt securities were classified as Level 1 or Level 2. If securities are traded in active markets, quoted prices are used to measure fair value (Level 1). All of our Level 2 securities are priced based on observable inputs, including (i) quoted prices in active markets for similar securities, (ii) quoted prices for identical or similar securities in markets that are not active or (iii) other observable inputs, including interest rates, volatilities, prepayment speeds, credit risks and default rates for the security. Our management is responsible for the valuation process and uses data from outside sources to assist with establishing fair value. As part of our process of reviewing the reasonableness of data obtained from outside sources, we review, in consultation with our investment portfolio manager, pricing changes that differ from those expected in relation to overall market conditions.

The following table presents our debt securities available for sale, classified by valuation hierarchy, as of September 30, 2009:


	Fair Value Measurement, Using
	Quoted
	Prices
	in Active
	Markets		Significant
	for		Other		Significant
	Identical		Observable		Unobservable
	Securities		Inputs		Inputs
	(Level 1)		(Level 2)		(Level 3)		Total
	In thousands

U.S. government securities	$	3,339	$	259	$	—	$	3,598
U.S. government agencies		—		308		—		308
Asset-backed and mortgage-backed securities		—		11,965		—		11,965
State and political subdivisions		—		16,376		—		16,376
Corporate securities		—		13,887		—		13,887

	$	3,339	$	42,795	$	—	$	46,134

The tax equivalent book yield on our investment portfolio was 4.48% and the average duration of the portfolio was 2.95 years at September 30, 2009.

Contractual Obligations and Commitments

We manage risk on certain long-duration claims by settling these claims through the purchase of annuities from unaffiliated life insurance companies. In the event these companies are unable to meet their obligations under these annuity contracts, we could be liable to the claimants, but our reinsurers remain obligated to indemnify us for all or part of these obligations in accordance with the terms of our reinsurance contracts. At December 31, 2008, we were contingently liable for annuities totaling $953,000 in connection with the purchase of structured settlements related to the resolution of claims. Loss reserves eliminated by these annuities at December 31, 2008 totaled $1.4 million. Each of the life insurance companies issuing these annuities, or the entity guaranteeing the life insurance company, has an A.M. Best Company rating of “A” (Excellent) or better.

The table below provides information with respect to our long-term debt and contractual commitments as of December 31, 2008:


			Payment Due by Period
			Less Than						More Than
	Total		1 Year		1-3 Years		3-5 Years		5 Years
	In thousands

Reserves for losses and loss adjustment expenses(1)	$	74,550	$	29,820	$	26,092	$	14,910	$	3,728
Notes payable(2)		28,208		5,466		7,610		7,257		7,875
Surplus notes payable(2)		1,359		1,359		—		—		—
Subordinated debentures(2)(3)		1,885		1,169		716		—		—
Non-cancelable operating leases		2,014		1,139		875		—		—
Other obligations		165		165		—		—		—

	$	108,181	$	39,118	$	35,293	$	22,167	$	11,603


(1)		The payment of reserves for losses and loss adjustment expenses by period are based on actuarial estimates of expected payout patterns and are not contractual liabilities as to a time certain. Our contractual liability is to provide benefits under the policy. As a result, our estimated payment of reserves for losses and loss adjustment expenses by period is subject to the same uncertainties associated with estimating loss and loss adjustment expense reserves generally and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. For a discussion of loss and loss adjustment expense reserves, see “Business — Reserves for Losses and Loss Adjustment Expenses.” Actual payment of reserves for losses and loss adjustment expenses by period will vary, perhaps materially, from the table above to the extent that reserves for losses and loss adjustment expenses vary from actual ultimate claims and as a result of variations between expected and actual payout patterns. Our business, financial condition and results of operations may be adversely affected if our actual losses and loss adjustment expenses exceed our estimated loss and loss adjustment expense reserves. See “Risk Factors — Risks Related to Our Business — Our business, financial condition and results of operations may be adversely affected if our actual losses and loss adjustment expenses exceed our estimated loss and loss adjustment expense reserves” for a discussion of the uncertainties associated with estimating loss and loss adjustment expense reserves.

(2)		Amounts include interest at rates in effect on December 31, 2008 associated with these obligations. The principal balance and accrued interest on our notes payable at December 31, 2008 was $20.8 million. The interest rate on our notes payable to Brooke and ULLICO, which together comprise approximately 92% of our total notes payable principal balance at December 31, 2008, is equal to the Federal Reserve prime rate plus 4.5% (7.75% at December 31, 2008 and September 30, 2009 as utilized in the commitment table above) and may change on a daily basis. The interest rate on our notes payable to Mr. Mariano, our


		Chairman and Chief Executive Officer and the beneficial owner of the majority of our shares, which comprise approximately 6% of our total notes payable principal balance at December 31, 2008, is equal to the Federal Reserve prime rate plus 3.0% (6.25% at December 31, 2008 and September 30, 2009 as utilized in the commitment table above) and may change on a daily basis. The note payable to Mr. Mariano is payable on demand, and, accordingly, the outstanding principal balance and interest payments on this note are reflected as due in less than 1 year. Payments on our notes payable to Brooke and ULLICO Inc. include guaranty fees payable to Mr. Mariano and do not contemplate prepayment. However, pursuant to the credit agreements and amendments thereto, notes payable may be prepaid. There is no prepayment premium. The principal and accrued interest on our surplus notes payable at December 31, 2008 was $1.4 million. The principal and accrued interest on our subordinated debentures at December 31, 2008 was $1.8 million. Interest rates on our surplus notes payable and subordinated debentures are fixed at 3.0%. See “— Liquidity and Capital Resources” for further discussion of our notes payable, surplus notes payable and subordinated debentures.

(3)		Subordinated debentures are subject to renewal generally for an additional term of three years. Certain of the subordinated debentures are subject to renewal for up to two additional one-year terms. The subordinated debentures that are shown as due and payable in less than one year became due and payable in the second and third quarters of 2008. The subordinated debentures are generally used as collateral in segregated portfolio captives. As such, if a holder were to demand payment, they would be required to post additional collateral of the same value. To date, none of the current holders has requested repayment of their subordinated debenture. We are in the process of seeking the consent of the holder to extend each of these subordinated debentures in accordance with their respective terms.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Quantitative and Qualitative Disclosures About Market Risk

Market risk is the risk of potential economic loss principally arising from adverse changes in the fair value of financial instruments. The major components of market risk affecting us are credit risk and interest rate risk. We did not own any equity securities at September 30, 2009. We currently have no exposure to foreign currency risk.

Credit Risk. Credit risk is the potential loss arising principally from adverse changes in the financial condition of the issuers of our fixed maturity securities and the financial condition of our reinsurers. We manage our credit risk related to the issuers of our fixed maturity securities by generally investing in fixed maturity securities that have a credit rating of “A−” or better by Standard & Poor’s. We and our independent asset manager also monitor the financial condition of all issuers of our fixed maturity securities. To limit our risk exposure, we employ diversification policies that limit our credit exposure to any single issuer or business sector. At December 31, 2008, 99.9% of our fixed maturity securities available for sale were rated “investment grade” (credit rating of AAA to BBB-) by Standard & Poor’s and 99.0% of our fixed maturity securities available for sale were rated A or better by Standard & Poor’s. See “Business — Investments.”

We are subject to credit risk with respect to our reinsurers. Although our reinsurers are obligated to reimburse us to the extent we cede risk to them, we are ultimately liable to our policyholders on all risks we have reinsured. As a result, reinsurance contracts do not limit our ultimate obligations to pay claims, and we might not collect amounts recoverable from our reinsurers. With respect to authorized reinsurers, we manage our credit risk by generally selecting reinsurers with a financial strength rating of “A−” (Excellent) or better by A.M. Best and by performing quarterly credit reviews of our reinsurers. At December 31, 2008, 97.4% of our gross exposures to authorized reinsurers were from reinsurers rated “A−” (Excellent) or better by A.M. Best. With respect to unauthorized reinsurers, which include segregated portfolio captives, we manage our credit risk by generally maintaining collateral, typically in the form of funds withheld and letters of credit, to secure reinsurance recoverable balances. At December 31, 2008, 86.2% of our gross exposures to

unauthorized reinsurers were collateralized. If one of our reinsurers suffers a credit downgrade, we may consider various options to lessen the risk of asset impairment including commutation, novation and additional collateral. See “Business — Reinsurance.”

We are subject to credit risk with respect to our customers. If a customer becomes insolvent or otherwise does not pay the full amount of the premium due on a policy, we may not receive adequate payment to compensate us for the risk incurred under the policy. If we are unable to recover the full amount of our premiums receivable, we recognize a pre-tax loss in the amount of any such unrecovered amount. We currently have an $8.3 premium receivable from PES, our then largest policyholder. See “Risk Factors — Risks Related to our Business — We have filed a lawsuit against our former largest customer regarding amounts we contend are due and owing and are in dispute. This customer is controlled by an individual who was one of our stockholders as of December 31, 2008. We may never receive any of the disputed amounts that we contend are due and owing.”

Interest Rate Risk. We have fixed maturity debt securities available for sale with a fair value of $54.4 million and notes payable with a fair value of $18.0 million at December 31, 2008, both of which are subject to interest rate risk. Interest rate risk is the risk that we may incur losses due to adverse changes in interest rates. Fluctuations in interest rates have a direct impact on the market valuation of our fixed maturity securities and the cost to service our notes payable.

The table below summarizes the interest rate risk associated with our fixed maturity debt securities held at December 31, 2008 by illustrating the sensitivity of fair value to selected hypothetical changes in interest rates, and the associated impact on our stockholders’ equity. We classify our fixed maturity securities as available-for-sale. These fixed maturity securities available-for-sale are carried on our balance sheet at fair value. Temporary changes in the fair value of our fixed maturity securities available for sale impact the carrying value of these securities and are reported in stockholders’ equity as a component of other comprehensive income, net of deferred taxes. The selected scenarios in the table below are not predictions of future events, but rather are intended to illustrate the effect such events may have on the fair value of our fixed maturity securities and on our stockholders’ equity.


			Estimated Increase
			(Decrease) in
						Stockholders’
Hypothetical Change in Interest Rates	Fair Value		Fair Value			Equity
	In thousands

200 basis point increase	$	50,616	$	(3,757	)	$	(2,480	)
100 basis point increase		52,590		(1,783	)		(1,177	)
No change		54,373		—			—
100 basis point decrease		55,955		1,582			1,044
200 basis point decrease		57,298		2,925			1,931

Inflation

Inflation rates may impact our financial condition and results of operations in several ways. Fluctuations in rates of inflation influence interest rates, which in turn affect the market value of our investment portfolio and yields on new investments. Inflation also affects the portion of reserves for losses and loss adjustment expenses that relates to hospital and medical expenses and property claims and loss adjustment expenses, but not the portion of reserves for losses and loss adjustment expenses that relates to workers’ compensation indemnity payments for lost wages, which are fixed by statute. Adjustments for inflationary effects are included as part of our review of loss reserve estimates. Increased costs are considered in setting premium rates, and this is particularly important in the health care area where hospital and medical inflation rates have exceeded general inflation rates. Operating expenses, including payrolls, are affected to a certain degree by the inflation rate.

BUSINESS

Overview

We produce, underwrite and administer alternative market and traditional workers’ compensation insurance plans and provide claims services for insurance companies, segregated portfolio captives and reinsurers. Through our wholly owned insurance company subsidiary, Guarantee Insurance, we generally participate in a portion of the insurance underwriting risk. In our insurance services segment, we generate fee income by providing workers’ compensation claims services as well as agency and underwriting services. Workers’ compensation claims services include nurse case management, cost containment services and claims administration and adjudication services. Workers’ compensation agency and underwriting services include general agency services and specialty underwriting, policy administration and captive management services. Claims services and agency and underwriting services are performed for the benefit of Guarantee Insurance, segregated portfolio captives and Guarantee Insurance’s traditional business quota share reinsurers, all under the Patriot Risk Services brand. We also provide these services for the benefit of another insurance company under the Patriot Underwriters’ brand, a practice which we refer to as business process outsourcing. In our insurance segment, we generate underwriting income and investment income by providing alternative market workers’ compensation risk transfer solutions and traditional workers’ compensation insurance coverage.

We provide insurance services, alternative market workers’ compensation risk transfer solutions and traditional workers’ compensation insurance coverage in Florida and 22 other jurisdictions. We believe that our insurance services capabilities, specialized alternative market product knowledge and our hybrid business model allow us to achieve attractive returns through a range of industry pricing cycles and provide a substantial competitive advantage in areas that are underserved by competitors, which are generally insurance service providers or insurance carriers. We believe that there are opportunities to market our insurance services, alternative market workers’ compensation risk transfer solutions and traditional workers’ compensation insurance coverage throughout the United States.

Our Services and Products

Workers’ Compensation Insurance Services

Our insurance services segment income includes all nurse case management, cost containment and other insurance services fee income earned by PRS and PUI. However, the fees earned by PRS and PUI that are attributable to the portion of the insurance risk that Guarantee Insurance retains and assumes from other insurance companies are eliminated upon consolidation. Therefore, our insurance services income, on a consolidated basis, consists of income for services provided to unaffiliated clients. With respect to business written by Guarantee Insurance, the fees earned by PRS represent the fees paid by segregated portfolio captives and our quota share reinsurers for services performed on their behalf and for which Guarantee Insurance is reimbursed through a ceding commission. For financial reporting purposes, we treat these ceding commissions as a reduction in net policy acquisition and underwriting expenses. With respect to business

produced for our BPO client, the fees earned by PRS and PUI represent fees paid by the BPO client attributable to the portion of insurance risk it retains.

In 2009, we began producing business and performing insurance services for our BPO client. We earn commissions for producing business and insurance services income for providing underwriting, policy and claims administration, nurse case management and cost containment services and, in certain cases, services to segregated portfolio cell captives on the business we produce for this customer. Additionally, we assume a portion of the premium and associated losses and loss adjustment expenses on the business we produce for our BPO client, as mutually determined on a policy-by-policy basis.

Workers’ Compensation Insurance Products

Alternative Market Business. Through Guarantee Insurance, we provide alternative market workers’ compensation risk transfer solutions, including workers’ compensation policies or arrangements where the policyholder, an agent or another party generally bears a substantial portion of the underwriting risk. For example, the policyholder, an agent or another party may bear a substantial portion of the underwriting risk through the reinsurance of the risk by a segregated portfolio captive that is controlled by the policyholder, an agent or another party. A segregated portfolio captive refers to a captive reinsurance company that operates as a single legal entity with segregated pools of assets, or segregated portfolio cells, the assets and associated liabilities of which are solely for the benefit of the segregated portfolio cell participants. Through our segregated portfolio captive arrangements, we generally retain between 10% and 90% of the underwriting risk and earn a ceding commission from the segregated portfolio captive, which is payment to Guarantee Insurance by the captive of a commission as compensation for providing underwriting, policy and claims administration, captive management and investment portfolio management services. For the nine months ended September 30, 2009, we retained approximately 14% of the underwriting risk under our segregated portfolio captive arrangements.

We provide alternative market risk transfer solutions to companies in a broad array of industries, including employers such as hospitality companies, construction companies, professional employer organizations, clerical and professional temporary staffing companies, industrial companies car dealerships, food services and retail and wholesale operations.

Traditional Business. Through Guarantee Insurance, we also provide traditional workers’ compensation insurance coverage. We manage insurance risk through the use of quota share and excess of loss reinsurance. Quota share reinsurance is a form of proportional reinsurance in which the reinsurer assumes an agreed upon percentage of each risk being insured and shares all premiums and losses with us in that proportion. Excess of loss reinsurance covers all or a specified portion of losses on underlying insurance policies in excess of a specified amount, or retention. We typically provide traditional workers’ compensation insurance coverage to:


	•	small to medium-sized employers in a broad array of industries, including clerical and professional services, food services, retail and wholesale operations and industrial services;

	•	low to medium hazard classes; and

	•	accounts with annual premiums below $250,000.

Our Competitive Strengths

We believe we have the following competitive strengths:


	•	Exclusive Focus on Workers’ Compensation Services and Products. Our operations are focused exclusively on workers’ compensation insurance services, workers’ compensation alternative market risk management solutions and traditional workers’ compensation insurance coverage. We believe this focus allows us to provide superior services and products to our customers relative to multiline insurance service providers and multiline insurance carriers. Furthermore, a significant portion of our services and products are provided in Florida, and we believe that certain of our multiline competitors that offer workers’ compensation coverage as part of a package policy including commercial property coverage tend to compete less for Florida workers’ compensation business because of property-related loss experience.

	•	Hybrid Business Model. In addition to the fee income we earn for nurse case management, cost containment and other insurance services, we also earn ceding commissions on our alternative market business involving segregated portfolio cell captives and we earn underwriting and investment income on our alternative market and traditional workers’ compensation business. Because our nurse case management and cost containment service income is principally related to workers’ compensation claim frequency and medical costs, the operating results of our insurance services segment are not materially dependent on fluctuations or trends in prevailing workers’ compensation insurance premium rates. We believe that by changing the emphasis we place on our insurance services segment and ceding commission-based alternative market business relative to our traditional workers’ compensation business, we will be better able to achieve attractive returns and growth through a range of market cycles.

	•	Targeted Market for Alternative Market Risk Transfer Solutions. Although other insurers generally only offer alternative market products to large corporate customers, we offer alternative market workers’ compensation solutions to small, medium and larger-sized employers, enabling them and others to share in the claims experience and benefit from favorable loss experience.

	•	Enhanced Traditional Business Product Offerings. In our traditional business, we offer a number of flexible payment plans, including pay-as-you-go plans in which we partner with payroll service companies and our independent agents and their small employer clients to collect premiums and payroll information on a monthly or bi-weekly basis. Pay-as-you-go plans provide us with current payroll data and allow employers to remit premiums through their payroll service provider in an automated fashion. Flexible payment plans give employers a way to purchase workers’ compensation insurance without having to make a large upfront premium deposit payment. We believe that flexible payment plans, including pay-as-you-go plans, for small employers provide us with the opportunity to earn more favorable underwriting margins due to several factors:


	i.	favorable cash flows afforded under this plan can be more important to smaller employers than a price differential;

ii. smaller employers are generally less able to obtain premium rate credits and discounts; and


	iii.	the premium remittance mechanism results in a more streamlined renewal process and a lower frequency of business being re-marketed at renewal, leading to more favorable retention rates.


	•	Specialized Underwriting Expertise. We select and price our alternative market and traditional business products based on the specific risk associated with each potential policyholder rather than solely on the policyholder’s industry class. We utilize state-specific actuarial models on accounts with annual premiums over $100,000. In our alternative market business, we seek to align our interests with those of our policyholders or other parties participating in the risk-sharing arrangements by having them share in the underwriting profits and losses. We believe that we can compete effectively for alternative market and traditional insurance business based on our specialized underwriting focus and our accessibility to our clients. We generally compete on these attributes more so than on price, which we believe is generally not a differentiating factor in the states in which we write most of our business. For

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		the nine months ended September 30, 2009 and year ended December 31, 2008, we reported consolidated net loss ratios of 55.9% and 58.3%, respectively. The net loss ratio is the ratio between losses and loss adjustment expenses incurred and net premiums earned, and is a measure of the effectiveness of our underwriting efforts.


	•	Effective Claims Management, Nurse Case Management and Cost Containment Services. Guarantee Insurance began writing business as a subsidiary of Patriot Risk Management in the first quarter of 2004. As our business has grown, we have been successful in reasonably estimating our total liabilities for losses and loss adjustment expenses, establishing and maintaining adequate case reserves and rapidly closing claims. We provide our customers with an active claims management program. Our claims department employees average more than 24 years of workers’ compensation insurance industry experience, and members of our claims management team average more than 21 years of workers’ compensation experience. In addition, our nurse case management and bill review professionals have extensive training and expertise in assisting injured workers to return to work quickly. As of December 31, 2008, approximately 6%, 2%, 1% and 0.4% of total reported claims for accident years 2007, 2006, 2005 and 2004, respectively, remained open. Final net paid losses and loss adjustment expenses associated with closed claims are approximately 5% less than the initial reserves established for them.

	•	Strong Distribution Relationships. We maintain relationships with our network of approximately 570 independent, non-exclusive agencies in 23 jurisdictions by emphasizing personal interaction and superior service and maintaining an exclusive focus on alternative market workers’ compensation solutions and traditional workers’ compensation insurance coverage. Our experienced underwriters work closely with our independent agents to market our products and serve the needs of prospective policyholders.

	•	Proven Leadership and Experienced Management. The members of our senior management team average over 20 years of insurance industry experience and workers’ compensation insurance experience. Their authority and areas of responsibility are consistent with their functional and state-specific experience.

Our Strategy

We believe that the net proceeds from this offering and the concurrent private placement will provide us with the additional capital necessary to increase the amount of insurance that we write and to make strategic acquisitions of insurance services operations and insurance companies. We plan to continue pursuing profitable growth and favorable returns on equity, and believe that our competitive strengths will help us achieve our goal of delivering attractive returns to our investors. Our strategy to achieve these goals is to:


	•	Expand in Our Existing Markets. In all of the states in which we operate, we believe that a significant portion of total workers’ compensation insurance premium is written by numerous companies that individually have a small market share. We believe that our market share in each of the states in which we currently write business does not exceed 3%. We plan to continue to take advantage of our competitive position to expand in our existing markets. We believe that our risk selection, claims management, nurse case management and cost containment capabilities position us to profitably increase market share in our existing markets.

	•	Expand into Additional Markets. We are licensed to write workers’ compensation insurance in 27 jurisdictions, and we also hold 4 inactive workers’ compensation licenses. For the nine months ended September 30, 2009, we wrote traditional and alternative market business in 23 jurisdictions, principally in those jurisdictions that we believe provide the greatest opportunity for near-term profitable growth. For the nine months ended September 30, 2009, approximately 74% of our traditional and alternative market business was written in Florida, New Jersey, Missouri, Georgia and New York. We wrote approximately 28% of our direct premiums written in Florida for the nine months ended September 30, 2009. We plan to expand our business in states where we believe we can profitably write business. To do this, we plan to continue to leverage our talented pool of personnel, some of whom have prior

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		expertise operating in states in which we do not currently operate. In addition, we may seek to acquire other insurance companies, books of business or other workers’ compensation policy and claims administration providers, general agencies or general underwriting organizations as we expand in our existing markets and into additional markets.


	•	Expand our BPO Business. In 2009, we entered into an agreement to produce business and perform insurance services for our BPO client to gain access to workers’ compensation insurance business in certain additional states. For the nine months ended September 30, 2009, approximately 34% of the business we produced and serviced for our BPO client was in California, and approximately 31% of such business was in either Texas, Michigan, Illinois or South Carolina. In the fourth quarter of 2009, we entered into a BPO relationship with another company, and we are seeking to enter into additional BPO relationships.

	•	Expand Nurse Case Management, Cost Containment and Other Insurance Services Operations. We plan to continue to generate fee income through our insurance services segment by offering workers’ compensation nurse case management and cost containment services to segregated portfolio captives and our quota share reinsurers. We plan to offer these services, together with general agency, general underwriting and policy and claims administration services, to other regional and national insurance companies and self-insured employers. We also plan to increase our insurance services income by expanding both organically and through strategic acquisitions of workers’ compensation policy and claims administration service providers, general agencies or general underwriting organizations. Taking advantage of our hybrid business model, we plan to identify and acquire insurance services operations that will create synergies with our alternative market and traditional workers’ compensation business.

	•	Obtain a Favorable Rating from A.M. Best. We have been informed by A.M. Best that after completion of this offering and the concurrent private placement, we may expect Guarantee Insurance to receive a financial strength rating of “A−” (Excellent), which is the fourth highest of fifteen A.M. Best rating levels. This indicative rating assignment is subject to the capitalization of Guarantee Insurance (and PF&C if we acquire it) at a level that A.M. Best requires to support the assignment of the “A−” rating through 2012 . We expect that the contribution of $155 million of the net proceeds of this offering and the concurrent private placement to Guarantee Insurance (or the contribution of $20 million to Guarantee Insurance and the capitalization of PF&C with $135 million if we acquire it) on or prior to March 31, 2010 will be sufficient to satisfy this requirement. If we acquire PF&C as described elsewhere in this prospectus, this rating assignment is also conditioned upon regulatory approval of a pooling agreement between Guarantee Insurance and PF&C that is satisfactory to A.M. Best. Pooling is a risk-sharing arrangement under which premiums and losses are shared between the pool members. We expect to make the contemplated capital contributions when we purchase PF&C or conclude not to proceed with that transaction, in either event prior to March 31, 2010. The indicative rating assignment we received from A.M. Best is not a guarantee of final rating outcome. In addition, in order to maintain this rating, Guarantee Insurance (and PF&C if we acquire it) must maintain capitalization at a level that A.M. Best requires to support the assignment of the “A−” rating, and any material negative developments in our operations, including in terms of management, earnings, capitalization or risk profile could result in negative rating pressure and possibly a rating downgrade. While we have expanded our business profitably without an A.M. Best rating and we believe that we can continue to do so with the net proceeds from this offering and the concurrent private placement, we believe that an “A−” rating from A.M. Best would increase our ability to market to large national brokers and large employers and create new opportunities for our products and services in rating sensitive markets. A.M. Best’s ratings reflect its opinion of an insurance company’s financial strength and ability to meet ongoing obligations to policyholders and are not intended for the protection of investors.

	•	Leverage Existing Infrastructure. We service our insurance services customers and policyholders through regional offices in three states, each of which we believe has been staffed to accommodate a certain level of insurance services business and premium growth. We plan to realize economies of scale in our workforce and leverage other scalable infrastructure costs.

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Our Organization

Patriot Risk Management, Inc. was incorporated in Delaware in April 2003 by Steven M. Mariano, our Chairman, President and Chief Executive Officer. In September 2003, our wholly owned subsidiary, Patriot National Insurance Group, Inc., acquired Guarantee Insurance Company (“Guarantee Insurance”), a shell property and casualty insurance company that was not writing new business at the time we acquired it. At that time, Guarantee Insurance had approximately $3.2 million in loss and loss adjustment expense reserves relating to commercial general liability claims that had been in run-off since 1983, and was licensed to write insurance business in 41 states and the District of Columbia. Guarantee Insurance is domiciled in Florida and began writing business as a subsidiary of Patriot Risk Management in the first quarter of 2004. Guarantee Insurance is currently licensed to write workers’ compensation insurance in 27 jurisdictions, and also holds 4 inactive workers’ compensation licenses.

In 2005, we formed PRS Group, Inc. as a wholly owned subsidiary and incorporated Patriot Risk Services, Inc. and Patriot Re International, Inc. as wholly owned subsidiaries of PRS Group, Inc. PRS provides nurse case management and cost containment services for the benefit of Guarantee Insurance, segregated portfolio captives and our quota share reinsurers. Patriot Re International, Inc. is licensed as a reinsurance intermediary broker in 2 jurisdictions, although Patriot Re’s business was in run-off through the second quarter of 2009 and is currently inactive.

In 2008, we formed Patriot Recovery, Inc. to assist us in investigation and subrogation activities.

On December 18, 2009, we entered into a stock purchase agreement with Argonaut Insurance Company to acquire Argonaut-Southwest Insurance Company, a shell property and casualty insurance company domiciled in Illinois for a cash price of $1.2 million plus the statutory surplus of that company as of September 30, 2009, which was approximately $15.5 million. We plan to rename Argonaut-Southwest as Patriot Fire & Casualty Insurance Company when we acquire it.

In connection with, and as a condition to our acquisition of PF&C, we are seeking to have it redomesticated to Florida. Both the redomestication and acquisition are subject to regulatory approvals by both the Illinois and Florida insurance departments. In addition, if we acquire PF&C, our indicative rating assignment from A.M. Best is conditioned upon Florida regulatory approval of a pooling agreement between PF&C and Guarantee Insurance that is satisfactory to A.M. Best. If we receive all regulatory approvals for this transaction, we plan to acquire PF&C on or prior to March 31, 2010. There can be no assurance that we will obtain the necessary regulatory approvals to complete this acquisition. We do not believe that our failure to acquire PF&C will adversely affect our business plan or prevent us from obtaining the “A−” rating from A.M. Best that we expect to receive upon completion of this offering and the concurrent private placement.

As of December 31, 2008, PF&C had approximately $17.7 million of total assets, comprised principally of cash and invested assets, and had approximately $2.7 of total liabilities, of which approximately $2.6 million represented ceded reinsurance premiums payable. For the year ended December 31, 2008, PF&C had approximately $3.7 million of direct premiums written, $2.7 million of direct premiums earned and $140,000 of net income, nearly all of which income represented investment income. The operations of PF&C for the years ended December 31, 2008, 2007 and 2006 were substantially different from our operations, and it will be a condition to closing the consummation of the acquisition that all in-force business is indemnity reinsured by an affiliate of Argonaut Insurance Company, and further that all of the liabilities of PF&C be transferred out of PF&C prior to or as soon as practicable after the closing. All of the in-force business is currently reinsured to an affiliate of Argonaut Insurance Company. PF&C’s annual historical financial statements for the years ended December 31, 2008, 2007 and 2006 and presentation of the pro forma effects of such business combination would not be meaningful to the understanding of our operations and, accordingly, have not been included in this prospectus.

PF&C is licensed to write workers’ compensation insurance in Arizona, Arkansas, California, Illinois, Louisiana, Mississippi, New Jersey, New Mexico, Oklahoma, Oregon, and Texas. Guarantee Insurance is licensed in each of these jurisdictions except for Arizona, California, Illinois, Oregon, and Texas. We intend to contribute a substantial portion of the proceeds of this offering and the concurrent private placement to

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Guarantee Insurance and, if we acquire it, to PF&C, to support their premium writings. We intend to use a portion of the net proceeds of this offering and the concurrent private placement to pay the purchase price to acquire PF&C on or prior to March 31, 2010. We believe that the acquisition of PF&C will allow us to obtain licenses to write business in additional states and offer, in certain states, separate rating plans from those offered through Guarantee Insurance, thus allowing us and our producers additional rating flexibility to write a broader range of risks than might be possible under the rating plans of only a single insurer.

In 2009, we renamed two of our inactive subsidiaries as Patriot Underwriters, Inc. and Patriot General Agency, Inc. These entities are obtaining licenses, as appropriate, to provide general agency and general underwriting services to third parties. General agency services were provided to third parties by certain PRS Group, Inc. subsidiaries in 2008 and 2007. Patriot Risk Services, Inc. is currently licensed as an insurance agent or producer in 19 jurisdictions. Patriot Insurance Management Company is currently licensed as an insurance agent or producer in 34 jurisdictions. Patriot Underwriters, Inc. is licensed as an insurance producer in 39 jurisdictions. Patriot General Agency, Inc. is licensed as an insurance producer in 39 jurisdictions. We plan to utilize Patriot Underwriters, Inc. and Patriot General Agency, Inc. to provide general agency and general underwriting services to third parties and cease providing general agency services through Patriot Risk Services, Inc. and Patriot Insurance Management Company. In 2009, we renamed Guarantee Insurance Group, Inc. as Patriot National Insurance Group, Inc.

Industry Overview and Outlook

Workers’ compensation insurance is a system established under state and federal laws under which employers are required to pay for their employees’ medical, disability, vocational rehabilitation and death benefit costs for injuries, death or occupational diseases arising out of employment, regardless of fault. The principal concept underlying workers’ compensation laws is that employees injured in the course and scope of their employment have only the legal remedies available under workers’ compensation laws and do not have any other recourse against their employer. An employer’s obligation to pay workers’ compensation benefits does not depend on any negligence or wrongdoing on the part of the employer and exists even for injuries that result from the negligence or fault of another person, a co-employee or the injured employee.

Insurance Services

Insurance services include workers’ compensation general agency, underwriting and captive management services, including policy administration, and claims services. Claims services include nurse case management, cost containment and claims administration.

With respect to claims services, workers’ compensation nurse case management and cost containment services are intended to help control the cost of workers’ compensation claims through intervention and ongoing review of services proposed and provided. Claims case management and cost containment techniques were originally developed to stem the rising costs of medical care for employers and health insurance companies. Employers and workers’ compensation insurance companies have been slow to implement nurse case management and cost containment techniques to workers’ compensation claims, primarily because the aggregate costs of workers’ compensation claims are relatively small compared to costs associated with group health benefits and because state-by-state regulations related to workers’ compensation are far more complex than those related to group health insurance. However, we believe that employers and insurance carriers have been increasing their focus on nurse case management and cost containment to control their workers’ compensation costs.

An increasing number of states have adopted legislation encouraging the use of workers’ compensation nurse case management and cost containment to assist employers in controlling their workers’ compensation costs. These laws generally provide employers an opportunity to channel injured employees into provider

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networks. In certain states, these laws require licensed organizations to offer certain specified services, such as utilization management, case management, peer review and provider bill review. We believe that these laws generally establish a framework within which we can provide our customers with a full range of nurse case management and cost containment services for greater workers’ compensation cost control.

Certain states do not permit employers to restrict a claimant’s choice of provider, making it more difficult for employers to utilize, or engage other organizations to provide, nurse case management and cost containment techniques. However, in certain states, employers have the right to direct employees to a specific primary healthcare provider during the onset of a workers’ compensation case, subject to the right of the employee to change physicians after a specific period. In addition, workers’ compensation laws vary from state to state, making it difficult for multi-state employers to adopt uniform policies to administer, manage and control the costs of benefits. As a result, we believe that effective nurse case management and cost containment requires approaches tailored to the specified regulatory environment in which the employer is operating.

Insurance

Workers’ compensation insurance policies generally provide that the insurance carrier will pay all benefits that the insured employer may become obligated to pay under applicable workers’ compensation laws. Each state has a regulatory and adjudicatory system that quantifies the level of wage replacement to be paid, determines the level of medical benefits to be provided and the cost of permanent impairment and specifies the options in selecting medical providers available to the injured employee or the employer. These state laws generally require two types of benefits for injured employees: medical benefits, which include expenses related to diagnosis and treatment of the injury, as well as any required rehabilitation, and indemnity payments, which consist of temporary wage replacement, permanent disability payments and death benefits to surviving family members. To fulfill these mandated financial obligations, virtually all employers are required to purchase workers’ compensation insurance or, if permitted by state law or approved by the U.S. Department of Labor, to self-insure. The employers may purchase workers’ compensation insurance from a private insurance carrier, a state-sanctioned assigned risk pool or a self-insurance fund, which is an entity that allows employers to obtain workers’ compensation coverage on a pooled basis. Employers, agents and other parties may also participate in workers’ compensation underwriting risk through a segregated portfolio captive that is controlled by the policyholder, agent or another party, or through other risk sharing arrangements, such as large deductible policies or retrospectively rated policies.

We believe the challenges faced by the workers’ compensation insurance industry over the past few years have created significant opportunity for us to increase the amount of business we write. According to the 2009 NCCI State of the Line Report, the workers compensation insurance industry combined ratio for both 2008 (preliminary) and 2007 was 101%, an eight-point increase from 2006’s combined ratio of 93%. Large carriers that traditionally compete for business on price rather than service dominate the industry. As the industry experiences an average underwriting loss (greater than 100% combined ratio), the large carriers charge higher prices and workers’ compensation clients may turn elsewhere for the lowest cost option. When the commodity portion of the market constricts, we believe more business moves towards specialty carriers like us.

Generally, market opportunities for commercial workers’ compensation insurers are more favorable when residual markets are less active and less profitable. Residual market organizations generally serve as “insurers of last resort,” issuing policies to those who are not able to find traditional coverage in the voluntary market. These organizations come in several forms, including joint underwriting associations, health associations, and compensation funds. The 2009 NCCI State of the Line Report shows that residual market policy year premium volume decreased from approximately $1.2 billion in 2006 to approximately $1.0 billion in 2007 and a projected $0.7 billion in 2008. According to the report, market share for the residual market decreased from approximately 10% in 2006 to approximately 8% in 2007 and approximately 6% in 2008 (preliminary).

According to the 2009 NCCI State of the Line Report, medical costs remain an area of concern. The report indicates that medical costs increased by approximately 7% per year from 2002 through 2007. The report projects that medical costs will comprise approximately 58% of total workers compensation claim costs

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in 2008, compared to approximately 53% in 1998 and 46% in 1988. To help control the impact of rising medical costs on workers’ compensation, we believe that states will continue to enact medical fee schedules and insurers will continue to aggressively manage vendor selection and performance and to control prescription drug expenditures through the use of generic drugs and care management initiatives.

For the nine months ended September 30, 2009 and the years ended December 31, 2008 and 2007, we wrote approximately 52%, 67% and 74%, of our direct premiums written, respectively, in administered pricing states — Florida, Indiana, New Jersey, and, prior to October 1, 2008, New York. Effective October 1, 2008, New York is no longer an administered pricing state. In 2008, we wrote approximately 46% of our direct premiums written in Florida. In administered pricing states, insurance rates are set by the state insurance regulators and are adjusted periodically. Rate competition generally is not permitted in these states. Therefore, rather than setting rates for the policies, our underwriting efforts in these states for our traditional business relate primarily to the selection of the policies we choose to write at the premium rates that have been set.

The Florida OIR has approved workers’ compensation rate decreases each year over the past several years. In August 2009, the NCCI submitted a filing proposing an overall workers’ compensation rate level decrease of 6.8%, effective January 1, 2010, which was approved by the Florida OIR on October 15, 2009. In October 2008, the Florida OIR approved an average statewide rate decrease of 18.6% effective January 1, 2009. In February 2009, the Florida OIR approved an average statewide rate increase of 6.4%, effective April 1, 2009, associated with the Florida Supreme Court’s decision to eliminate statutory limits on attorneys’ fees that were imposed as a result of 2003 reforms. In June 2009, the Florida OIR approved a rollback to the rates that became effective on January 1, 2009 in connection with Florida legislation that restored the limit on attorneys’ fees and clarified related statutory language that the Florida Supreme Court had determined to be ambiguous. In October 2007, the NCCI submitted an amended filing calling for a Florida statewide rate decrease of 18.4%, which was approved by the Florida OIR on October 31, 2007 and was effective January 1, 2008. In October 2006, the Florida OIR approved an average statewide rate decrease of 15.7%, effective January 1, 2007.

Significant declines in claim frequency and an improvement in loss development in Florida since the legislature enacted certain reforms in 2003 are two principal reasons for the mandated premium level decreases. We have responded to these rate decreases by expanding our alternative market business in Florida and strengthening our collateral on reinsurance balances on Florida alternative market business. We expect an increase in Florida experience modifications, which serve as a basic factor in the calculation of premiums. We anticipate that our ability to adjust to these market changes will create opportunities as our competitors find the Florida market less desirable.

Business Segments

We operate in two business segments:


	•	Insurance Services Segment. In our insurance services segment, we generate fee income by providing workers’ compensation claims services as well as agency and underwriting services. Workers’ compensation claims services include nurse case management, cost containment services and, beginning in the second quarter of 2009, claims administration and adjudication services. Workers’ compensation agency and underwriting services include general agency services and, beginning in the second quarter of 2009, specialty underwriting, policy administration and captive management services. Nurse case management and cost containment services are performed for the benefit of Guarantee Insurance, segregated portfolio captives and our traditional business quota share reinsurers under the Patriot Risk Services brand. In addition, we perform claims services and agency and underwriting services under the Patriot Underwriters’ brand for the benefit of another insurance company, which we refer to as our BPO client, through a business process outsourcing arrangement.

	•	Insurance Segment. In our insurance segment, we provide workers’ compensation alternative market insurance solutions and traditional workers’ compensation policies for small to mid-sized employers as well as larger companies. In the alternative market, we write policies under which the policyholder, an agent or another party bears a substantial portion of the underwriting risk through a segregated portfolio

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		captive or other arrangements, including large deductible policies and retrospectively rated policies, all of which allow policyholders, agents or other parties to share in the insured’s claims experience. Our alternative market clients typically have premiums of less than $3 million. We also write workers’ compensation business for employers with annual premiums generally below $250,000 for which Guarantee Insurance bears substantially all of the underwriting risk (subject to reinsurance arrangements), which we refer to as traditional business. For employers with larger annual premiums, we evaluate whether the risk is appropriate for our traditional business or more suited to an alternative market solution.

Insurance Services Segment

Operating Strategy

Through PRS and, beginning in 2009, PUI, the primary insurance services provided by us are claims services, including nurse case management and cost containment services for workers’ compensation claims. In the second quarter of 2009, we began providing these claims services, together with claims administration and adjudication services and general agency, underwriting and captive management services to our BPO client.

For the nine months ended September 30, 2009, services provided to Guarantee Insurance for the benefit of segregated portfolio captives and our quota share reinsurers and services provided to our BPO client accounted for approximately 64% and 36%, respectively, of insurance services income. For the years ended December 31, 2008, 2007 and 2006, services provided to Guarantee Insurance for the benefit of segregated portfolio captives and our quota share reinsurers accounted for substantially all of our insurance services income. We expect our nurse case management, cost containment and other insurance services operations will become less dependent over time on Guarantee Insurance’s premium and risk retention levels as we expand our BPO relationships, obtain additional general agency appointments and secure other third-party insurance services contracts for nurse case management, cost containment and claims administration and adjudication services.

To complement our organic insurance services growth, we intend to expand our insurance services operations through additional targeted strategic relationships and explore acquisition opportunities. These relationships may involve fronting arrangements, where we assume a portion of the underwriting risk, or distribution and insurance services relationships, where we do not assume any underwriting risk but earn commissions for producing business and insurance services income for providing nurse case management and cost containment services and, in certain cases, services to segregated portfolio cell captives. In addition, we may seek to acquire other workers’ compensation policy and claims administration providers, general agencies or general underwriting organizations as we expand in our existing markets and into additional markets. Although we are not currently engaged in discussions with any potential acquisition candidates, we are routinely pursuing and evaluating acquisition opportunities that would enable us to expand our insurance services operations.

Customers

Our insurance services revenues for the nine months ended September 30, 2009 were derived principally from Guarantee Insurance Company, segregated portfolio captives, our quota share reinsurers and our BPO client. Our insurance services revenues for the years ended December 31, 2008, 2007 and 2006 were derived principally from Guarantee Insurance, segregated portfolio captives and our quota share reinsurers.

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Products and Services

PRS and PUI earn insurance services income for the following services:

Claims Services


	•	Nurse Case Management. PRS provides nurse case management services for the benefit of Guarantee Insurance, segregated portfolio captives, our quota share reinsurers and our BPO client. PRS has been awarded Case Management Accreditation by the Utilization Review Accreditation Committee (URAC), a nationally recognized leader in promoting health care quality through its accreditation and certification programs. PRS’s nurse case managers have nationally recognized credentials accepted by workers’ compensation insurers, including the following: Registered Nurse, Certified Rehabilitation Registered Nurse and State Qualified Rehabilitation Provider. Upon receipt of the notice of injury, claims are assigned to a nurse case manager. PRS’s nurse case managers do not provide health care services to the claimant. The nurse case manager’s role is to assist in resolving the claim and returning the injured worker to work as efficiently as possible. PRS nurse case managers actively monitor each file pursuant to a process that includes peer review and utilization guidelines for treatment. PRS’s nurse case managers contact the injured worker within two business days after claim filing to assess and assist in the early-intervention process. We believe that early intervention is essential for medical management and early return to work. PRS’s nurse case managers remain active on the claim from inception until claim resolution. The nurse case manager and the claims adjuster work together to achieve the overall goal of helping the injured employee return to work and closing the claim. The case management process remains active during the course of treatment to help ensure there is medically necessary treatment towards resolution and the injured worker returns to work or pre-injury status. PRS provides these nurse case management services for a flat monthly fee over the life of the claim. For the nine months ended September 30, 2009 and the year ended December 31, 2008, fees earned by PRS for nurse case management services represented approximately 32% and 47% of insurance services income, respectively.

	•	Cost Containment Services. PRS provides cost containment services for the benefit of Guarantee Insurance, segregated portfolio captives and our quota share reinsurers. In the second quarter of 2009, PRS also began providing cost containment services for the benefit of our BPO client. PRS has developed an extensive preferred provider network of physicians, clinics, hospitals, pharmacies and the like. Participating in PPO networks allows access to discounted services, which yield medical costs savings. For the years ended December 31, 2008 and 2007, PRS cost containment activities reduced medical bills by an average of 54% and 45%, resulting in a total savings in medical costs of $20.5 million and $10.6 million, respectively. PRS provides these bill review services on a percentage of savings basis. For the nine months ended September 30, 2009 and the year ended December 31, 2008, fees earned by PRS for cost containment services represented approximately 31% and 43% of insurance services income, respectively.

	•	Claims Administration and Adjudication Services. In the second quarter of 2009, PRS began providing workers’ compensation claims administration and adjudication services for the benefit of our BPO client. Claims administration and adjudication services are provided pursuant to and in compliance with state rules and regulations as well as client-specific process guidelines. For the nine months ended September 30, 2009, fees earned by PRS for claims administration and adjudication services represented 1% of insurance services income. No fees were earned by PRS for claims administration for the year ended December 31, 2008.

General Agency, Underwriting and Captive Management Services

PRS began acting as a general agent for other insurance companies in late 2007. PUI replaced PRS as the provider of general agency and underwriting services in 2009. We facilitate the placement of workers’ compensation submissions on behalf of independent retail agents throughout the country, and receive commission income as a percentage of premiums written. PRS and PUI have never taken underwriting risk.

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During the second quarter of 2009, we also began offering general agency services to our BPO client and plan to further expand our general agency services through additional business processing relationships and carrier appointments.

Through PUI, we provide workers’ compensation general underwriting and captive management services to our BPO client. This customer, which does not specialize in workers’ compensation coverage, contracted with us to source, underwrite, process and service workers’ compensation insurance business on its behalf. We earn insurance services fee income for providing these services. Our BPO client benefits from a specialty book of workers’ compensation insurance business, written on its insurance policies, without the need for it to build the necessary infrastructure and distribution network. For the nine months ended September 30, 2009 and the year ended December 31, 2008, fees earned by us for general agency, underwriting and captive management services provided to our BPO clients represented approximately 36% and 10% of insurance services income, respectively.

Captive management services include the formation and management of the segregated portfolio captive. Formation of the segregated portfolio captive involves the submission of an application for regulatory approval by the captive domiciliary regulatory body, together with supporting financial information and a business plan, and the creation and execution of participation agreements, subscription agreements and reinsurance agreements pertaining to the segregated portfolio cell. Management of the segregated portfolio captive includes compliance monitoring, segregated cell financial reporting and investment portfolio management services.

Reinsurance Intermediary Services

Through a reinsurance co-brokerage agreement that we entered into in 2008 with an independent third-party reinsurance intermediary, PRS placed excess of loss reinsurance and quota share reinsurance for Guarantee Insurance. This reinsurance co-brokerage agreement was terminated in the second quarter of 2009, and we do not expect reinsurance intermediary services to be a material component of our future insurance services income. For the nine months ended September 30, 2009 and the year ended December 31, 2008, fees earned by us for reinsurance intermediary services represented approximately 1% and 6% of insurance services segment income, respectively.

Marketing

In addition to Guarantee Insurance, the segregated portfolio cell captives and our quota share reinsurers, PRS and PUI market their claims services and general agency, underwriting and captive management services, respectively, through direct contact with insurance companies, reinsurance intermediaries and other insurance and claims service providers. Additionally, PRS and PUI participate in insurance conventions and industry activities and advertise in insurance industry publications.

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The following table sets forth the total premiums produced for our BPO client for the nine months ended September 30, 2009. PRS and PUI provide their claims services and general agency, underwriting and captive management services on this business.


	Nine Months Ended September 30, 2009
	Alternative Market
	Business					Traditional Business					Total
	Premium		Percentage			Premium		Percentage			Premium		Percentage
	$ in thousands

California	$	6,630		34.1	%	$	—		—	%	$	6,630		34.1	%
Texas		2,211		11.4			—		—			2,211		11.4
Illinois		1,419		7.3			—		—			1,419		7.3
Michigan		1,240		6.4			—		—			1,240		6.4
South Carolina		1,138		5.9			—		—			1,138		5.9
Florida		686		3.5			—		—			686		3.5
North Carolina		685		3.5			—		—			685		3.5
Idaho		663		3.4			—		—			663		3.4
Tennessee		543		2.8			—		—			543		2.8
Oklahoma		532		2.7			—		—			532		2.7
Arizona		516		2.7			—		—			516		2.7
Other States		3,165		16.3			—		—			3,165		16.3

Total	$	19,428		100.0	%	$	—		—	%	$	19,428		100.0	%

For Guarantee Insurance’s direct premiums written by state for the nine months ended September 30, 2009 and the year ended December 31, 2008, for which PRS provides its claims services, see “Business — Insurance Segment — Products.”

Insurance Segment

Operating Strategy

We are committed to individual account underwriting and to selecting quality risks. Within our insurance segment, we have two lines of business: alternative market insurance solutions and traditional business. For alternative market insurance solutions, our business is comprised of various risk classifications and hazard levels. For higher risk classifications and hazard levels, we seek to mitigate our risk by retaining only a small portion of the exposure, securing adequate collateral to protect our interests in the event of adverse claims experience and charging an appropriate premium for the underlying risks. For traditional business, we generally write low to medium risk classifications and hazard levels, such as clerical office, light manufacturing, artisan contractors and the service industry.

Alternative Market Insurance Solutions. Through Guarantee Insurance, we provide alternative market workers’ compensation risk transfer solutions, including workers’ compensation policies or arrangements where the policyholder, an agent or another party generally bears a substantial portion of the underwriting risk.

The primary risk sharing arrangement we employ involves the use of a segregated portfolio captive, which refers to a captive reinsurance company that operates as a single legal entity with segregated pools of assets, or segregated portfolio cells, the assets and associated liabilities of which are solely for the benefit of the segregated portfolio cell participants. We sometimes refer to the segregated portfolio cell participants as the owners of the cell. Arrangements for segregated portfolio cells that are owned by the policyholder or another party generally involve a single policy. For segregated portfolio cells that are owned by the policyholder or another party, we generally retain 10% of the underwriting risk. We typically provide these solutions to companies in a broad array of industries, including employers such as hospitality companies, construction companies, professional employer organizations, clerical and professional temporary staffing companies, industrial companies, car dealerships, food services and retail and wholesale operations. At

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September 30, 2009, Guarantee Insurance had 22 segregated portfolio captive risk-sharing arrangements under which the segregated portfolio cells are owned by the policyholder or another party, with an average premium per segregated portfolio cell of approximately $570,000.

Arrangements for segregated portfolio cells that are owned by an insurance agency or group of insurance agencies generally involve a number of policies for small to medium-sized employers in a broad array of industries, which become part of the segregated portfolio captive arrangement as the business is written or renewed by the agency. For segregated portfolio cells that are owned by an insurance agency or group of insurance agencies, we retain between 10% and 90% of the underwriting risk. At September 30, 2009, Guarantee Insurance had 11 segregated portfolio captive risk-sharing arrangements under which the segregated portfolio cells are owned by an insurance agency or group of insurance agencies. One agency-owned segregated portfolio cell comprised 41% of our total alternative market gross premiums written for the nine months ended September 30, 2009. No other segregated portfolio cell comprised more than 5% of our total alternative market gross premiums written for the nine months ended September 30, 2009.

For the nine months ended September 30, 2009, we retained approximately 14% of the underwriting risk under our segregated portfolio captive arrangements. Under all of our segregated portfolio captive arrangements, we earn a ceding commission from the segregated portfolio captive, which is payment to Guarantee Insurance by such captive of a commission as compensation for providing underwriting, policy and claims administration, captive management and investment portfolio management services for the benefit of the segregated portfolio cell.

Our alternative market business also includes other arrangements through which we share underwriting risk with our policyholders or other parties participating in the risk-sharing arrangements, such as large deductible policies or policies for which the final premium is based on the insured’s actual loss experience during the policy term, which we refer to as retrospectively rated policies. Unlike our traditional workers’ compensation policies, these arrangements align our interests with those of the policyholders or such other parties, allowing them to share in the underwriting profit or loss. In addition, our alternative market business includes guaranteed cost policies issued to certain professional employer organizations and professional temporary staffing organizations on which we retain the risk. The excess of loss reinsurance on these policies is provided by the same reinsurer that covers our segregated portfolio captive insurance plans, retrospectively rated plans and large deductible plans, and these plans may be converted to risk sharing arrangements in the future.

Many of our alternative market insurance solutions allow policyholders to share in their own claims experience and be rewarded for low claims costs rather than simply paying fixed premiums. In other cases, agencies or other parties participate in the risk. We believe that other insurers generally offer alternative market insurance solutions to larger corporate customers. We offer our alternative market solutions to small, medium and larger sized companies, generally with stable profitable claims experience.

Our renewal rates on alternative market business that we elected to quote for renewal for the year ended December 31, 2008, based on segregated portfolio cell counts, was 100%.

Traditional Business. We began writing workers’ compensation policies through Guarantee Insurance in the first quarter of 2004. We focus on servicing small to mid-sized employers in a broad array of industries, including clerical and professional services, food services, retail and wholesale operations and industrial services located in Florida and other states in the Southeast and Midwest United States that generally have fewer than 300 employees. In certain circumstances, we also write traditional policies for larger employers. We typically write these policies for:


	•	low to medium risk classifications and hazard levels; and

	•	accounts with annual premiums below $250,000.

As of September 30, 2009, we had approximately 5,200 traditional workers’ compensation policyholders and an average annual premium per policyholder of approximately $11,400.

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Products

All states require employers to provide workers’ compensation benefits to their employees for injuries and occupational diseases arising out of employment, regardless of whether such injuries or disease result from the employer’s or the employee’s negligence. Employers may either insure their workers’ compensation obligations or, subject to regulatory approval, self-insure their liabilities. Workers’ compensation statutes require that a policy cover three types of benefits: medical expenses, disability benefits and death benefits. Our workers’ compensation insurance policies also provide employers liability coverage, which provides coverage for an employer if an injured employee sues the employer for damages as a result of the employee’s injury.

Through Guarantee Insurance, we offer a range of workers’ compensation products and a variety of payment options designed to fit the needs of our policyholders and employer groups. Working closely with our independent agents, our underwriting staff helps determine which type of workers’ compensation insurance solution is appropriate for each risk.

Alternative Market Insurance Solutions. We provide a variety of services to employers, insurance agencies or other parties who wish to bear a substantial portion of the underwriting risk with respect to workers’ compensation exposures, including fronting, claims adjusting, claims administration and investment management services. We earn a ceding commission as compensation for these services. Our alternative market customers are subject to, at a minimum, monthly self-reporting of payroll figures. Our alternative market insurance solutions include the following:


	•	Segregated portfolio captive insurance plans. We offer segregated portfolio captive plans to small, medium and larger-sized employers in a broad array of industries, including hospitality companies, construction companies, professional employer organizations, clerical and professional temporary staffing companies, industrial companies, car dealerships, food services and retail and wholesale operations, using both onshore and offshore captive facilities. Prior to the advent of segregated portfolio captive programs, only very large risks could afford the capitalization and administrative costs associated with captive insurance company formation. Our approach utilizes standardized agreements and processes that allow employers, insurance agencies and other parties to participate. Through our captive insurance plans, we write a workers’ compensation policy for the employer and facilitate the establishment of a segregated portfolio cell within a segregated portfolio captive by coordinating the necessary interactions among the party controlling the cell, the insurance agency, the segregated portfolio captive, our manager and insurance regulators in the jurisdiction where the captive is domiciled. These segregated portfolio cells may be controlled by policyholders, insurance agencies, parties related to policyholders or other parties.

Once the segregated portfolio cell is established, Guarantee Insurance enters into a captive reinsurance agreement with the segregated portfolio captive acting on behalf of the segregated portfolio cell. Guarantee Insurance generally retains 10% to 90% of the underwriting risk under arrangements for segregated portfolio cells owned by the policyholder or another party, and cedes the balance of such risk on a quota share basis to the segregated portfolio captive. Guarantee Insurance retains between 10% and 90% of the underwriting risk under arrangements for segregated portfolio cells that are owned by an insurance agency or group of insurance agencies, and cedes the balance of the risk to the segregated portfolio cell captives. For the nine months ended September 30, 2009, we retained approximately 14% of the underwriting under risk under our segregated portfolio captive arrangements. Any amount of losses in excess of $1.0 million per occurrence is not covered by the captive reinsurance agreement. If the aggregate covered losses for the segregated portfolio cell exceed the level specified in the reinsurance agreement, the segregated portfolio captive reinsures the entire amount of the excess losses up to the aggregate liability limit specified in the captive reinsurance agreement. If the aggregate losses for the segregated portfolio cell exceed the aggregate liability limit, Guarantee Insurance retains 100% of those excess losses, except to the extent that any loss exceeds $1.0 million per occurrence, in which case the amount of such loss in excess of $1.0 million is reinsured under Guarantee Insurance’s excess of loss reinsurance program.

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Because reinsurance does not relieve Guarantee Insurance of liability under the underlying workers’ compensation policies and Guarantee Insurance’s ability to collect for losses incurred is limited to the assets of the segregated portfolio cell, we generally protect ourselves from potential credit risk related to a segregated portfolio cell by holding collateral, including funds withheld for the account of the cell, to provide for payment of the reinsurance obligations incurred by the segregated portfolio captive on behalf of the cell. Funds withheld consists of ceded premiums net of ceding commissions, less claims paid on behalf of the segregated portfolio cell, together with collateral that the segregated portfolio captive posts on behalf of the cell in the form of cash. Funds withheld also include interest credited to the funds withheld account. In certain cases, the segregated portfolio cell captive also provides letters of credit or other financial instruments acceptable to Guarantee Insurance as collateral. In addition, we generally require the party controlling the segregated portfolio cell to guarantee the payment to Guarantee Insurance of all liabilities and obligations related to the cell that are owed under the captive reinsurance agreement and related agreements.

Segregated portfolio captives are generally required to provide collateral to us with respect to a cell in an amount that is greater than or equal to the ceded reserves that Guarantee Insurance initially estimates will be required on the underlying workers’ compensation policies relating to such cell. On an ongoing basis, we evaluate the adequacy of the collateralization of the segregated portfolio cell reserves. If we determine that the amount of collateral is inadequate, we seek additional collateral or otherwise evaluate the likelihood, based on available information, that the full amount of the reinsurance recoverable balance from the cell is collectible. If we deem it probable, based on available information, that all or a portion of a cell’s uncollateralized reinsurance recoverable balance is not collectible, we establish an allowance for such uncollectible reinsurance recoverable.

In order for the party controlling a segregated portfolio cell to receive any funds withheld attributable to our segregated portfolio captive insurance program, that party must formally request a dividend. However, dividends may only be declared by the board of the segregated portfolio captive out of the profits of the segregated portfolio cell under the captive reinsurance agreement or out of monies otherwise available for distribution in accordance with applicable law. In practice, upon receipt of a dividend request, Guarantee Insurance determines whether all expenses and liabilities with respect to the cell have been reasonably provided for or paid. If Guarantee Insurance approves the dividend request, we will submit a formal request to the domiciliary captive manager, supported with relevant financial justification for final approval. If approved by applicable regulatory authorities and the board of the segregated portfolio captive, Guarantee Insurance will remit the remaining funds attributable to the cell to the captive for payment to the party controlling the cell.

For the nine months ended September 30, 2009 and the year ended December 31, 2008, approximately 79% and 77%, respectively, of our direct premiums written on alternative market business were derived from captive insurance arrangements, respectively. For the nine months ended September 30, 2009 and the year ended December 31, 2008, we ceded approximately 86% and 88%, respectively, of our segregated portfolio captive alternative market gross premiums written under quota share reinsurance agreements with segregated portfolio captives.

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The following schematic illustrates the basic elements of a segregated portfolio captive arrangement, with our subsidiaries shaded:


*		Ceded premiums, net of ceding commission, are held by Guarantee Insurance for the account of the segregated portfolio cell and, along with the collateral, constitute the loss fund for payment of reinsured claims.


	•	Large deductible plans. In 2008, we began offering large deductible plans as an alternative market insurance solution. Under these plans, we generally receive a lower premium than we would for a traditional plan, but the insured retains a greater share of the underwriting risk through a higher per-occurrence deductible. This gives the policyholder greater incentive to exercise effective loss controls. The per-occurrence deductibles on these plans range from $100,000 to $1,000,000, with various levels of aggregate protection. Under these plans, the policyholder is responsible for payments of claims that fall below the deductible. Guarantee Insurance pays the below-the-deductible portion of the claim and bills the policyholder for reimbursement. These types of programs require collateral from the policyholder based upon its individual loss profile and the loss development factors in the states where it is insured. For the nine months ended September 30, 2009 and the year ended December 31, 2008, approximately 7% and 6% of our direct premiums written on alternative market business were derived from large deductible plans, respectively.

	•	Retrospectively rated plans. Under retrospectively rated plans, we charge an initial premium that is subject to adjustment at the end of the policy period. Retrospectively rated policies use formulae to adjust premiums based on the policyholder’s actual losses and loss adjustment expenses incurred and paid during the policy period, subject to a minimum and maximum premium. These policies are typically subject to annual adjustments until claims are closed. Unlike policyholder dividend plans in our traditional business (described below), retrospective premium adjustments are established contractually and are not determined at the discretion of the board of directors of Guarantee Insurance. Guarantee Insurance generally offers retrospectively rated policies to employers with minimum annual premiums of $100,000. For the nine months ended September 30, 2009 and the year ended December 31, 2008, approximately 2% and 4% of our direct premiums written on alternative market business were derived from retrospectively rated policies, respectively.

	•	Guaranteed cost policies with no risk sharing features. Our alternative market business also includes policies issued to certain professional employer organizations and professional temporary staffing organizations on which we retain the risk. The excess of loss reinsurance on these policies is provided

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		by the same reinsurer that covers our segregated portfolio captive insurance plans, retrospectively rated plans and large deductible plans, and these plans may be converted to risk sharing arrangements in the future. For the nine months ended September 30, 2009 and the year ended December 31, 2008, approximately 11% and 12% of our direct premiums written on alternative market business were derived from these guaranteed cost policies issued to certain professional employer organizations and professional temporary staffing organizations.

Traditional Business. Through Guarantee Insurance, we also provide traditional workers’ compensation insurance coverage, under which Guarantee Insurance bears substantially all of the underwriting risk, subject to reinsurance arrangements. We manage that risk through the use of quota share and excess of loss reinsurance. Quota share reinsurance is a form of proportional reinsurance in which the reinsurer assumes an agreed upon percentage of each risk being insured and shares all premiums and losses with us in that proportion. Excess of loss reinsurance covers all or a specified portion of losses on underlying insurance policies in excess of a specified amount, or retention. We typically provide traditional workers’ compensation insurance coverage to small to medium-sized employers in a broad array of industries, including clerical and professional services, food services, retail and wholesale operations and industrial services, generally in low to medium risk classifications and hazard levels.

We write the following types of traditional workers’ compensation insurance business:


	•	Guaranteed cost plans. Our basic traditional product is a guaranteed cost policy, under which the premium for a policyholder is set in advance based upon rate filings approved by the insurance regulator and varies based only upon changes in the policyholder’s employee class codes and payroll. The premium does not increase or decrease based upon an updated participating employee census during the policy period. We regularly audit the payroll records of our policyholders to help ensure that appropriate premiums are being charged and paid and adjust premiums as appropriate. For the nine months ended September 30, 2009 and the year ended December 31, 2008, approximately 73% and 76% of our direct premiums written on traditional business were derived from guaranteed cost products, respectively.

	•	Pay-as-you-go plans. We offer a monthly self-reporting option, under which a policyholder’s monthly premium payments are calculated by the policyholder using actual monthly payroll figures. We refer to these as pay-as-you-go plans. Pay-as-you-go plans are a relatively recent innovation in the workers’ compensation industry. With pay-as-you-go plans, the insured works with a payroll vendor to collect accurate payrolls and corresponding premiums to be remitted to us. Pay-as-you-go plans have become popular with insureds, and as a result some payroll companies now own their own insurance agency and some traditional insurance agencies now own their own payroll company. We believe that pay-as-you-go plans are a more efficient method of underwriting and administering workers’ compensation. These plans reduce our credit exposure for additional premiums that we determine we are owed based on payroll audits. Furthermore, the plans create a more precise ongoing workers’ compensation insurance expense and more predictable ongoing cash flow expectations for our policyholders. We began offering pay-as-you-go plans in late 2006. For the nine months ended September 30, 2009 and the year ended December 31, 2008, approximately 17% and 18% of our direct premiums written on traditional business were derived from pay-as-you-go plans, respectively.

	•	Policyholder dividend plans. Generally, under a policyholder dividend plan a fixed premium is charged based upon rate filings approved by the insurance regulator, but the insured may receive a dividend based upon favorable loss experience during the policy period. We began offering policyholder dividend plans in Florida and other states in 2007. Eligibility for these plans varies based upon the nature of the policyholder’s operations, value of premium generated, loss experience and existing controls intended to minimize workers’ compensation claims and costs. Policyholder dividends, which are to be paid at the discretion of the board of directors of Guarantee Insurance and in accordance with law, cannot be guaranteed and are generally based upon the policyholder’s loss experience and other terms stipulated in the policyholder dividend plan filed with the appropriate insurance regulators and policy terms, including the applicable dividend endorsements. We plan to pay dividends, if any,

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		18 months after policy expiration. For the nine months ended September 30, 2009 and the year ended December 31, 2008, approximately 10% and 6% of our direct premiums written on traditional business were derived from policyholder dividend plans, respectively.

The following table sets forth gross premiums written and net premiums earned for alternative market and traditional business:


	Nine Months
	Ended September 30,				Years Ended December 31,
	2009		2008		2008		2007		2006
	In thousands

Gross premiums written:
Direct business:
Alternative market	$	42,163	$	42,168	$	47,374	$	34,316	$	33,921
Traditional business		44,378		51,912		69,182		50,599		26,636

Total direct business		86,541		94,080		116,566		84,915		60,557
Assumed business
BPO Client	$	7,824	$	—	$	—	$	—	$	—
NCCI National Workers’ Compensation Pool		1,607		798		—		—		—

Total assumed business		9,431		798		1,007		895		1,815

Total	$	95,972	$	94,878	$	117,563	$	85,810	$	62,372
Net premiums earned:
Direct business:
Alternative market	$	8,444	$	8,110	$	15,733	$	3,054	$	2,852
Traditional business		16,971		23,350		32,456		20,490		16,584

Total direct business		25,415		31,460		48,189		23,544		19,436
Assumed business
BPO Client	$	1,538	$	—	$	—	$	—	$	—
NCCI National Workers’ Compensation Pool		1,416		816		—		—		—

Total assumed business		2,954		816		1,031		1,069		1,617

Total	$	28,369	$	32,276	$	49,220	$	24,613	$	21,053

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The following tables set forth the total direct premiums written for the nine months ended September 30, 2009 and year ended December 31, 2008:


	Nine Months Ended September 30, 2009
	Alternative Market
	Business					Traditional Business					Total
	Premium		Percentage			Premium		Percentage			Premium		Percentage
	In thousands (other than percentages)

Florida	$	14,112		33.5	%	$	9,911		22.3	%	$	24,023		27.8	%
New Jersey		8,530		20.2			9,078		20.5			17,608		20.3
New York		4,099		9.7			4,273		9.6			8,372		9.7
Georgia		5,297		12.6			3,049		6.9			8,346		9.6
Missouri		1,629		3.9			3,686		8.3			5,315		6.1
Arkansas		873		2.1			2,568		5.8			3,441		4.0
Oklahoma		1,745		4.1			1,569		3.5			3,314		3.8
Indiana		407		1.0			2,738		6.2			3,145		3.6
Virginia		875		2.1			1,806		4.1			2,681		3.1
Other States		4,596		10.9			5,700		12.8			10,296		11.9

Total	$	42,163		100.0	%	$	44,378		100.0	%	$	86,541		100.0	%


	Year Ended December 31, 2008
	Alternative Market
	Business					Traditional Business					Total
	Premium		Percentage			Premium		Percentage			Premium		Percentage
	In thousands (other than percentages)

Florida	$	32,977		69.6	%	$	20,658		29.9	%	$	53,635		46.0	%
New Jersey		1,792		3.8			9,681		14.0			11,473		9.8
Missouri		981		2.1			8,590		12.4			9,571		8.2
Georgia		4,097		8.6			4,508		6.5			8,605		7.4
Indiana		255		0.5			6,330		9.1			6,585		5.6
New York		2,586		5.5			3,510		5.1			6,096		5.2
Arkansas		474		1.0			4,523		6.5			4,997		4.3
Alabama		1,465		3.1			1,068		1.5			2,533		2.2
Oklahoma		492		1.0			1,834		2.7			2,326		2.0
Other States		2,255		4.8			8,480		12.3			10,735		9.2

Total	$	47,374		100.0	%	$	69,182		100.0	%	$	116,556		100.0	%

Marketing and Distribution

We distribute our alternative market solutions and traditional workers’ compensation plans exclusively through a network of independent agencies. We select agencies based on several key factors, such as size and scope of the agency’s operations, loss ratio of its existing business, targeted classes of business, reputation of the agency and our principals, producers and business philosophy. We target agencies that we believe share our service philosophy and are likely to send us the quality of business we are seeking. We invest a substantial amount of time in developing relationships with our agents, and we believe that this gives us the opportunity to underwrite the most profitable business in each state in which we write premiums. As of November 24, 2009, Guarantee Insurance had direct contracts with approximately 570 independent non-exclusive agencies, with approximately 235 in the Midwest and 60 in the Northeast and 275 in the Southeast, including approximately 220 in Florida. As we seek to expand geographically, we plan to continue to devote considerable time developing strong relationships with quality agents that share our service philosophy.

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Working in conjunction with our agents, we evaluate whether a given risk is appropriate for the traditional or alternative market. Our alternative market insurance solutions are attractive to our agents’ larger employer customers with favorable loss profiles because they are able to share in the risk and reduce their workers’ compensation insurance costs if they continue to realize favorable loss experience.

We assign marketing representatives and underwriters based on relationships with agents and not necessarily based on geographic area. Our marketing efforts directed at agencies are implemented by our field underwriters, marketing staff and client services personnel. These personnel are assigned to specific agencies and work with these agencies in making sales presentations to potential policyholders.

We hold annual planning meetings with our agents to discuss the prior year’s results and to determine financial goals for the coming year. It is imperative to our success that we understand the goals and objectives of our agents. To date, this understanding has been an integral factor in our success. The relationships with our agencies are managed primarily through our field marketing and underwriting staff. However, key management personnel also maintain strong relationships with most of our agencies’ principals.

With our focus on workers’ compensation insurance, our range of workers’ compensation insurance solutions and products and our quality of service, we believe we are able to compete with larger, better capitalized and highly rated insurance company competitors by forming close relationships with our agents and focusing on small to mid-sized businesses. We strive to provide excellent customer service to our agents and policyholders, including fast turnaround of policy submissions, in order to attract and retain business. Our “pay-as-you-go” plan, pursuant to which we partner with payroll service companies and their clients to collect premiums and payroll information on a monthly basis, is attractive to our agents’ smaller business customers. Using this program, we are able to underwrite smaller businesses without requiring a large premium down payment, which eases the cash flow burden for these companies.

We also take an active role in several program and trade associations. These marketing efforts include print advertising in trade magazines as well as involvement in associations. We target the trade organizations that service the classes of business that we seek to write. This involvement helps to build client loyalty not only at the agency level, but at the insured level as well.

Underwriting

We do not use a class underwriting approach that targets specific classes of business or industries in which the acceptability of a risk is determined by the entire class or industry. Our underwriting strategy is to identify and target individual risks based on the individual characteristics of a prospective insured. However, we do not underwrite exposures involving occupational disease or exposures that are excluded from our reinsurance agreements. See “— Reinsurance.”

Our underwriters develop close relationships with our independent agency network through telephone and Internet contact and personal visits. Underwriters’ personal interaction with agents provides an enhanced understanding of the businesses we underwrite and the needs of both the agents and prospective insureds. Our underwriters have authority to underwrite individual risks both in the field and in the office. The extent of their authority is based on their personal industry experience and the individual risk characteristics of the prospective business. Risks outside of an underwriter’s authority are referred to underwriting management for underwriting approval. None of our agents has authority to bind Guarantee Insurance on policies for either alternative market or traditional business.

In assessing a risk, the underwriter and underwriting management review the individual exposures and consider many factors, including an employer’s prior loss experience, risk environment, commitment to loss prevention, willingness to offer modified duty or return to work to injured employees, safety record and operations.

In addition, the underwriters also evaluate losses in the employer’s specific industry, geographic area and other non-employer specific conditions. These and other factors are documented on our underwriting risk worksheet. Our underwriting risk worksheet was created as a way to document the decision process, the factors that went into making the decision to write the business and any information pertinent to the risk itself.

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We apply experience modification factors to a policyholder’s rate either to increase the policy premium due to a history of prior losses or to reduce the policy premium due to a favorable prior claims history.

Our underwriting strategy focuses on developing a relationship with the insured and the agent to promote account safety, long-term loyalty and continued profitability. Our loss prevention professionals visit many policyholders to ascertain the policyholder’s willingness to comply with our underwriting and loss prevention philosophy.

Our underwriting process and risk management techniques are substantially similar for our alternative market insurance solutions and our traditional business, except that we employ two additional underwriting criteria on alternative market business. Using an actuarial loss development model, we trend past losses and develop pricing for the prospective policy year. We also conduct a financial review of the prospective insured. We may write higher risk classifications and hazard levels in the alternative market than we do in our traditional business due to the fact that alternative market plans are generally either largely reinsured to a segregated portfolio captive or written on a large deductible or retrospectively rated policy, reducing our underwriting exposure. In addition, we believe that most of our alternative market insurance solutions provide an incentive for the policyholder to achieve favorable loss experience, which helps mitigate the exposures typically associated with higher risk classifications and hazard levels.

Loss Control

Our loss control process begins with a request from our underwriting department to perform an inspection. Our inspections focus on a policyholder’s operations, loss exposures and existing safety controls designed to prevent potential loss. The factors considered in our inspections include employee experience, employee turnover, employee training, previous loss history and corrective actions, and workplace conditions, including equipment condition and, where appropriate, use of fall protection, respiratory protection or other safety devices. Our inspectors travel to employers’ worksites to perform these safety inspections.

During our relationship with our policyholders, we seek to emphasize workplace safety by periodically visiting the workplace, assisting the policyholder in designing and implementing enhanced safety management programs, providing current industry-specific safety-related information and conducting rigorous post-accident management.

We have a loss control department that handles loss control management, supervision and administration within the State of Florida. Outside of Florida, we utilize third-party vendors to provide inspection services.

Our loss control procedures support our loss reduction and prevention philosophy, which involves adhering to the early-return-to-work programs and implementing recommended safety practices. To the extent we are permitted by law, we will cancel or not renew the policy of a policyholder that is not willing to comply with our loss control procedures and risk reduction and prevention philosophy.

Pricing

Generally, premiums for our alternative market workers’ compensation insurance solutions and our traditional workers’ compensation insurance business are a function of the state regulatory environment, the amount of the insured employer’s payroll, the insured employer’s risk class code, and factors reflecting the insured employer’s historical loss experience.

We write business in both “administered pricing” and “competitive rating” states. In administered pricing states, insurance rates are set by the state insurance regulators and are adjusted periodically. Rate competition generally is not permitted in these states and, consequently, our alternative market insurance solutions can be an important competitive factor. For example, by adjusting the amount of collateral required from a segregated portfolio captive or through the use of high deductible or retrospectively rated policies, we seek to maintain appropriate pricing in administered pricing states for business that would be difficult to insure through a traditional guaranteed cost plan. Florida, Indiana and New Jersey are administered pricing states, while the rest of the states in which we operate are competitive rating states. In both administrative pricing and competitive rating states, we strive to achieve proper risk selection through disciplined underwriting. In competitive rating

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states, we have more flexibility to charge premium rates that reflect the risk we are taking based on each employer’s profile. In administered pricing states, we are able to maintain appropriate pricing by adjusting collateral requirements, using consent-to-rate programs and applying experience modification factors to our rates.

Through our consent-to-rate program, the Florida OIR allows insurers to charge a rate that exceeds the state-established rate when deemed necessary by the insurer. Use of this program is limited to 10% of the number of an insurer’s policies written in Florida. The insurer is responsible for determining the additional premium based on the specific characteristics of a policyholder that result in the need for additional premium, such as poor loss history, lack of prior experience, inadequate rate for exposure and specific lack of safety programs and procedures. The goal of the consent-to-rate program in Florida is for policyholders to be able to obtain coverage while working to improve their risk profile and to realize premium reductions over time and ultimately eliminate the consent-to-rate factor as improvements are achieved. This program enables us to maintain appropriate pricing in Florida’s administered pricing environment. We look for strong partnerships with, and commitments from, our policyholders and agents with respect to participation in this program. We use the consent-to-rate program primarily when rehabilitation of a policyholder is required or the exposures of a policyholder warrant additional premium. Approximately 1% of our Florida policies written in 2008 were written pursuant to the consent-to-rate program, which represented approximately 3% of our direct premiums written in Florida in 2008. Through this program, we have been able to underwrite otherwise uncertain accounts that exhibited a strong commitment to improve their working conditions and risk profile.

In competitive rating states, the state approves a set of competitive prices that provides for expected payments. Regulators then permit pricing flexibility primarily through two variables: (1) the selection of the competitive pricing multiplier insurers apply to competitive prices to determine their insurance rates and (2) schedule rating modifications that allow insurers to adjust premiums upwards or downwards for specific risk characteristics of the policyholder, such as type of work conducted, on-site medical facilities, level of employee safety, use of safety equipment and policyholder management practices. In competitive pricing states, we use both variables to calculate a policy premium that we believe will cover the claims costs and policy acquisition and underwriting expenses and produce an acceptable underwriting profit for it.

Claims

We believe that the claims management process is an integral part of our success. Establishing claims benchmarks, reviewing outcomes and conducting routine random audits help us achieve our claims adjudication goals and objectives. Our claims management program strives to ensure that the injured worker’s medical care restores health in an effective and efficient manner, promotes the early return to work and provides appropriate and prompt payment of benefits while producing an economical net claim cost.

We have established claims controls and a claims adjudication infrastructure to assist us in meeting these goals. The foundation of our claims quality and service excellence is built on the following set of goals and initiatives, which we collectively refer to as best practices:


	•	Coverage Verification. Immediate analysis and documentation of confirmation of coverage.

	•	Contact. Contact with the parties involved in the loss within two business days of the receipt of a claim. When the claim is received, the adjuster and a telephonic case manager registered nurse will make contact with the injured worker, employer and/or medical provider. We believe that having both an adjuster and nurse case manager make these contacts and assist in establishing the most appropriate and efficient medical treatment helps restore health and return the injured party to work as soon as practical.

	•	Investigation. Within 14 days of receipt of a claim, a claim adjudication and management strategy is developed, including the identification and communication of what we believe to be the most appropriate medical treatment and indemnity benefits to be paid.

	•	Recovery and Cost Offsets. Effective recognition, investigation and pursuit of recovery and cost offsets. Recoveries can be for a third-party claim and, in certain states (e.g., South Carolina and

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		Georgia), for second injury fund claims. In some jurisdictions, such as Florida, where the claimant may also be eligible for social security disability benefits, the amount of such benefits received can be offset from the weekly workers’ compensation rate using a prescribed formula.


	•	Evaluation. Appropriate analysis of claim exposure to probable ultimate cost. The claim file should reflect the action plan necessary to resolve the claim, while complying with applicable state laws, rules and regulations and corporate, insurer, reinsurer and employer reporting requirements.

	•	Medical/Disability/Rehabilitation Management. Appropriate assistance in managing medical care and treatment, utilizing a broad range of techniques designed to return the injured worker to work as quickly as practical. We believe that the most successful technique in returning injured workers back to work as soon as possible is ongoing communication with the injured worker, medical provider and employer. Consistent contact with the medical provider, including requests for light duty restrictions as appropriate, can hasten an injured worker’s return to work. In many cases, the medical provider does not know the employer is able to make reasonable accommodations or offer the injured worker alternative work during recuperation. We reinforce the value of a working employee with the employer and assist in the identification of suitable light duty work when appropriate. Securing an employer’s cooperation to identify suitable jobs and assisting in promptly returning employees to work can substantially reduce overall claim costs.

	•	Negotiation and Disposition. Timely claim negotiation and disposition to achieve an equitable, cost-effective result.

	•	Litigation Management. A proactive initiative by claims staff to manage litigation and, where necessary, involve defense counsel who are committed to providing aggressive, high quality, efficient representation under the direction of the claims management team.

	•	Supervision. Consistent supervision of the claim by our claims staff with precise, documented guidance and coaching throughout the life of the claim that clearly pursues resolution and strives to ensure best practices of claims handling.

	•	Data Quality. Clear understanding of the importance of data quality, reflected through prompt, accurate and thorough maintenance of claims data, resulting in timely and accurate reporting.

	•	Customer Service. Prompt initial contact and ongoing contact with insured employers, including thorough and prompt responses to requests.

	•	Privacy. An ongoing commitment to maintaining the integrity of claimant data and safeguarding medical and other information pertaining to injured workers and healthcare providers.

To help execute these initiatives and achieve these goals, we target experienced claims adjusters with a minimum of 5 years of experience handling workers’ compensation claims within their jurisdictions of assignment. Our claims department employees average more than 24 years of workers’ compensation insurance industry experience, and members of our claims management team average more than 21 years of workers’ compensation experience. To facilitate effective claims handling, we seek to limit the average number of claims handled at a time to approximately 125 per lost time adjuster and approximately 250 per medical-only adjuster.

Once a policy is bound, we send a claims kit to the insured outlining the policy provisions, mandated posting notices, information on how to report a claim and the importance of reporting all claims on a timely basis and answers to frequently asked questions. We make available a toll-free reporting line for insureds or employers to report injuries, available 24 hours a day, seven days a week, and can receive notices of injury via the Internet as well.

We use preferred provider organization networks and bill review services to reduce our overall claim costs. We assign authority levels for settlement authority and reserve placement to adjusters based upon their level of experience and position. Management must approve any changes of reserves that fall above the adjuster’s authority to help ensure proper action plans are current in the claim. Claims that are reserved at

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$50,000 or more must have a large loss report created that outlines the facts of the claim, as well as the reasons for the reserve requested. This report is reviewed by senior management. In addition, our claims adjusters coordinate with our underwriters and loss control personnel when it appears that there may be safety issues at the insured’s location or if the work conducted by the injured employee at the time of the accident does not match the class codes on the policy.

We monitor open claims for potential subrogation, which is the recovery of a portion of paid medical and indemnity losses from a third party that has liability for the losses suffered. We review new reported claims daily to help ensure timely identification of potential subrogation recoveries. We seek to place third parties on notice and keep them apprised of the status of the subject claim at regular intervals, including amounts paid by us for medical and indemnity benefits. We keep claims referred for subrogation open until a recovery has been received or a determination made that no subrogation is available.

Florida and many of the other states in which we operate require that all insurance carriers establish a special investigative unit to investigate and report fraudulent activities. Our in-house special investigations unit, or SIU, has established guidelines for fraud investigation that exceed minimum SIU standards in each jurisdiction in which we operate and have been approved by the State of Florida.

Our SIU operates in conjunction with the claims, audit, collections, loss prevention and underwriting departments to determine whether an allegation of fraud is valid. We investigate allegations of fraud on the part of both policyholders and injured workers. Files referred to our SIU are reviewed to determine whether an investigation should be opened. If an investigation is opened, SIU gathers the information necessary to submit to the appropriate division of insurance fraud for further investigation.

We also utilize an internal control specialist, or ICS, to monitor the adjusters’ compliance with best practices for claims handling. The ICS reviews specific areas of performance such as timely contact, proper coverage determination, investigations, litigation management, reserve integrity, documentation, supervision and direction, resolution and case closure action plans. On a monthly basis, the ICS reviews a certain number of claims by adjuster and evaluates our adjusters’ performance. We have utilized these reviews to assist in the development of additional training programs and coaching points with our adjusters. The use of these ICS reviews assists us in determining that our claims procedures and protocols are being carried out by our claims staff and our performance standards and goals are being consistently met.

Claims administration for our alternative market business is handled in a manner substantially similar to our traditional business. We have dedicated adjusters assigned to alternative market plans, both for the medical only and lost time claims, to help ensure a smooth working relationship. Our alternative market insurance solutions tend to involve higher risk classifications and hazard levels than our traditional policies. However, we generally retain little underwriting risk on our alternative market business, and we generally maintain a higher level of contact and communication with our alternative market customers as they have a shared incentive to resolve claims as effectively as possible and to assist employees to return to work. As a result, the claims closure rates for the alternative market tend to be slightly higher than the traditional market. As with claims in our traditional business, we review reserve adequacy on our alternative market business on a regular basis until claims are closed.

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We strive for rapid closure of claims in order to reduce the cost of medical and indemnity expenses. The table below sets forth our open claim counts by accident year and our open claims as a percentage of reported claims for alternative market and traditional business, in the aggregate, as of December 31, 2008, together with industry average open claims as a percent of reported claims:


						Worker’s
						Compensation
	Patriot					Industry Average
	As of December 31, 2008					Open Claims as a
			Open Claims as a			Percent of
	Number of		Percentage of			Reported Claims as of
Accident Year	Open Claims(1)		Reported Claims			December 31, 2008(2)

2008		1,745		25.8	%		30.0	%
2007		314		6.3	%		8.6	%
2006		85		1.8	%		4.3	%
2005		38		1.0	%		2.6	%
2004		4		0.4	%		1.8	%


(1)		Open claim counts were 547, 184, 57, 29, and 3 as of September 30, 2009 for accident years 2008, 2007, 2006, 2005 and 2004, respectively.

(2)		Industry data from Highline Data, an affiliate of The National Underwriter Company and a provider of insurance industry financial performance data.

We also measure our claims activity by monitoring our claims frequency per million dollars of direct written premium, which we refer to as our claims frequency ratio. The table below sets forth our claims frequency ratios for both alternative market and tradition business for the periods presented:


	Claims Frequency Ratios as
	of September 30, 2009
	Alternative		Traditional
	Market		Market

2006 and prior		63.7		70.7
2007		52.5		68.9
2008		62.1		69.3
First 9 months of 2009		37.1		57.3

Policyholder Audits

We conduct premium audits on our alternative market and traditional business policyholders annually upon the expiration of each policy, including when the policy is renewed. The purpose of these audits is to verify that policyholders have accurately reported their payroll expenses and employee job classifications, and therefore have paid the premium required under the terms of their policies. In addition to annual audits, we selectively perform interim audits on certain classes of business if significant or unusual claims are filed or if the monthly reports submitted by a policyholder reflect a payroll pattern or any aberrations that cause underwriting, safety or fraud concerns.

Reinsurance

Reinsurance is a transaction between insurance companies in which an original insurer, or ceding company, remits a portion of its premiums to a reinsurer, or assuming company, as payment for the reinsurer’s commitment to indemnify the original insurer for a portion of its insurance liability. Reinsurance agreements may be proportional in nature, under which the assuming company shares proportionally in the premiums and losses of the ceding company. This arrangement is known as quota share reinsurance. Reinsurance agreements may also be structured so that the assuming company indemnifies the ceding company against all or a specified portion of losses on underlying insurance policies in excess of a specified amount, which is called an attachment level or retention, in return for a premium, usually determined as a percentage of the ceding company’s primary insurance premiums. This arrangement is known as excess of loss reinsurance. Excess of

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loss reinsurance may be written in layers, in which a reinsurer or group of reinsurers accepts a band of coverage up to a specified amount. One form of excess of loss reinsurance is so-called “clash cover” reinsurance which only covers occurrences resulting in losses involving more than one reinsured policy or, in the case of workers’ compensation insurance, more than one injured worker. Any liability exceeding the outer limit of a reinsurance program is retained by the ceding company. The ceding company also bears the credit risk of a reinsurer’s insolvency.

Reinsurance can be facultative reinsurance or treaty reinsurance. Under facultative reinsurance, each policy or portion of a risk is reinsured individually. Under treaty reinsurance, an agreed-upon portion of a class of business is automatically reinsured.

Reinsurance is very important to our business. Guarantee Insurance reinsures a portion of its exposures and pays to the reinsurers a portion of the premiums received on all policies reinsured. Insurance policies written by Guarantee Insurance are reinsured with other insurance companies principally to:


	•	reduce net liability on individual risks;

	•	mitigate the effect of individual loss occurrence (including catastrophic losses);

	•	stabilize underwriting results;

	•	decrease underwriting leverage; and

	•	increase its underwriting capacity.

We determine the amount and scope of reinsurance coverage to purchase each year based on a number of factors. These factors include the evaluation of the risks accepted, consultations with reinsurance representatives and a review of market conditions, including the availability and pricing of reinsurance.

The cost and limits of the reinsurance coverage we purchase vary from year to year based upon the availability of reinsurance at an acceptable price, our catastrophe exposure and our desired level of retention. Retention refers to the amount of risk that we retain for our own account.

We regularly monitor our reinsurance requirements and review the availability, the amount and cost of reinsurance and our experience with insured losses. The availability, amount and cost of reinsurance are subject to market conditions and to our experience with insured losses. There can be no assurance that our reinsurance agreements can be renewed or replaced prior to expiration upon terms as favorable as those currently in effect. If we are unable to renew or replace our reinsurance agreements, or elect to reduce or eliminate our quota share reinsurance, our net liability on individual risks would increase, we would have greater exposure to catastrophic losses, our underwriting results would be subject to greater variability, and our underwriting capacity would be reduced.

Guarantee Insurance purchases both quota share and excess of loss reinsurance. The protection afforded by such reinsurance is subject to various limitations and restrictions. For example, it excludes coverage for certain high-risk occupations, such as tunnel construction, mining and the handling of explosives. In addition, the majority of this reinsurance either excludes or limits coverage for occupational diseases or excludes coverage for risks with known occupational disease exposures. The majority of this reinsurance also excludes or limits coverage for extra contractual damages, including punitive, exemplary, compensatory and consequential damages, as well as for losses paid in excess of policy limits. It also includes sunset clauses, which limit reinsurance coverage to claims reported to reinsurers within 84 months of the inception of the contract period for the reinsurance. In addition, many of our reinsurance policies include commutation clauses, which permit the reinsurers to terminate their obligations by making a final payment to us based on an estimate of their remaining reinsurance liabilities, which may ultimately prove to be inadequate. Also, certain reinsurance purchased by us excludes all coverage for terrorism losses, while other reinsurance excludes coverage for terrorism losses involving nuclear, biological or chemical explosion, pollution or contamination, applies an aggregate limit on the recovery of terrorism losses and/or otherwise limits coverage for terrorism losses.

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Alternative Market Business

Combined Quota Share and Aggregate Excess of Loss Reinsurance. In the alternative market, Guarantee Insurance issues workers’ compensation and employers’ liability coverage to employers that share in the income and losses associated with this insurance, including the loss experience and expenses under such policies, primarily through the employers’ participation in a segregated portfolio captive reinsurance facility. Each segregated portfolio captive reinsures, on a quota share basis, a percentage (typically 50% to 90%) of the premiums and losses on the insurance that Guarantee Insurance issues for participating employers. If aggregate covered losses exceed the level specified in the reinsurance agreement, the segregated portfolio captive reinsures the entire amount of the excess losses up to the aggregate liability limit specified in the agreement. If the aggregate losses for the segregated portfolio cell exceed the aggregate liability limit, Guarantee Insurance retains 100% of those excess losses. Losses in excess of $1.0 million per occurrence are not covered by this reinsurance agreement. To the extent that any loss exceeds $1.0 million per occurrence, the amount of such loss in excess of $1.0 million is reinsured subject to certain limitations under Guaranteed Insurance’s excess of loss reinsurance program. In addition, the segregated portfolio captive’s liability with respect to the underlying workers’ compensation policies is limited to the assets held in the segregated portfolio cell for that employer’s benefit.

Excess of Loss Reinsurance. Guarantee Insurance has purchased excess of loss reinsurance for alternative market workers’ compensation losses in excess of $1.0 million per occurrence. Guarantee Insurance generally cedes between 10% and 90% of the losses falling within this $1.0 million retention under the segregated cell captive reinsurance agreements as described above. Some of the excess of loss reinsurance purchased by Guarantee Insurance applies solely to our alternative market business, while other excess of loss reinsurance applies to both the alternative market and the traditional business.

July 1, 2005 through June 30, 2006. For alternative market workers’ compensation policies that commence during the period from July 1, 2005 through June 30, 2006, Guarantee Insurance retains $1.0 million per occurrence and cedes losses greater than this $1.0 million retention subject to certain limitations. This reinsurance applied to both traditional and alternative market business and is described below in the section describing excess of loss reinsurance for traditional business.

July 1, 2006 through April 30, 2007. For alternative market workers’ compensation policies that commenced during the period July 1, 2006 through April 30, 2007, Guarantee Insurance retains $1.0 million per occurrence. We purchased excess of loss reinsurance in the amount of $4.0 million per occurrence for this alternative market business, but commuted this reinsurance effective May 1, 2007. Depending on the date of the loss occurrence, additional reinsurance protection was provided by excess of loss and clash cover reinsurance attaching over $5.0 million per occurrence, which is described below in the section relating to excess of loss reinsurance for traditional business.

May 1, 2007 through June 30, 2008. For alternative market workers’ compensation policies that commence during the period from May 1, 2007 through June 30, 2008, Guarantee Insurance retains $1.0 million per occurrence and cedes losses greater than this $1.0 million retention. Pursuant to the reinsurance agreement, which is with National Indemnity Company, a subsidiary of Berkshire Hathaway, Inc. rated A++ (Superior) by A.M. Best Company, the first layer excess of loss reinsurance for such claims and for losses occurring after May 1, 2007 under alternative market policies in force prior to that date provides $4.0 million of coverage per occurrence excess of Guarantee Insurance’s $1.0 million retention. The agreement reinsures losses in excess of $1.0 million up to $5.0 million per occurrence and has an aggregate limit of $16.0 million during the contract period. In addition, depending on the date of the loss occurrence, additional reinsurance protection is provided by excess of loss and clash cover reinsurance attaching over $5.0 million per occurrence, which is described below in the section dealing with excess of loss reinsurance for traditional business.

July 1, 2008 through June 30, 2009. Guarantee Insurance obtained excess of loss reinsurance for our alternative market policies from National Indemnity Company effective July 1, 2008 in an amount of $4.0 million per occurrence in excess of a $1.0 million retention. This reinsurance applies to losses occurring during the period July 1, 2008 through June 30, 2009 and has an aggregate limit of $16.0 million during the

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contract period. It excludes coverage for participation in assigned risk pools. The reinsurance for the period ended June 30, 2008 was written on a “risk attaching” basis. Coverage incepting July 1, 2008 is written on a “losses occurring” basis and applies to losses occurring during the period July 1, 2008 through June 30, 2009. Additional reinsurance is provided by excess of loss and clash cover reinsurance attaching over $5.0 million per occurrence, which is described below in the section dealing with excess of loss reinsurance for traditional business. In addition, certain alternative market insurance policies, commencing during the period July 1, 2008 through June 30, 2009, for which Guarantee Insurance typically cedes 50% to 90% of losses to a segregated portfolio captive controlled by an insurance agency, are not reinsured under the excess of loss reinsurance purchased for Guarantee Insurance’s alternative market business but instead are reinsured under the first layer of excess of loss reinsurance purchased for Guarantee Insurance’s traditional business, which is also described in the section below under the heading “— Traditional Business — Excess of Loss Reinsurance.”

July 1, 2009 through June 30, 2010. Guarantee Insurance has obtained excess of loss reinsurance for our alternative market policies from two reinsurers — National Liability and Fire Insurance Company, a subsidiary of Berkshire Hathaway, Inc. rated A+ (Superior) by A.M. Best Company, and from ULLICO Casualty Company effective July 1, 2009, in an amount of $4.0 million per occurrence in excess of a $1.0 million retention. This reinsurance, under which 90% of the coverage is provided by National Liability and Fire Insurance Company, and the remaining 10% is provided by ULLICO Casualty Company, applies to losses occurring during the period July 1, 2009 through June 30, 2010, reinsures losses in excess of $1.0 million up to $5.0 million per occurrence, and has an aggregate limit of $16.0 million during the contract period. It excludes coverage for participation in assigned risk pools and has other limitations. For example, it reinsures employer’s liability losses at lower limits than those applicable to Guarantee Insurance’s statutory workers’ compensation liabilities and has a lower aggregate limit for employer’s liability losses. Additional reinsurance is provided by excess of loss and clash cover reinsurance attaching over $5.0 million per occurrence, which is described in the section below under the heading “— Traditional Business — Excess of Loss Reinsurance.” In addition, certain alternative market insurance policies, commencing during the period July 1, 2009 through June 30, 2010, for which Guarantee Insurance typically cedes 50% to 90% of losses to a segregated portfolio captive controlled by an insurance agency, are not reinsured under the excess of loss reinsurance purchased for Guarantee Insurance’s alternative market business but instead are reinsured under the first layer of excess of loss reinsurance purchased for Guarantee Insurance’s traditional business, which is also described in the section below under the heading “— Traditional Business— Excess of Loss Reinsurance.”

Traditional Business

Quota Share Reinsurance. Effective July 1, 2006, Guarantee Insurance entered into a quota share reinsurance agreement with National Indemnity Company. Pursuant to this agreement, Guarantee Insurance ceded 50% of our traditional business, excluding South Carolina, Georgia and Indiana, in force on July 1, 2006 and 50% of our new and renewal traditional business, excluding these states, effective during the period from July 1, 2006 through June 30, 2007. Effective July 1, 2007, Guarantee Insurance entered into a second quota share reinsurance agreement with National Indemnity Company pursuant to which we ceded 50% of our new and renewal traditional business, excluding South Carolina, Georgia and Indiana, effective during the period from July 1, 2007 through June 30, 2008. Both of these quota share agreements covered all losses up to $500,000 per occurrence, subject to various restrictions and exclusions. Under these agreements, Guarantee Insurance ceded premiums and received a ceding commission in return.

Effective July 1, 2008, Guarantee Insurance entered into a third quota share reinsurance agreement with both National Indemnity Company, which is rated A++ (Superior) by A.M. Best Company, and Swiss Reinsurance America Corporation, which is rated A (Excellent) by A.M. Best Company. Pursuant to this agreement, Guarantee Insurance again ceded 50% of our new and renewal traditional business, excluding South Carolina, Georgia and Indiana, effective on or after July 1, 2008. National Indemnity Company provided 75% of this reinsurance coverage, while Swiss Reinsurance America Corporation provided the remaining 25%. The agreement covered 50% of net retained liabilities for losses up to $500,000 per occurrence arising from all subject traditional business. The agreement was written on a “losses occurring” basis and applies to losses

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occurring during the contract period, which extends from July 1, 2008 through January 1, 2009 for National Indemnity Company’s share of the reinsured risks and from July 1, 2008 through June 30, 2009 for Swiss Reinsurance America Corporation’s share of the reinsured risks. The quota share reinsurance for prior periods was written on a “risk attaching” basis to cover all losses insured under policies commencing during the reinsurance contract period, including losses that occur after the end of that period. This prior reinsurance has been cut off with an adjustment of reinsurance premium for all losses occurring after June 30, 2008. These losses are covered by the reinsurance incepting July 1, 2008. The change from reinsurance written on a “risk attaching” basis to reinsurance written on a “losses occurring” basis will facilitate early termination of the reinsurance at the option of Guarantee Insurance. Guarantee Insurance has the option of terminating the reinsurance upon 15 days’ prior notice. Effective January 1, 2009, coverage from National Indemnity Company expired, coverage from Swiss Reinsurance America Corporation was increased from 12.5% to 25.0% and previously excluded stated were added to the coverage.

Guarantee Insurance entered into an additional quota share agreement with Harco National Insurance Company pursuant to which we ceded 37.83% of Guarantee Insurance’s traditional business gross unearned premium reserves as of December 31, 2008 and 37.83% of the first $500,000 of losses and certain loss adjustment expenses incurred on all subject business in force at December 31, 2008, subject to various restrictions and exclusions. Under this agreement, Guarantee Insurance ceded unearned premium reserves and received a ceding commission, which varies based on loss experience. In return, Harco National Insurance Company is obligated to pay its pro rata share of losses and loss adjustment expenses.

Effective January 1, 2009, Guarantee Insurance entered into a quota share agreement with ULLICO Casualty Company, an insurance company from which we borrowed approximately $5.5 million on December 31, 2008. Pursuant to the quota share agreement, Guarantee Insurance ceded 68% of traditional new and renewal business in the states of Georgia, New Jersey and Florida on the first $1.0 million of incurred losses and certain loss adjustment expenses, subject to various restrictions and exclusions. The quota share agreement covers losses occurring during the contract period of January 1, 2009 to December 31, 2009, under traditional new and renewal policies issued during that period. ULLICO is obligated to pay its pro rata share of losses and certain loss adjustment expenses, subject to an aggregate cap of 90% of the gross earned premium income on the subject policies.

Excess of Loss Reinsurance. In addition to quota share reinsurance, Guarantee Insurance purchases excess of loss reinsurance. Effective July 1, 2007, Guarantee Insurance’s retention for its reinsured statutory workers’ compensation liabilities is $1.0 million per occurrence. All of Guarantee Insurance’s excess of loss agreements are subject to various restrictions and exclusions.

The following description of Guarantee Insurance’s excess of loss reinsurance for its statutory workers’ compensation liabilities covers the period from July 1, 2005 through June 30, 2010. Different layers of this excess of loss reinsurance were renewed at different times during the applicable calendar year. All of the layers in the 2009/2010 program are scheduled to expire on June 30, 2010. In addition, until July 1, 2008, the first layer of this reinsurance was written on a “risk attaching” basis, while certain upper layers of this reinsurance apply only to losses occurring during the reinsurance contract period. Thus, for periods prior to July 1, 2008, a single loss may be reinsured under first layer reinsurance covering a particular period based on the date of policy issuance and under upper layer reinsurance covering a later period based on the date of the loss occurrence. Effective July 1, 2008, all layers of this excess of loss reinsurance are written on a “losses occurring” basis.

Guarantee Insurance purchases first layer excess of loss reinsurance that applies solely to its traditional business. It purchases upper layers of excess of loss reinsurance (including clash cover reinsurance that only applies if an occurrence involves injuries to multiple employees) that apply to both our traditional and alternative market business. As a result, losses from both business segments would be applied against any aggregate limits for such upper layers.

July 1, 2005 through June 30, 2006. For workers’ compensation claims covered under policies for its traditional business that commence during the period July 1, 2005 through June 30, 2006, Guarantee Insurance retains $750,000 per occurrence. Guarantee Insurance cedes losses greater than this $750,000 retention. Subject to certain limitations, the excess of loss reinsurance for such claims provides coverage up to

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$19.3 million per occurrence provided in four layers, including in the two upper layers, certain clash covers that only apply if an occurrence involves injuries to multiple employees.


	•	For losses incurred under policies commencing during the period July 1, 2005 through June 30, 2006, the first layer of excess of loss reinsurance provides $250,000 of coverage per occurrence excess of Guarantee Insurance’s $750,000 retention. This layer reinsures losses in excess of the $750,000 retention up to $1.0 million and only applies to our traditional business.

	•	For losses incurred under policies commencing during the period July 1, 2005 through June 30, 2006, the second layer of excess of loss reinsurance provides $4.0 million of coverage per occurrence excess of $1.0 million. This layer reinsures losses in excess of $1.0 million up to $5.0 million, subject to a maximum amount of recovery under this layer equal to 225% of the total reinsurance premiums paid by Guarantee Insurance for the layer. However, in the event of a loss falling within this layer, reinsurance premiums payable by Guarantee Insurance are based on a 3% minimum reinsurance premium rate applied to the subject premium base of $70 million plus 110% of paid losses falling within the layer, all subject to a maximum premium amount of $8.75 million. This means that regardless of the number of occurrences covered by this reinsurance with incurred losses in excess of $1.0 million, no net income statement benefit is received for the first $6.65 million of aggregate losses falling within this layer. The aggregate amount of reinsurance recoveries paid under this layer will never exceed $19.69 million. This reinsurance applies to both traditional and alternative market business.

	•	The third layer of excess of loss reinsurance consists of two separate clash cover treaties. Each of these treaties provides $5.0 million of coverage per occurrence in excess of $5.0 million. Each reinsures losses in excess of $5.0 million up to $10.0 million. The first of these treaties, which applied to losses incurred under policies commencing during the period from July 1, 2005 through June 30, 2006, was commuted in 2006 and no longer is in force. The second of these treaties, which has not been commuted and remains in force, applies to losses occurring from January 1, 2006 through December 31, 2006. This second treaty covers both traditional and alternative market business but excludes coverage for participation in assigned risk pools.

	•	The fourth layer of excess of loss reinsurance also consists of two separate clash cover treaties. Each of these treaties provides $10.0 million of coverage per occurrence in excess of $10.0 million. Each reinsures losses in excess of $10.0 million up to $20.0 million. The first of these treaties, which applied to losses incurred under policies commencing from July 1, 2005 through June 30, 2006, was commuted in 2006 and no longer is in force. The second of these treaties, which has not been commuted and remains in force, applies to losses occurring from January 1, 2006 through December 31, 2006. This second treaty covers both traditional and alternative market business but excludes coverage for participation in assigned risk pools.

July 1, 2006 through June 30, 2007. For workers’ compensation claims covered under traditional policies that commence during the period July 1, 2006 through June 30, 2007, Guarantee Insurance retains $750,000 per occurrence and cedes losses greater than this $750,000 retention. The amount of the excess of loss reinsurance that applies to such claims totals $19.3 million per occurrence provided in three layers, including in the two upper layers certain clash covers.


	•	For losses incurred under policies commencing during the period July 1, 2006 through June 30, 2007, the first layer of excess of loss reinsurance provides $4.3 million of coverage per occurrence excess of Guarantee Insurance’s $750,000 retention. This layer has an annual aggregate deductible of $250,000 and reinsures losses in excess of the $750,000 retention up to $5.0 million. Pursuant to these deductible provisions, Guarantee Insurance must pay $250,000 in combined statutory workers’ compensation and employers’ liability losses incurred in the twelve-month contract period in addition to its $750,000 retention before it is entitled to any excess of loss reinsurance recovery under this layer.

	•	The second layer of excess of loss reinsurance consists of two separate treaties. Each of these treaties provides $5.0 million of coverage per occurrence in excess of $5.0 million. Each reinsures losses in

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		excess of $5.0 million up to $10.0 million. The first of these treaties is a clash cover, which applies to losses occurring from January 1, 2006 through December 31, 2006. The second is not a clash cover and applies to losses occurring from January 1, 2007 through June 30, 2008, subject to an aggregate limit of $10.0 million. This aggregate limit means that regardless of the number of occurrences during the 18-month contract period with incurred losses in excess of $5.0 million, the aggregate amount paid under this treaty would not exceed $10.0 million. Both of these treaties cover traditional and alternative market business but exclude coverage for participation in assigned risk pools.


	•	The third layer of excess of loss reinsurance consists of two separate clash cover treaties. Each of these treaties provides $10.0 million of coverage per occurrence in excess of $10.0 million. Each reinsures losses in excess of $10.0 million up to $20.0 million. The first of these treaties applies to losses occurring from January 1, 2006 through December 31, 2006. The second applies to losses occurring from January 1, 2007 through June 30, 2008, subject to an aggregate limit of $20.0 million. Both of these treaties cover traditional and alternative market business but exclude coverage for participation in assigned risk pools.

July 1, 2007 through June 30, 2008. For workers’ compensation claims covered under traditional insurance policies that commence during the period from July 1, 2007 through June 30, 2008, Guarantee Insurance retains $1.0 million per occurrence and cedes losses greater than this $1.0 million retention. The amount of the excess of loss reinsurance that applies to such claims totals $19.0 million per occurrence, provided in three layers, including a clash cover treaty in the highest layer.


	•	Pursuant to a workers’ compensation excess of loss reinsurance agreement between Guarantee Insurance and Midwest Employers Casualty Company, the first layer of the excess of loss reinsurance provides $4.0 million of coverage per occurrence excess of Guarantee Insurance’s $1.0 million retention for losses insured under policies commencing during the period July 1, 2007 through June 30, 2008. It reinsures losses in excess of $1.0 million up to $5.0 million.

	•	Pursuant to a workers’ compensation excess of loss reinsurance agreement between Guarantee Insurance and reinsurers Max Re, Ltd., Aspen Insurance UK Limited and various underwriters at Lloyd’s London, the second layer of excess of loss reinsurance provides $5.0 million of coverage per occurrence in excess of $5.0 million for losses occurring on or after January 1, 2007 and prior to July 1, 2008. This second layer reinsures losses in excess of $5.0 million up to $10.0 million and has an aggregate limit of $10.0 million. The second layer covers both traditional and alternative market business and excludes coverage for participation in assigned risk pools.

	•	The third layer of excess of loss reinsurance is a clash cover provided pursuant to a workers’ compensation excess of loss reinsurance agreement between Guarantee Insurance and the reinsurers Aspen Insurance UK Limited and various underwriters at Lloyd’s London. This reinsurance applies to losses occurring from January 1, 2007 through June 30, 2008 and provides $10.0 million of coverage per occurrence in excess of $10.0 million, subject to an aggregate limit of $20.0 million. This third layer reinsures losses in excess of $10.0 million up to $20.0 million. The third layer covers both traditional and alternative market business and excludes coverage for participation in assigned risk pools.

July 1, 2008 through June 30, 2009. Guarantee Insurance obtained excess of loss reinsurance, effective July 1, 2008, in the same three layers ($4.0 million excess of a $1.0 million retention, $5.0 million excess of $5.0 million and $10.0 million excess of $10.0 million) as were in place for the prior period ended June 30, 2008. The first layer of this coverage, provided by Midwest Employers Casualty Company, applies only to traditional insurance policies. The second layer, provided by Max Bermuda, Ltd., Aspen Insurance UK Limited and various underwriters at Lloyd’s London, applies to both traditional and alternative market insurance policies. The third layer, provided by Max Bermuda, Ltd., Tokio Millennium Reinsurance Limited, Aspen Insurance UK Limited and various underwriters at Lloyd’s London, applies to both traditional and alternative market insurance policies and is a clash cover.

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The first layer of coverage for the prior period ended June 30, 2008 was written on a “risk attaching” basis. Coverage under all layers of excess of loss reinsurance incepting July 1, 2008 is written on a “losses occurring” basis and applies to losses occurring during the period July 1, 2008 through June 30, 2009. Coverage under the first layer of this new reinsurance is subject to an annual deductible of $1.0 million such that this reinsurance only applies to losses in excess of $1.0 million per occurrence during the period July 1, 2008 through June 30, 2009 to the extent that such losses exceed $1.0 million in the aggregate. Coverage under the second layer is subject to an aggregate limit of $10.0 million, while coverage under the third layer is subject to an annual limit of $20.0 million. All three layers exclude coverage for participation in assigned risk pools.

July 1, 2009 through June 30, 2010. Guarantee Insurance has obtained excess of loss reinsurance, effective July 1, 2009, in four layers ($4.0 million excess of a $1.0 million retention, $5.0 million excess of $5.0 million, $10.0 million excess of $10.0 million and $30 million excess of $20 million). The first layer of this coverage, which is provided by a group of reinsurers led by Maiden Re and applies only to traditional insurance policies, is subject to an annual aggregate deductible of $1.0 million. The second layer, provided by a group of reinsurers led by the Amlin Syndicate at Lloyd’s, applies to both traditional and alternative market insurance policies. The third layer, provided by a group of reinsurers led by Amlin Syndicate, applies to both traditional and alternative market insurance policies and is a clash cover. The fourth layer provided by a group of reinsurers led by Amlin Syndicate Re is also a clash cover.

Coverage under all layers of excess of loss reinsurance incepting July 1, 2009 is written on a “losses occurring” basis and applies to losses occurring during the period July 1, 2009 through June 30, 2010. Coverage under the first layer of this reinsurance is subject to an annual deductible of $1.0 million such that this reinsurance applies only to losses in excess of $1.0 million per occurrence during the period July 1, 2009 through June 30, 2010, and then only to the extent that these excess loss amounts (amounts over $1 million per occurrence) exceed $1.0 million in the aggregate during the coverage period. Coverage under the first layer is subject to an annual aggregate limit of $20.0 million; coverage under the second layer is subject to an annual aggregate limit of $10.0 million; coverage under the third layer is subject to an annual aggregate limit of $20.0 million; and coverage under the fourth layer is subject to an annual aggregate limit of $60.0 million.

Recoverability of reinsurance. Reinsurance does not discharge or diminish our obligation to pay claims covered under insurance policies we issue. However, it does permit us to recover losses on such risks from our reinsurers. We would be obligated to pay claims in the event these reinsurers were unable to meet their obligations. Therefore, we are subject to credit risk with respect to the obligations of our reinsurers. A reinsurer’s ability to perform its obligations may be adversely affected by events unrelated to workers’ compensation insurance losses.

On a routine basis, we review the financial strength of our authorized and unauthorized reinsurers, monitor the aging of reinsurance recoverables on paid losses and assess the adequacy of collateral underlying reinsurance recoverable balances. If a reinsurer is unable to meet any of its obligations under the reinsurance agreements, we would be responsible for the payment of all claims and claims expenses that we have ceded to such reinsurer. The collateral Guarantee Insurance maintains from certain reinsurers serves to mitigate this risk.

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As of December 31, 2008, approximately 94% of our reinsurance recoverable balances on paid and unpaid losses and loss adjustment expenses are either due from authorized reinsurers or are fully secured with collateral provided by unauthorized reinsurers. To date, we have not, in the aggregate, experienced difficulties in collecting balances from our reinsurers. However, we have historically maintained an allowance for the potential uncollectibility of reinsurance balances on paid and unpaid losses and loss adjustment expenses by authorized and unauthorized reinsurers. The table below sets forth our reinsurance recoverable balances as of December 31, 2008:


			Reinsurance Recoverable Balances
						Unpaid
			Paid Losses			Losses
			and Loss			and Loss
	A.M.		Adjustment			Adjustment							Net
	Best Rating		Expenses			Expenses		Total			Collateral(1)		Exposures
	In thousands

Authorized reinsurers:
National Indemnity Company (a subsidiary of Berkshire Hathaway, Inc.)		A++	$	2,301		$	13,435	$	15,736		$	—	$	15,736
Swiss Reinsurance America Corporation		A		293			1,643		1,936			—		1,936
Midwest Employers Casualty Company		A+		1,474			1,674		3,148			—		3,148
Other authorized reinsurers				441			2,468		2,909			238		2,671

Total authorized reinsurers				4,509			19,220		23,729			238		23,491

Unauthorized reinsurers:
Excess of loss reinsurers:
With net exposures				—			—		—			—		—
With no net exposures				—			537		537			1,618		—

Total excess of loss reinsurers				—			537		537			1,618		—

Segregated portfolio cell captives:
With net exposures				—			3,011		3,011			1,574		1,437
With no net exposures				—			11,340		11,340			22,301		—

Total segregated portfolio cell captives				—			14,351		14,351			23,875		—

Legacy exposure reinsurers:
With net exposures				340			2,111		2,451			1,303		1,148
With no net exposures				93			1,273		1,366			2,350		—

Total legacy exposure reinsurers				433			3,384		3,817			3,653		1,148

Total unauthorized reinsurers				433			18,272		18,705			29,146		2,585

Total				4,942			37,492		42,434		$	29,384	$	26,076

Less allowance				(300	)		—		(300	)

Net			$	4,642		$	37,492	$	42,134


(1)		Collateral is principally comprised of funds held by Guarantee Insurance under reinsurance treaties and letters of credit.

As of December 31, 2008, Guarantee Insurance had net exposures from five segregated portfolio captive cells totaling approximately $1.4 million. Individually, net exposures from these five segregated portfolio captive cells ranged from approximately $23,000 to approximately $498,000.

As of December 31, 2008, Guarantee Insurance had net exposures from six unauthorized reinsurers totaling approximately $1.1 million attributable to its legacy asbestos and environmental claims and

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commercial general liability claims which arose from the sale of general liability insurance and participations in reinsurance assumed through underwriting management organizations. See “— Legacy Claims.” Individually, net exposures from these six reinsurers ranged from approximately $44,000 to approximately $598,000.

Reserves for Losses and Loss Adjustment Expenses

We record reserves for estimated losses under insurance policies that we write and assume and for loss adjustment expenses related to the investigation and settlement of policy claims. Our reserves for losses and loss adjustment expenses represent the estimated cost of all reported and unreported losses and loss adjustment expenses incurred and unpaid at a given point in time. We do not discount loss and loss adjustment expense reserves for the time value of money attributable to the period that elapses from the date of loss to claim payment dates.

We seek to provide estimates of loss and loss adjustment expense reserves that equal ultimate incurred losses and loss adjustment expenses. Maintaining the adequacy of loss and loss adjustment reserve estimates is an inherent risk of the workers’ compensation insurance business. We use an independent actuarial consulting firm to assist in the evaluation of the adequacy of our loss and loss adjustment reserves. Workers’ compensation claims may be paid over a long period of time. Estimating reserves for these claims may be more uncertain than estimating reserves for other lines of insurance with shorter or more definite periods between occurrence of the claim and final determination of the loss. We endeavor to minimize this risk by closing claims promptly and by relying on the estimates of our professional claims adjusting staff, supplemented by actuarial estimation techniques.

The three main components of loss and loss adjustment expense reserves are (1) case reserves for reported claims and associated adjustment costs, (2) aggregate reserves for claims incurred but not reported and associated adjustment costs (IBNR reserves) and (3) aggregate reserves for adjusting and other claims administration costs, which includes expenses such as claims-related salaries and associated overhead.

Case reserves are estimates of future claim payments based upon periodic case-by-case evaluation and the judgment of our claims adjusting staff. When a claim is reported, we establish an initial case reserve for the estimated amount of our losses and loss adjustment expenses based on our estimate of the most likely outcome of the claim at that time. Generally, a case reserve is established within 14 days after the claim is reported and consists of anticipated medical costs, indemnity costs and specific adjustment expenses, which we refer to as defense and cost containment expenses, or DCC expenses. At any point in time, the amount paid on a claim, plus the reserve for future amounts to be paid represents the estimated total cost of the claim, or the case incurred loss and loss adjustment expense amount. The estimated amount of loss for a reported claim is based upon various factors, including:


	•	type of loss;

	•	severity of the injury or damage;

	•	age and occupation of the injured employee;

	•	estimated length of temporary disability;

	•	anticipated permanent disability;

	•	expected medical procedures, costs and duration;

	•	our knowledge of the circumstances surrounding the claim;

	•	insurance policy provisions, including coverage, related to the claim;

	•	jurisdiction of the occurrence; and

	•	other benefits defined by applicable statute.

The case incurred loss and loss adjustment expense amount can vary due to uncertainties with respect to medical treatment and outcome, length and degree of disability, employment availability and wage levels and

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judicial determinations. As changes occur, the case incurred loss and loss adjustment expense amount is adjusted. The initial estimate of the case incurred amount can vary significantly from the amount ultimately paid, especially in circumstances involving severe injuries with comprehensive medical treatment. Changes in case incurred amounts, or case development, are an important component of our historical claim data. Adjustments for inflationary effects are included as part of our review of loss reserve estimates, but our reserving system does not make explicit provision for the effects of inflation.

In addition to case reserves, we establish IBNR reserves, which are intended to provide for losses and loss adjustment expenses that have been incurred but not reported, aggregate changes in case incurred losses and loss adjustment expenses and recently reported claims for which an initial case reserve has not yet been established. In establishing our IBNR reserves, we project ultimate losses by accident year both through use of our historical experience and the use of industry experience by state. We project ultimate losses using 3 accepted actuarial methods and evaluate statistical information to determine which methods are most appropriate and whether adjustments are needed within the particular methods. This supplementary information may include open and closed claim counts, statistics related to open and closed claim count percentages, claim closure rates, average case reserves and average losses and loss adjustment expenses incurred on open claims, reported and ultimate claim severity, reported and projected ultimate loss ratios and loss payment patterns.

The third component of our reserves for losses and loss adjustment expenses is our adjusting and other expense reserves, which represent an estimate of the future aggregate costs of administering all known and unknown claims.

An additional component of our reserves for losses and loss adjustment expenses is the reserve for mandatory participation in pooling arrangements. We record reserves for mandatory pooling arrangements as those reserves are reported to us by the pool administrators.

The statistical and actuarial analysis we employ in estimating our loss and loss adjustment expense reserves uses 3 methods to project ultimate losses. Claims are grouped by accident year and adjusted by (1) state-specific NCCI loss development factors, modified as we deem appropriate; (2) development factors derived from our historical annual experience; and (3) development factors derived from our historical quarterly experience. NCCI loss development factors are measures over time of industry-wide claims reported, average case incurred amounts, case development, duration, severity and payment patterns. However, NCCI loss development factors do not take into consideration differences in our own claims reserving and claims management practices, the employment and wage patterns of our policyholders relative to the industry as a whole or other subjective factors. As a result, we modify the NCCI loss development factors to reflect these differences and the differences between ultimate benefits that serve as the basis of the NCCI factors and our excess of loss reinsurance per occurrence retentions. We also supplement the modified NCCI loss development factors with factors derived from our own quarterly and annual historical experience. We average the results from the use of modified NCCI factors, the results from the use of our own quarterly experience and the results from our own annual historical experience to arrive at our estimates for our reserves for losses and loss adjustment expenses.

We calculate the amount of our total losses and loss adjustment expenses that we estimate will ultimately be paid by our reinsurers, and subtract this amount from our estimated total gross reserves to produce our estimated total net reserves.

As of December 31, 2008, our estimate of our ultimate liability for losses and loss adjustment expenses was approximately $74.6 million and our estimate of amounts recoverable from reinsurers for unpaid losses and loss adjustment expenses was approximately $37.5 million. Accordingly, our reserves for losses and loss adjustments expenses, net of amounts recoverable from reinsurers, was approximately $37.1 million. This amount included approximately $1.8 million associated with our mandatory participation in the assumption of workers’ compensation business from NCCI, for which reserves are maintained as reported by NCCI. This amount also included approximately $4.5 million in net reserves for legacy asbestos and environmental and commercial general liability claims, approximately $525,000 of which related to 29 direct claims for which we maintain reserves, and approximately $4.0 million of which related to pooling arrangements, for which reserves are maintained as reported by the pool administrators.

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Our best estimate of our ultimate liability for losses and loss adjustment expenses was derived from the process and methodology described above, which relies on substantial judgment. There is inherent uncertainty in estimating our reserves for losses and loss adjustment expenses. It is possible that our actual losses and loss adjustment expenses incurred may vary significantly from our estimates. Accordingly, the ultimate settlement of losses and loss adjustment expenses may vary significantly from estimates included in our financial statements.

We have prepared a sensitivity analysis of our net reserves for losses and loss adjustment expenses as of December 31, 2008 by analyzing the effect of reasonably likely changes to the percentage weighting assigned to the modified NCCI loss development factors in deriving our estimates. We believe the results of this sensitivity analysis, which are summarized in the table below, constitute a reasonable range of the expected outcomes of our reserves for net losses and loss adjustment expenses.

For traditional and alternative market business, the low end of the range of our sensitivity analysis was derived from the assumption that the percentage weighting assigned to the modified NCCI factors was reduced to 25.0% rather than 33.3%, with the 75% remaining weight assigned to our quarterly and annual historical experience. The high end of the range of our sensitivity analysis was derived from the assumption that the percentage weighting assigned to the modified NCCI factors was increased from 33.0% to 50%, with the 50% remaining weight assigned to our quarterly and annual historical experience.

For assumed business, which was attributable to our mandatory participation in the assumption of workers’ compensation business from NCCI as of December 31, 2008, net reserves are maintained as reported by the NCCI. For legacy asbestos and environmental and commercial general liability claims, referred to as “legacy business”, net reserves are maintained based on (i) gross reserves reported by pool administrators, reduced by ceded reserves pursuant to our reinsurance arrangements on this business, and (ii) case-by-case reserve estimates made by us totaling approximately $525,000 on 29 direct claims. We believe that reserves reported by third parties for assumed business and the majority of legacy asbestos and environmental and commercial general liability claims represent the best estimate of our obligation for these claims, and we do not believe that it would be meaningful to prepare a sensitivity analysis on these net reserves. See “Risk Factors — Risks Related to Our Business — Guarantee Insurance has legacy commercial general liability claims, including asbestos and environmental liability claims.”

For unallocated loss adjustment expenses, net reserves are maintained based on management’s estimate of the future

PATRIOT RISK MANAGEMENT, INC. S-1/A