form10-k.htm


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

 
FORM 10-K
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2010
 
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission File Number: 1-14094
 
MEADOWBROOK INSURANCE GROUP, INC.
(Exact name of Registrant as specified in its charter)
Michigan
38-2626206
(State of Incorporation)
(IRS Employer Identification No.)
   
26255 American Drive, Southfield, MI
48034-6112
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (248) 358-1100
Securities registered pursuant to Section 12(b) of the Act:
 
Title of Each Class
Name of Exchange
on Which Registered
Common Stock, $.01 par value per share
New York Stock Exchange
 
Securities registered pursuant to Section 12(g) of the Act:  None
 
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
 
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes o No x
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x   No o
 
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes o  No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 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 x   Non-accelerated filer o   Smaller reporting company o
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No x
 
The aggregate market value of the voting and non-voting common stock held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of June 30, 2010 was $462,218,847.  As of March 10, 2011, there were 53,252,404 shares of the Company’s common stock ($.01 par value) outstanding.
 
Documents Incorporated by Reference
 
Certain portions of the Registrant’s Proxy Statement for the 2011 Annual Shareholders’ Meeting scheduled for May 19, 2011 are incorporated by reference into Part III of this report.
 


 
 

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
PART I
 
ITEM 1. BUSINESS
 
Legal Organization
 
As used in this Form 10-K, references to the “Company”, “we”, “us”, or “our” refer to Meadowbrook Insurance Group, Inc. (“Meadowbrook”) and its subsidiaries: Star Insurance Company (“Star”), ProCentury Corporation (“ProCentury”), Meadowbrook Inc., and Crest Financial Corporation. References to Meadowbrook also includes Star’s wholly-owned subsidiaries Ameritrust Insurance Corporation (“Ameritrust”), Savers Property and Casualty Insurance Company (“Savers”), and Williamsburg National Insurance Company (“Williamsburg”) and ProCentury’s wholly-owned subsidiaries Century Surety Company (“Century”), ProCentury Insurance Company (“PIC”), and ProCentury Risk Partners Insurance Company (“Propic”).
 
Star, Savers, Williamsburg, Ameritrust, Century, and PIC are collectively referred to as the Insurance Company Subsidiaries.
 
Meadowbrook was founded in 1955 as Meadowbrook Insurance Agency and was subsequently incorporated in Michigan in 1965. Meadowbrook Insurance Group, Inc. (“We,” “Our,” “Us,” or “Meadowbrook”) (NYSE: MIG) is a holding company organized as a Michigan corporation in 1985. Our principal executive offices are located at 26255 American Drive, Southfield, Michigan 48034-6112 (telephone number: (248) 358-1100).
 
Business Overview 
 
We are a specialty niche focused commercial insurance underwriter and insurance administration services company.  We market and underwrite specialty property and casualty insurance programs and products on both an admitted and non-admitted basis through a broad and diverse network of independent retail agents, wholesalers, program administrators and general agents, who value service, specialized knowledge, and focused expertise.  Program business refers to an aggregation of individually underwritten risks that have some unique characteristic and are distributed through a select group of agents. We seek to combine profitable underwriting, income from our net commissions and fees, investment returns and efficient capital management to deliver consistent long-term growth in shareholder value.
 
Through our retail property and casualty agencies, we also generate commission revenue, which represents 1.5% of our total consolidated revenues. Our agencies are located in Michigan, California, and Florida and produce commercial, personal lines, life and accident and health insurance that is placed with more than fifty unaffiliated insurance carriers. These agencies produce a minimal amount of business for our Insurance Company Subsidiaries.
 
We recognize revenue related to the services and coverages within the following categories: net earned premiums, management fees, claims fees, loss control fees, reinsurance placement, investment income, commission revenue, and net realized gains (losses).
 
We compete in the specialty insurance market. Our wide range of specialty niche insurance expertise allows us to accommodate a diverse distribution network ranging from specialized program agents to insurance brokers. In the specialty market, competition tends to place considerable focus on availability, service and other tailored coverages in addition to price. Moreover, our broad geographical footprint enables us to function with a local presence on both a regional and national basis. We also have the capacity to write specialty insurance in both the admitted and non-admitted markets. These unique aspects of our business model enable us to compete on factors other than price.
 
The Meadowbrook Approach
 
We have built our business in a manner that enables us to adapt to changing market conditions and deliver consistent, profitable results. The following highlights key aspects of our model that contribute to our balanced approach:
 
Diverse Revenue Sources: We generate the vast majority of our revenues from net earned premiums. To grow our premiums, we have developed specialty niche expertise relative to a wide range of underwriting risks. Consequently, our premium base is broadly diversified by line of business, customer, type of distribution and geography. We also generate fee-for-service revenues from risk management services and commission revenue from our agency that are not related to our insurance underwriting operations. Our range of capabilities provides flexibility for our long-term business development efforts as we seek to continue to generate profitable growth. We also believe revenue diversification reduces our risk profile and enables us to deliver more predictable results.
 
 
2

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
Positioned to Manage Insurance Cycles: The markets we serve operate on different market cycles and results in more stable earnings. Our admitted market capabilities generally provide a consistent source of revenues as this market generally has less pronounced cycles, higher renewal retentions, and more stable pricing than the non-admitted markets. Our non-admitted capabilities enable us to respond opportunistically to the unavailability of insurance and volatile pricing environment. We believe our mix of admitted and non-admitted capabilities enhances our profitability without increasing our risk profile.
 
Conservative Investment Philosophy: We seek to generate consistent investment income through a low-risk, high-quality investment portfolio.  We manage overall credit, interest rate, and liquidity risks when making investment decisions. We invest in highly rated, investment grade securities. We manage the duration of our investment portfolio to match our liabilities and ensure that we have sufficient liquidity to fund our cash needs without having to sell securities prior to maturity. This approach reinforces our focus on underwriting profitability and reduces our overall risk-return profile.
 
Ability to Attract and Retain Talented Insurance Professionals throughout U.S.: We have assembled a team of talented insurance professionals with a wide range of expertise across all functions and lines of business. Moreover, our regional structure enables our associates to deliver strong and responsive local service to our clients. We believe this is a unique aspect of our business model that enables us to better serve our agency network.
 
Strong Capital and Liquidity Position: We believe the Company is currently operating from a strong capital position. Our Insurance Company Subsidiaries are rated “A-” (Excellent) by A.M. Best Company (“A.M. Best”). A.M. Best’s ratings represent an independent third-party evaluation that provides an opinion of an insurer’s financial strength and ability to meet ongoing obligations to policyholders. We believe our Insurance Company Subsidiaries are well capitalized and have adequate surplus to support meaningful future premium growth. We generate cash flows from both regulated and non-regulated sources, which provides us with the flexibility to grow profitably during different market cycles. Additionally, our debt levels are very manageable and we have access to a $35 million line of credit that is available for general business purposes (no outstanding balance as of December 31, 2010). See “Management’s Discussion and Analysis” for further discussion on our liquidity position.
 
Our approach has delivered results over time. Between 2006 and 2010, net operating income per share has grown at a compound annual growth rate (CAGR) of 9.7% and from $0.74 to $1.07. Over the same period, our book value per share has grown at a CAGR of 10.4% and from $6.93 to $10.28. We also initiated a quarterly dividend during this period, which is currently at $0.04 per share.
 
Objective and Strategy
 
Our objective is to generate predictable results across the market cycle, with a target return on average equity range of 10%-17%. To achieve these results we seek to leverage the unique characteristics of our balanced business model to generate:
 
 
Consistent, profitable underwriting results
 
Predictable investment income in a low-risk, high-quality, fixed income portfolio
 
Profitable growth both organically and through acquisitions
 
Strong cash flow from our Insurance Company Subsidiaries and non-regulated fee-based services to leverage invested assets to equity and manage debt service
 
Steady fee and commission income
 
We monitor our objectives and strategy in the context of the interest rate environment, insurance market cycle conditions, and general economic conditions. As we seek to maximize long-term shareholder value, our priorities may be influenced by these factors.
 
Disciplined Underwriting Approach
 
We underwrite for predictability and profitability by adhering to the following business practices as they relate to our corporate underwriting discipline:
 
 
Re-underwrite excess and surplus lines business for accuracy and completeness;
 
Limit exposure to catastrophe-prone areas and purchase excess of loss and catastrophe reinsurance;
 
Our associates have significant underwriting experience and expertise;
 
Our actuarial associates support underwriting with pricing and loss analysis;
 
New business or program opportunities undergo a thorough due diligence process;
 
Robust program controls help monitor programs for performance; and
 
Creation and maintenance of long-term agent relationships, which are matched with high quality reinsurance partners.
 
 
3

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
Reclassifications and Redefining Segment Reporting
 
During the first quarter of 2010, the Company made certain reclassifications to the expense classifications in the Consolidated Statement of Income.  These reclassifications were made to enable the user of the financial statements to calculate the GAAP combined ratio directly from the Consolidated Statement of Income.   The reclassifications were the result of a comprehensive cost allocation study that allowed us to better align the underlying internal salary and administrative costs with the underlying function of those costs.  Previously, internal salary and administrative costs were charged to the Insurance Company Subsidiaries based upon an estimated management fee and later eliminated during consolidation.  Under this new methodology, the actual costs are reimbursed by the Insurance Company Subsidiaries and the expenses are eliminated as a reimbursement of costs.  As such, the nature of the costs retain their underlying function in the consolidation process.  The Consolidated Statement of Income for the years ended December 31, 2008 and 2009 has been reclassified to conform to this revised presentation. Additional information relating to the reclassification in included in Note 1 – Summary of Significant Accounting Policies.
 
In addition, as part of this study, the Company re-evaluated its operating segments.  As a result of this re-evaluation, the Company concluded that the previously reported Agency Operations segment should no longer be considered a separate segment of the Company as Agency Operations now represents less than 2% of the Company’s consolidated revenues and less than 1% of the Company’s consolidated pre-tax profits.  As such, the Company will only report one operating segment – Specialty Insurance Operations.
 
Significant Mergers, Acquisitions, and Strategic Investments
 
Meadowbrook actively reviews merger, acquisition and strategic investment prospects and these transactions play a significant role in our growth strategy. We consider a range of strategic factors when looking at acquisitions including:
 
 
High probability that revenue and cost synergies such as the ability to leverage our diverse revenue platform, expansion of current distribution network, enhancement of servicing capabilities, and complimentary product lines and classes.
 
Ability to attract and retain talented insurance professionals that blend with our culture.
 
Opportunity to create “win-win” situations by mitigating our downside risk and providing sellers with opportunity to obtain fair value through deal structure, including adjustments to the purchase price based upon actual results.
 
The following is a summary of significant transactions we have entered into during the last five years:
 
Midwest Financial Holdings, LLC (“MFH”): In July 2009, our subsidiary, Star, purchased a 28.5% ownership interest in MFH. MFH is a limited liability holding company with the primary purpose of providing workers’ compensation insurance coverage for a variety of businesses. MFH’s holding company system consists of a managing general agency and an insurance company. We serve as the primary market for MFH’s managing general agent and we have a quota share agreement in place with MFH’s insurance company. In 2010, MFH’s wholly-owned subsidiaries placed $133.3 million of gross written premiums with us. We performed an analysis under ASC 810 – Consolidations and determined that we are not MFH’s primary beneficiary. Therefore, we are not required to consolidate this investment. Accordingly, we account for this investment under the equity method of accounting. Under this accounting method we recognize 28.5% of MFH’s profits and losses.
 
ProCentury Corporation (“ProCentury”): In July 2008, we completed the ProCentury Corporation (“ProCentury”) merger (“Merger”). ProCentury is a specialty insurance company that primarily underwrites general liability, commercial property, environmental, garage, commercial multi-peril, commercial auto, surety, and marine insurance primarily. This business is primarily in the excess and surplus lines or “non-admitted” market and is distributed through a select group of general agents. Since the completion of the merger, we have executed on numerous revenue enhancement opportunities, such as, launching a new wholesale relationship in the Midwest, offering a surplus lines market for an existing workers’ compensation partner in New England, and executing on various opportunities to enhance our specialty niche expertise. We have also been able to leverage our existing infrastructure and increased size.
 
U.S. Specialty Underwriters, Inc. (“USSU”): In April 2007, we acquired the business of USSU. USSU is a specialty program manager that produces fee based income by underwriting targeted classes within excess workers’ compensation coverage for a select group of insurance companies through its national network of agents and brokers. This acquisition enhanced our existing specialty niche capabilities, added an additional source of fee-based revenues and expanded our distribution network. During 2010 this program was converted into an insured program within the Company’s underwriting subsidiary.
 
 
4

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
Description of Programs, Products, and Services
 
We market and underwrite specialty property and casualty insurance programs and products on both an admitted and non-admitted basis. Within our insurance operations, we categorize our products into the following four categories:
 
Admitted Programs: The admitted programs that we write as part of our specialty insurance operations are characterized by risks that are homogeneous or similar within programs but have a diverse geographic profile.  Generally, the average account premium is small and due to the specialized nature of the program and distribution style, our admitted programs have high premium retention levels.  This helps create stability in our business amid the cyclicality of the insurance industry.  Examples of admitted programs we write are coverages for picture framers, music equipment stores, booksellers and chemical distributors.  We seek to write programs that have a history of proven profitable performance.  The admitted programs that we write and retain are the result of long-term, stable relationships with agents that have a targeted and specialized distribution style.
 
Main Street Excess and Surplus Lines: The excess and surplus lines business we write is characterized by broad classes of “Main Street” commercial risks that are ineligible for coverage by the standard market.  Similar to our admitted programs, the average account premium size for the excess and surplus lines risks we write tend to be small.  Examples of markets we serve with our excess and surplus lines business are offering are restaurants, bars and taverns, apartments, hotels and motels, mercantile and contractors’ liability.  The excess and surplus lines regulatory environment allows rate and form freedom, which gives us the flexibility to design tailored coverage forms that are often more restrictive than those available in the admitted market.  The high degree of flexibility contributes to heightened competition during soft markets and creates the potential for rapid expansion during hard markets.
 
Non-Admitted Programs: The non-admitted programs we write have characteristics that are similar to our admitted programs; however, the commercial risks we provide coverage for are ineligible for coverage by the standard or admitted market.  With this focus on non-admitted program underwriting, we are able to provide coverage for start-up organizations and relatively low volume programs that other markets are unable or unwilling to serve.  Two examples of non-admitted programs we offer are coverages for pet-sitters and oil and gas contractors.
 
Specialty Markets: We also offer coverage for specialty markets, where specific and unique underwriting expertise is required.  We develop solutions for specific market segments that may leverage either our admitted market or non-admitted market product capabilities, or both, depending on the market need.  The specific and unique underwriting expertise that is required to write business profitably in the segments we serve creates barriers to entry for new competitors.  Examples of specialty markets we serve are the excess workers’ compensation, transportation, agriculture and marine.
 
In addition to the programs and products outlined above, we provide the following services to our fee-for-service and agency clients:
 
Program and Product Design. Before implementing a new program on behalf of a client, we generally review: (1) financial projections for the contemplated program, (2) historical loss and actuarial experience, (3) actuarial studies of the underlying risks, (4) the credit worthiness of the potential agent or client, and (5) the availability of reinsurance. Our senior management team and associates representing each of the risk-management disciplines work together to design, market, and implement new programs. Our due diligence process is structured to provide an underwriting risk assessment of the program and how the program fits within our client’s entity wide business plan and risk profile.
 
Underwriting Risk Selection and Policy Issuance. Our underwriting personnel help develop the proper criteria for selecting risks, while actuarial and reinsurance personnel evaluate and recommend the appropriate levels of rate and risk retention. The program is then tailored according to the requirements and qualifications of each client. With managed programs, we may also perform underwriting services based upon the profile of the specific program for a fee.
 
Claims Administration and Handling.  We provide substantially all claims management and handling services for workers’ compensation and most other lines, such as property, professional liability, and general liability. Our claims handling standards are set by our corporate claims department and are monitored through self-audits, corporate claim audits, internal controls, and other executive oversight reports. We handle substantially all claims functions for the majority of the programs we manage. Our involvement in claims administration and handling provides feedback to program managers in assessing the client’s risk environment and the overall structure of the program.
 
 
5

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
Loss Prevention and Control.  We provide loss control services, which are designed to help clients prevent or limit the impact of certain loss events. Through an evaluation of the client’s workplace environment, our loss control specialists assist the client in planning and implementing a loss prevention program and, in certain cases, provide educational and training programs. With our managed programs, we provide these same services for a fee based upon the profile of the specific program.
 
Administration of Risk-Bearing Entities.  We generate fee revenue by assisting in the formation and administration of risk-bearing entities for clients and agents. Through our subsidiaries in Bermuda and Washington D.C., we provide administrative services for certain captives and/or rent-a-captives.
 
Reinsurance Placement.  Through our reinsurance intermediary subsidiary, we earn commissions from placing excess-of-loss reinsurance and insurance coverage with high deductibles for insurance companies, captives, and managed self-insured programs.  Reinsurance is also placed for clients who do not have other business relationships with us.
 
Agency.  We earn commission revenue through the operation of our retail property and casualty insurance agencies, located in Michigan, California and Florida. These agencies produce commercial, personal lines, life and accident and health insurance with more than fifty unaffiliated insurance carriers.
 
Distribution
 
We market our specialty property and casualty insurance products on both an admitted and non-admitted basis through a broad and diverse network of independent retail agents, wholesalers, program administrators and general agents (referred to as, “agents” or “producers”). On a limited basis, some of our producers provide certain policy issuance functions on our behalf.
 
Our largest producer in 2010 was Midwest General Agency, which accounted for 14.4% of our gross written premium. We have a 28.5% equity interest in Midwest General Agency’s parent, MFH. No other producer was responsible for more than 10% of our gross written premium.
 
We seek to incentivize our distribution network in a manner that aligns their financial interests with our continued profitability. Our experience has been that the number of claims and the cost of losses tend to be lower in risk-sharing programs than with traditional forms of insurance. We believe that risk-sharing motivates participants to focus on underwriting selection, loss prevention, risk control measures and adherence to stricter underwriting guidelines. Risk sharing structures are designed based on the particular risk management goals of our clients, market conditions and our assessment of the opportunity for operating profit. We categorize risk sharing into two categories: profit sharing and quota sharing.
 
Profit-Sharing: The most common way we incentivize our distribution network is through profit-sharing commissions. In these scenarios, we provide our agent the opportunity to accept an upfront provisional commission rate that is then adjusted either upward or downward, based on the actual underwriting results as compared to predetermined metrics. As a result, the agent is incentivized to produce profitable business.
 
Quota Sharing:  A second way we incentivize our producers is through quota sharing reinsurance structures. In these scenarios, producers of the business determine which risks to submit to us for underwriting. For risks submitted, Meadowbrook underwrites individual primary insurance policies for members of a group or association, or a specific industry. We share in the operating results with the producer through a quota share reinsurance agreement with an insurance company (owned by the producer) or a captive or rent-a-captive.
 
Technology
 
We seek to leverage our business technology platform in order to achieve a high level of customer service and enhance operating efficiencies. We provide a select set of internet-based business processing systems to our producers to automate their capability to rate, quote, bind and service insurance policies in a timely and efficient manner. Advantage is a processing system for quoting and binding workers’ compensation insurance policies. CenturyOnLine (“COL”) is a processing system for quoting, binding, and issuing policies for general liability, property and garage insurance policies underwritten by our excess and surplus lines company, Century. Further, we provide additional systems on a network-accessible basis for processing select package and commercial auto programs. In addition to reducing our internal administrative processing costs, these systems enhance underwriting practices by automating risk selection criteria.
 
 
6

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
Competition and Pricing
 
As a provider of specialty niche programs, products and risk management services, we are part of a highly competitive industry that is cyclical and historically characterized by periods of high premium rates and shortages of underwriting capacity followed by periods of intense competition and excess underwriting capacity. We compete with other providers of specialty insurance programs, products, and risk management services, as well as, with traditional providers of commercial insurance. Some of our competitors may have greater financial resources than we do.
 
Pricing is a primary means of competition in the commercial insurance market. Competition is also based on the availability and quality of products, quality and speed of service (including claims service), financial strength, ratings, distribution systems and technical expertise. The primary basis for competition among risk management providers varies with the financial and insurance needs and resources of each potential insured. Principal factors that are considered by insureds include an analysis of the net present-value (after-tax) of the cost of financing the insured’s expected level of losses; the amount of excess coverage provided in the event losses exceed expected levels; cash flow and tax planning considerations; and the expected quality and consistency of the services to be provided. We believe that we are able to compete based on our experience, the quality of our products and services, our processing technology platforms, and our program-oriented approach. However, our ability to successfully compete is dependent upon a number of factors, including market and competitive conditions, many of which are outside of our control.
 
Geographic Diversity and Mix of Business
 
Our revenues are diversified geographically, by class and line of business, type of insured and distribution. Our corporate strategy emphasizes a regional focus and diverse source of revenues between underwriting premiums, fee-for-service revenue and commissions. We believe our approach balances an effective local touch with efficient national coordination. Additionally, this allows us to leverage fixed costs over a larger revenue base and opportunistically take advantage of new opportunities. Within the workers’ compensation line of business, we have a regional focus in California and New England.  Within the commercial auto and commercial multiple peril line of business, we have a regional focus in the Southeast and California. Within the general liability line of business we have a focus in Texas.  Our fee-for-service business is managed on a regional basis with an emphasis in the Midwest, New England, and southeastern regions of the United States.
 
The following table summarizes our gross written premium distribution by state for the years ended December 31, 2010, 2009, and 2008 (in thousands). We include only states that were top ten gross written premium production states in 2010:

Gross Written Premium
   
2010
   
%
   
2009
   
%
   
2008
   
%
 
California
      285,771       35.6 %     209,293       30.4 %     84,828       18.5 %
Florida
      80,876       10.1 %     74,639       10.8 %     52,073       11.4 %
Texas
      51,621       6.4 %     51,506       7.5 %     35,793       7.8 %
New Jersey
      38,198       4.8 %     41,095       6.0 %     40,002       8.7 %
New York
      25,366       3.2 %     21,704       3.2 %     14,268       3.1 %
Missouri
      23,882       3.0 %     23,711       3.4 %     24,135       5.3 %
Michigan
      23,074       2.9 %     17,445       2.5 %     12,501       2.7 %
Illinois
      18,772       2.3 %     15,432       2.2 %     9,991       2.2 %
Louisiana
      16,878       2.1 %     15,937       2.3 %     8,524       1.9 %
Pennsylvania
      15,143       1.9 %     14,771       2.1 %     12,431       2.7 %
All Other States
      222,319       27.7 %     203,154       29.6 %     163,137       35.7 %
 
Total
    801,900       100.0 %     688,687       100.0 %     457,683       100.0 %
 
As previously indicated, the merger with ProCentury was completed following the close of business on July 31, 2008. Therefore, the table above includes only five months of premium for ProCentury for the year ended December 31, 2008 and twelve months for the years ended December 31, 2010 and 2009.
 
 
7

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
The most significant shift in geographic mix over the past five years was our decision to enter the California workers’ compensation market in 2009. Prior to making this decision, we had been studying this market for several years and concluded that profitable growth could be achieved in select niche areas. The increase in our 2009 premium was largely related to our new relationship with a general agent who specializes in non-contractor workers’ compensation, as well as new programs which include a general agent that primarily focuses on the food service industry.  It is important to note the business we added had has a history of proven, profitable performance. Moreover, since launching these new initiatives, we have been able to achieve additional rate increases of 19%.
 
As part of our growth strategy, we manage our business to reduce geographic concentration of risk that could increase our exposure to losses from natural or intentionally caused catastrophic events. We also monitor the regulatory environment within our concentrated regions. We believe we have been able to strategically increase our California exposure, while maintaining a geographically diverse premium base.
 
The following table summarizes gross written premiums, net earned premiums, and net written premiums by line of business for the years ended December 31, 2010, 2009, and 2008 (in thousands):
                                     
Gross Written Premium
 
2010
   
%
   
2009
   
%
   
2008
   
%
 
Workers’ Compensation
  $ 320,348       39.95 %   $ 233,269       33.87 %   $ 137,503       30.04 %
Commercial Multi-Peril Liability
    47,493       5.92 %     43,428       6.31 %     29,114       6.36 %
Commercial Multi-Peril Property
    62,769       7.83 %     54,901       7.97 %     37,519       8.20 %
Other Liability
    164,111       20.46 %     169,968       24.68 %     116,988       25.56 %
Commercial Auto Liability
    101,096       12.61 %     92,632       13.45 %     73,952       16.16 %
All Other Lines
    106,083       13.23 %     94,489       13.72 %     62,607       13.68 %
                                                 
Total
  $ 801,900       100.00 %   $ 688,687       100.00 %   $ 457,683       100.00 %
                                                 
Net Earned Premium
    2010    
%
      2009    
%
      2008    
%
 
Workers’ Compensation
  $ 275,585       41.76 %   $ 163,834       30.36 %   $ 109,312       29.57 %
Commercial Multi-Peril Liability
    41,697       6.32 %     37,133       6.88 %     46,326       12.53 %
Commercial Multi-Peril Property
    48,956       7.42 %     45,660       8.46 %     31,847       8.61 %
Other Liability
    122,714       18.60 %     140,486       26.04 %     74,470       20.14 %
Commercial Auto Liability
    89,215       13.52 %     79,802       14.79 %     62,306       16.85 %
All Other Lines
    81,673       12.38 %     72,687       13.47 %     45,460       12.30 %
                                                 
Total
  $ 659,840       100.00 %   $ 539,602       100.00 %   $ 369,721       100.00 %
                                                 
Net Written Premium
    2010    
%
      2009    
%
      2008    
%
 
Workers’ Compensation
  $ 291,670       42.05 %   $ 206,246       35.56 %   $ 120,507       32.12 %
Commercial Multi-Peril Liability
    45,620       6.58 %     38,825       6.69 %     24,690       6.58 %
Commercial Multi-Peril Property
    54,667       7.88 %     45,462       7.84 %     30,270       8.07 %
Other Liability
    125,189       18.05 %     131,921       22.75 %     87,760       23.39 %
Commercial Auto Liability
    91,860       13.24 %     82,499       14.22 %     64,678       17.24 %
All Other Lines
    84,593       12.20 %     75,065       12.94 %     47,289       12.60 %
                                                 
Total
  $ 693,599       100.00 %   $ 580,018       100.00 %   $ 375,194       100.00 %
 
In 2010, we had an increase in our premium writings specific to our workers’ compensation line of business, which was primarily related to our new relationship with a general agent who specializes in non-contractor workers’ compensation in California, the Midwest, and other western states, as well as new programs that included a general agent who primarily focuses on the food service industry and a general agent who focuses on heterogeneous workers’ compensation in the Southeast region of the United States. All of the relationships referred to above were related to efforts generated in the second half of 2009. For 2010, our workers’ compensation rates were up approximately 4.4%, which was primarily because of rate increases of 19.0% in California. Our workers’ compensation book of business is comprised primarily of accounts that generate average premium size of less than $10,000 in low hazard classes of business. The characteristics of this business further facilitates growth as retention rates tend to be high.
 
 
8

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
The merger with ProCentury contributed to the overall diversification of our business mix.  The majority of our other liability line of business is primarily related to shorter tail lines of business, such as habitational risks (i.e., hotels, motels and apartments, mercantile operations, etc.).  The majority of our primary liability insurance policies have limits of coverage between $500,000 and $1.0 million.
 
The increase in premium volume in lines other than workers’ compensation has been driven by new programs we have implemented with both existing and new program agents, all of which have a history of profitability and for which we believe we are receiving adequate pricing to produce our targeted return on equity. Rates in the other lines of business increased by 2.0% and our excess and surplus lines rates were stable.
 
Overall, we believe we have achieved controlled, profitable growth.
 
Reserves
 
The following table shows the development of reserves for unpaid losses and loss adjustment expenses (“LAE”) from 2001 through 2010 for our Insurance Company Subsidiaries, and the deconsolidation impact of American Indemnity Insurance Company, Ltd (“American Indemnity”). American Indemnity is a wholly-owned subsidiary that is not consolidated pursuant to ASC 810 – Consolidations. Prior to 2004, we consolidated American Indemnity.
 
Development on the ProCentury acquired reserves is not included for the years prior to 2008, because our merger was not effective until August 1, 2008.  The lower portion of the table reflects the impact of reinsurance for the years 2001 through 2010, reconciling the net reserves shown in the upper portion of the table to gross reserves.
 
Additional information relating to our reserves is included within the Losses and Loss Adjustment Expenses and Reinsurance Recoverables section of Note 1 ~ Summary of Significant Accounting Policies and Note 5 ~ Liability for Losses and Loss Adjustment Expenses of the Notes to the Consolidated Financial Statements, as well as to the Critical Accounting Policies section and the Reserves section of Item 7, Management’s Discussion and Analysis.
 
 
9

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
Analysis of Loss and Loss Adjustment Expense Development (1)
 
   
Years Ended December 31,
 
   
2001
   
2002
   
2003
   
2004
   
2005
   
2006
   
2007
   
2008
   
2009
   
2010
 
   
(in thousands)
 
Reserves for losses and LAE at end of period
  $ 198,653     $ 193,116     $ 192,019     $ 226,996     $ 271,423     $ 302,655     $ 341,541     $ 625,331     $ 682,376     $ 784,202  
                                                                                 
Deconsolidation of subsidiary
    (5,572 )     (2,973 )     (2,989 )                                                        
                                                                                 
Adjusted reserves for losses and LAE at end of period
  $ 193,081     $ 190,143     $ 189,030     $ 226,996     $ 271,423     $ 302,655     $ 341,541     $ 625,331     $ 682,376     $ 784,202  
Cumulative paid as of
                                                                               
1 year later
    77,038       78,023       71,427       79,056       83,271       81,779       95,393       173,525       187,818          
2 years later
    130,816       122,180       118,729       124,685       133,809       140,308       155,745       279,221                  
3 years later
    157,663       151,720       145,279       153,780       170,226       207,227       197,558                          
4 years later
    176,172       167,288       159,220       171,946       210,110       204,802                                  
5 years later
    186,847       174,778       169,980       195,328       210,993                                          
6 years later
    191,936       180,489       184,663       195,691                                                  
7 years later
    196,486       190,133       183,961                                                          
8 years later
    204,386       187,692                                                                  
9 years later
    202,411                                                                          
Reserves re-estimated as of end of year:
                                                                               
1 year later
    199,171       193,532       193,559       231,880       268,704       295,563       330,416       596,661       651,373          
2 years later
    205,017       196,448       203,394       227,462       263,069       286,647       327,862       566,878                  
3 years later
    207,379       202,126       205,650       226,437       261,319       283,583       331,034                          
4 years later
    211,394       203,738       202,748       226,492       260,373       293,897                                  
5 years later
    213,802       202,028       202,716       229,746       268,007                                          
6 years later
    212,274       201,786       203,727       233,560                                                  
7 years later
    212,292       201,355       207,401                                                          
8 years later
    211,550       203,867                                                                  
9 years later
    214,456                                                                          
Net cumulative redundancy (deficiency):
                                                                               
Dollars
  ($ 21,375 )   ($ 13,724 )   ($ 18,371 )   ($ 6,564 )   $ 3,416     $ 8,758     $ 10,507     $ 58,453     $ 31,003          
Percentage
    -11.1 %     -7.2 %     -9.7 %     -2.9 %     1.3 %     2.9 %     3.1 %     9.3 %     4.5 %        
Net reserves
    193,081       190,143       189,030       226,996       271,423       302,655       341,541       625,331       682,376       784,202  
Ceded reserves
    195,943       181,817       147,446       151,161       187,254       198,422       198,461       260,366       266,801       280,854  
Gross reserves
    389,024       371,960       336,476       378,157       458,677       501,077       540,002       885,697       949,177       1,065,056  
Net re-estimated
    214,456       203,867       207,401       233,560       268,007       293,897       331,034       566,878       651,373          
Ceded re-estimated
    286,459       256,147       244,899       208,510       209,031       204,500       200,544       247,583       256,528          
Gross re-estimated
    500,915       460,013       452,300       442,069       477,038       498,397       531,578       814,461       907,901          
Gross cumulative redundancy (deficiency)
  ($ 111,891 )   ($ 88,053 )   ($ 115,824 )   ($ 63,913 )   ($ 18,361 )   $ 2,680     $ 8,424     $ 71,236     $ 41,276          
 
(1) In accordance with ASC 810 - Consolidations, we performed an evaluation of our business relationship and determined that our wholly owned subsidiary, American Indemnity, did not meet the tests for consolidation, as neither us, nor our subsidiary Star, are the primary beneficiaries of American Indemnity.  Therefore, effective January 1, 2004, we deconsolidated American Indemnity on a prospective basis in accordance with the provisions of ASC 810.  Accordingly, we have adjusted the reserves and development within the above table.  The adoption of ASC 810 and the deconsolidation of American Indemnity did not have a material impact on our consolidated balance sheet or consolidated statement of income.
 
 
10

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
The following table sets forth the difference between GAAP reserves for loss and loss adjustment expenses and statutory reserves for loss and loss adjustment expenses at December 31, (in thousands):
 
   
2010
   
2009
 
GAAP reserves for loss and LAE
  $ 1,065,056     $ 949,177  
Reinsurance recoverables for unpaid losses
    (280,854 )     (266,801 )
Statutory reserves for loss and LAE
  $ 784,202     $ 682,376  
 
For the year ended December 31, 2010, the Company reported a decrease of $41.3 million in gross ultimate loss estimates for accident years 2009 and prior, or 4.4% of $949.2 million of gross loss and LAE reserves at January 1, 2010.  The Company reported a $31.0 million decrease in net ultimate loss and LAE estimates for accident years 2009 and prior, or 4.5% of $682.4 million of net loss & LAE reserves at January 1, 2010.
 
For the year ended December 31, 2009, we reported a decrease of $32.2 million in gross ultimate loss estimates for accident years 2008 and prior, or 3.6% of $885.7 million of gross loss and LAE reserves at January 1, 2009.  We reported a $28.7 million decrease in net ultimate loss and LAE estimates for accident years 2008 and prior, or 4.6% of $625.3 million of net loss and LAE reserves at January 1, 2009.
 
Reinsurance
 
Information relating to our reinsurance structure and treaty information is included within Note 6 ~ Reinsurance of the Notes to the Consolidated Financial Statements.
 
Investments
 
Information relating to our investment portfolio is included within Note 3 ~ Investments of the Notes to the Consolidated Financial Statements and the Investments section of Item 7, Management’s Discussion and Analysis, as well as Item 7A Quantitative and Qualitative Disclosures about Market Risk.
 
Regulation
 
Insurance Company Regulation
 
Our Insurance Company Subsidiaries are subject to regulation in the states where they conduct business. State insurance regulations generally are designed to protect the interests of policyholders, state insurance consumers or claimants rather than shareholders or other investors. The nature and extent of such state regulation varies by jurisdiction, but generally involves:
 
 
prior approval of the acquisition of control of an insurance company or of any company controlling an insurance company;
 
regulation of certain transactions entered into by an insurance company with any of its affiliates;
 
approval of premium rates, forms and policies used for many lines of insurance;
 
standards of solvency and minimum amounts of capital and surplus that must be maintained;
 
establishment of reserves required to be maintained for unearned premium, loss and loss adjustment expense, or for other purposes;
 
limitations on types and amounts of investments;
 
underwriting and claims settlement practices;
 
restrictions on the size of risks that may be insured by a single company;
 
licensing of insurers and agents;
 
deposits of securities for the benefit of policyholders; and
 
the filing of periodic reports with respect to financial condition and other matters.
 
In addition, state regulatory examiners perform periodic examinations of insurance companies. The results of these examinations can give rise to regulatory orders requiring remedial, injunctive or other corrective action.
 
 
11

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
Insurance Holding Company Regulation
 
We operate as an insurance holding company system and are subject to regulation in the jurisdictions in which we conduct business. These regulations require that each insurance company in the system register with the insurance department of its state of domicile and furnish information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system domiciled in that state. The insurance laws similarly provide that all transactions among members of a holding company system must be fair and reasonable. Transactions between insurance subsidiaries and their parents and affiliates generally must be disclosed to the state regulators, and prior approval of the applicable state insurance regulator generally is required for any material or extraordinary transaction. In addition, a change of control of a domestic insurer or of any controlling person requires the prior approval of the state insurance regulator. Generally, any person who acquires ten percent or more of the outstanding voting securities of the insurer or its parent company is presumed to have acquired control of the domestic insurer.
 
Various State and Federal Regulation
 
Insurance companies are also affected by a variety of state and federal legislative and regulatory measures and judicial decisions that define and extend the risks and benefits for which insurance is sought and provided. These include redefinition of risk exposure in areas such as product liability, environmental damage, and workers’ compensation. In addition, individual state insurance departments may prevent premium rates for some classes of insureds from reflecting the level of risk assumed by the insurer for those classes. Such developments may adversely affect the profitability of various lines of insurance. In some cases, these adverse effects on profitability can be minimized through repricing, if permitted by applicable regulations, of coverages or limitations or cessation of the affected business.
 
Reinsurance Intermediary
 
Our reinsurance intermediary is also subject to regulation. Under applicable regulations, the intermediary is responsible, as a fiduciary, for funds received on account of the parties to the reinsurance transaction and is required to hold such funds in appropriate bank accounts subject to restrictions on withdrawals and prohibitions on commingling.
 
Licensing and Agency Contracts
 
We, or certain of our designated employees, must be licensed to act as agents by state regulatory authorities in the states in which we conduct business. Regulations and licensing laws vary in individual states and are often complex.
 
Insurance licenses are issued by state insurance regulators upon application and may be of perpetual duration or may require periodic renewal. We must apply for and obtain appropriate new licenses before we can expand into a new state on an admitted basis or offer new lines of insurance that require separate or additional licensing.  
 
Insurers operating on an admitted basis must file premium rate schedules and policy or coverage forms for review and approval by the insurance regulators. In many states, rates and policy forms must be approved prior to use, and insurance regulators have broad discretion in judging whether an insurer’s rates are adequate, not excessive and not unfairly discriminatory.
 
The applicable licensing laws and regulations in all states are subject to amendment or reinterpretation by state regulatory authorities, and such authorities are vested in most cases with relatively broad discretion as to the granting, revocation, suspension and renewal of licenses. We, or our employees, could be excluded, or temporarily suspended, from continuing with some or all of our activities in, or otherwise subjected to penalties by, a particular state.
 
 
12

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
Insurance Regulation Concerning Change or Acquisition of Control
 
Star, Williamsburg, and Ameritrust are domestic property and casualty insurance companies organized under the insurance laws (the “Insurance Codes”) of Michigan, while Savers, Century, PIC, and Propic are organized under the Insurance Codes of Missouri, Ohio, Texas, and Washington D.C., respectively.  The Insurance Codes provide that acquisition or change of control of a domestic insurer or of any person that controls a domestic insurer cannot be consummated without the prior approval of the relevant insurance regulatory authority.  A person seeking to acquire control, directly or indirectly, of a domestic insurance company or of any person controlling a domestic insurance company must generally file with the relevant insurance regulatory authority an application for change of control (commonly known as a “Form A”) containing information required by statute and published regulations and provide a copy of such Form A to the domestic insurer. In Michigan and Missouri, control is generally presumed to exist if any person, directly or indirectly, owns, controls, holds with the power to vote or holds proxies representing ten percent or more of the voting securities of the company.
 
In addition, many state insurance regulatory laws contain provisions that require pre-notification to state agencies of a change in control of a non-domestic admitted insurance company in that state. While such pre-notification statutes do not authorize the state agency to disapprove the change of control, such statutes do authorize issuance of a cease and desist order with respect to the non-domestic admitted insurer if certain conditions exist, such as undue market concentration.
 
Any future transactions that would constitute a change in control would also generally require prior approval by the Insurance Departments of Michigan, Missouri, Ohio, Texas, and Washington D.C. and would require pre-acquisition notification in those states that have adopted pre-acquisition notification provisions and in which the insurers are admitted. Such requirements may deter, delay or prevent certain transactions that could be advantageous to our shareholders.
 
Membership in Insolvency Funds and Associations and Mandatory Pools
 
Most states require admitted property and casualty insurers to become members of insolvency funds or associations, which generally protect policyholders against the insolvency of such insurers.  Members of the fund or association must contribute to the payment of certain claims made against insolvent insurers.  Maximum contributions required by law in any one year vary between 1% and 2% of annual premium written by a member in that state.  For 2010, 2009, and 2008, assessments from insolvency funds were $5.1 million, $491,000, and $196,000, respectively.  Most of these payments are recoverable through future policy surcharges and premium tax reductions.  Except for New Jersey, business written on a surplus lines basis is not subject to state guaranty fund assessments.  
 
Our Insurance Company Subsidiaries are also required to participate in various mandatory insurance facilities or in funding mandatory pools, which are generally designed to provide insurance coverage for consumers who are unable to obtain insurance in the voluntary insurance market.  Among the pools participated in are those established in certain states to provide windstorm and other similar types of property coverage.  These pools typically require all companies writing applicable lines of insurance in the state for which the pool has been established to fund deficiencies experienced by the pool based upon each company’s relative premium writings in that state, with any excess funding typically distributed to the participating companies on the same basis.  To the extent that reinsurance treaties do not cover these assessments, they may adversely affect us.  For 2010, 2009, and 2008, total assessments paid to all such facilities were $3.5 million, $2.7 million, and $2.4 million, respectively.
 
Restrictions on Dividends and Risk-Based Capital
 
For information on Restrictions on Dividends and Risk-based Capital that affect us please refer to Note 10 ~ Regulatory Matters and Rating Issues of the Notes to the Consolidated Financial Statements and the Regulatory and Rating Issues section within Item 7, Management’s Discussion and Analysis.
 
NAIC-IRIS Ratios
 
The National Association of Insurance Commissioners’ (“NAIC”) Insurance Regulatory Information System (“IRIS”) was developed by a committee of state insurance regulators and is primarily intended to assist state insurance departments in executing their statutory mandates to oversee the financial condition of insurance companies operating in their respective states.  IRIS identifies thirteen industry ratios and specifies “usual values” for each ratio.  Departure from the usual values on four or more ratios generally leads to inquiries or possible further review from individual state insurance commissioners.  Refer to the Regulatory and Rating Issues section of Item 7, Management’s Discussion and Analysis.
 
 
13

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
Effect of Federal Legislation
 
The Terrorism Risk Insurance Act of 2002 (“TRIA”) established a program under which the United States federal government will provide governmental support for businesses that suffer damages from certain acts of international terrorism. In 2007, TRIA was extended through December 31, 2014.  The terms of the legislation enacted now also include domestic terrorist acts.  TRIA serves as an additional high layer of reinsurance against losses that may arise from a terrorist incident. The impact upon us resulting from TRIA is minimal as we generally do not underwrite risks that are considered targets for terrorism, avoid concentration of exposures in both property and workers’ compensation and have terrorism coverage included in our reinsurance treaties to cover the most likely exposure.
 
Employees
 
At March 10, 2011, we employed approximately 967 associates to service our clients and provide management services to our Insurance Company Subsidiaries as described below. We believe we have good relationships with our associates.
 
Available Information
 
Our Internet address is www.meadowbrook.com.  There we make available, free of charge, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Statements of Beneficial Ownership (Forms 3, 4, and 5), and any amendments to those reports, as soon as reasonably practicable after we electronically file such material with, or furnish to, the SEC.  You may read and copy materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington D.C., 20549.  You may obtain information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.  In addition, the SEC maintains an Internet site that contains reports, proxy statements, and other information that we file at www.sec.gov.  Our SEC reports can also be accessed through the investor relations section of our website.  The information found on our website is not part of this or any other report we file with, or furnished to the SEC.  The Charters of the Nominating and Governance Committee, the Compensation Committee, the Audit Committee, Risk Management and Finance Committee, and Investment Committee, as well as the Board of Directors Governance Guidelines are also available on our website, or available in print to any shareholder who requests this information.  In addition, our Compliance Code of Conduct and Business Ethics Policy are available on our website, or in print to any shareholder who requests this information.

ITEM 1A. RISK FACTORS
 
We face competitive pressures in our business that could cause our revenues to decline and adversely affect our profitability.
 
      We compete with a large number of other companies in our selected lines of business. Many of our competitors have greater financial and marketing resources. A number of new, proposed or potential legislative or industry developments could further increase competition in our industry including:
 
 
the formation of new insurers and an influx of new capital in the marketplace as existing companies attempt to expand their business as a result of better pricing and/or terms;
 
programs in which state-sponsored entities provide property insurance in catastrophe-prone areas, other alternative market types of coverage; or other non-property insurance; and
 
changing practices created by the Internet, which has increased competition within the insurance business.
 
New competition from these developments could make the property and casualty insurance marketplace more competitive by increasing the supply of insurance capacity. In that event, the current market softens further, and it may negatively influence our ability to maintain or increase rates. Consequently, our profitability could be adversely impacted by increased competition.
 
 
14

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
The property and casualty insurance industry is cyclical in nature, which may affect our overall financial performance.
 
Historically, the financial performance of the property and casualty insurance industry has tended to fluctuate in cyclical periods of price competition, excess capacity and lower levels of profitability (known as a soft market) followed by periods of high premium rates, shortages of underwriting capacity, and higher levels of profitability (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 property and casualty insurance companies tends to follow this cyclical market pattern. Specific factors that can drive the industry’s profitability include:
 
 
rising levels of actual costs that are not known by companies at the time they price their products;
 
volatile and unpredictable developments, including man-made, weather-related and other natural catastrophes or terrorist attacks;
 
changes in loss reserves resulting from the general claims and legal environments as different types of claims arise and judicial interpretations relating to the scope of insurer’s liability develop;
 
fluctuations in interest rates, inflationary pressures and other changes in the investment environment, which affect returns on invested assets and may impact the ultimate payout of losses; and
 
increases in medical costs beyond historic or expected annual inflationary levels.
 
Because the cyclicality of our industry is due in large part to the actions of competitors and general economic conditions, we cannot predict with certainty the timing or duration of changes in the market cycle.
 
Actual loss and loss adjustment expenses may exceed our reserve estimates, which would negatively impact our profitability and financial position.
 
In many cases, several years may elapse between the occurrence of an insured loss, the reporting of the loss to us and our payment of the loss.  To recognize liabilities for unpaid losses, we establish reserves as balance sheet liabilities representing estimates of amounts needed to pay reported and unreported losses and the related loss adjustment expenses. Loss reserves are an estimate of what we anticipate the ultimate costs to be and therefore do not represent an exact calculation of liabilities. Estimating loss reserves is a difficult and complex process involving many variables and subjective judgments. As part of the reserving process, we review historical data and consider the impact of various factors such as:
 
 
Loss emergence patterns;
 
Emerging economic and social trends;
 
Inflation; and
 
Changes in the regulatory and litigation environments.
 
This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future results. It also assumes that adequate historical or other data exists upon which to make these judgments. There is no precise method, however, for evaluating the impact of any specific factor on the adequacy of reserves and actual results are likely to differ from original estimates. If the actual amount of insured losses is greater than our reserve estimates, our profitability and financial position could suffer.
 
In addition, an increase in reserves may also require us to write off a portion of our deferred acquisition costs asset, which would also negatively impact our operating results and financial position.
 
Severe weather conditions and other catastrophes are inherently unpredictable and could cause us to suffer material financial losses.
 
The majority of our property business is exposed to the risk of severe weather conditions and other catastrophes. Catastrophes can be caused by various events, including natural events, such as hurricanes, winter weather, tornadoes, windstorms, earthquakes, hailstorms, severe thunderstorms and fires, and other events, such as explosions, terrorist attacks and riots. The incidence and severity of catastrophes and severe weather conditions are inherently unpredictable.  Generally these losses result in an increase in the number of claims incurred as well as the amount of compensation sought by claimants.  We did not have any significant catastrophic-related losses in 2010 or 2009.  Currently, we purchase catastrophe reinsurance to cover for a potential catastrophe.   However, it is possible that a catastrophic event or multiple catastrophic events could cause our loss and loss adjustment expense reserves to increase and our liquidity and financial condition to decline.  Refer to Note 6 ~ Reinsurance for a detailed description of our reinsurance treaties and structure.
 
 
15

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
The failure of any of the loss limitation methods we employ could have a material adverse effect on our results of operations and financial condition.
 
Various provisions of our policies, such as limitations or exclusions from coverage or choice of forum, have been negotiated to limit our risks. It is possible that a court or regulatory authority could nullify or void an exclusion, or legislation could be enacted that modifies or voids the use of such endorsements and limitations in a way that could have a materially adverse impact on our financial condition and operating results. We also seek to limit our loss exposure by geographic diversification. One or more catastrophic or other events could result in claims that substantially exceed our expectations, which could have an adverse effect on our results of operations or financial condition.  Likewise, for catastrophe events and for per-risk events we buy a limited amount of reinsurance coverage that we believe is adequate to reimburse us for our large losses with a very high degree of probability. Should an unlikely event occur that exceeds our reinsurance coverage, then the amounts in excess of our reinsurance coverage could adversely impact our financial condition or results of operations.
 
Litigation may have an adverse effect on our business
 
We are subject at times to various claims, lawsuits and proceedings relating principally to alleged errors or omissions in the placement of insurance, claims administration, consulting services and other business transactions arising in the ordinary course of business. Where appropriate, we vigorously defend such claims, lawsuits and proceedings. Some of these claims, lawsuits and proceedings seek damages, including consequential, exemplary, or punitive damages, in amounts that could, if awarded, be significant. Most of the claims, lawsuits and proceedings arising in the ordinary course of business are covered by the policy at issue, errors and omissions insurance or other appropriate insurance. In terms of deductibles associated with such insurance, we have established provisions against these items, which are believed to be adequate in light of current information and legal advice. With the assistance of outside counsel, we adjust such provisions according to new developments or changes in the strategy in dealing with such matters. On the basis of current information, we do not expect the outcome of the claims, lawsuits and proceedings to which we are subject to, either individually, or in the aggregate, will have a material adverse effect on our financial condition. However, it is possible that future results of operations or cash flows for any particular quarter or annual period could be materially affected by an unfavorable resolution of any such matters.
 
Our geographic concentration ties our performance to the business, economic, natural perils, man made perils, and regulatory conditions within our concentrated regions.
 
One of our predominate lines of business is workers’ compensation (41.8% of net earned premiums in 2010), which is concentrated in California. Accordingly, unfavorable business, economic or regulatory conditions in this state could negatively impact our business. California is also exposed to climate and environmental changes, natural perils such as earthquakes, water supplies, and the possibility of pandemics or terrorist acts.  Because our business is concentrated in this manner, we may be exposed to economic and regulatory risks or risk from natural perils that are greater than the risks associated with greater geographic diversification.  Refer to Note 6 ~ Reinsurance for further information regarding our reinsurance structure related to workers’ compensation business.
 
Our success depends on our ability to appropriately price the risks we underwrite.
 
Our financial results depend on our ability to underwrite and collect adequate premium rates for a wide variety of risks. Rate adequacy is necessary to generate sufficient premiums to pay losses, loss expenses, and underwriting expenses and to earn a profit. To price our products accurately, we must collect and properly analyze a substantial amount of data, develop, test and apply appropriate rating formulas, monitor and react to changes in trends and project both severity and frequency of losses with reasonable accuracy. These activities are subject to a number of risks and uncertainties that are outside our control, including:
 
availability of sufficient reliable data and our ability to properly analyze available data;
● uncertainties that inherently characterize estimates and assumptions;
● selection and application of appropriate rating and pricing techniques;
● changes in legal standards, claim settlement practices, medical care expenses and restoration costs;
● changes in mandated rates or benefits set by the state regulators; and
● legislative actions.
 
Consequently, we could underprice risks, which would negatively affect our profit margins, or we could overprice risks, which could reduce our sales volume and competitiveness. In either event, our profitability could be materially and adversely affected.
 
 
16

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
If market conditions cause our reinsurance to be more costly or unavailable, we may be required to bear increased risks or reduce the level of our underwriting commitments.
 
As part of our overall risk and capacity management strategy, we purchase reinsurance for significant amounts of risk underwritten by our Insurance Company Subsidiaries, especially for the excess-of-loss and severity risks. Market conditions beyond our control determine the availability and cost of the reinsurance we purchase, which may affect the level of our business and profitability. Our reinsurance facilities are generally subject to annual renewal. We may be unable to maintain our current reinsurance facilities or to obtain other reinsurance in adequate amounts and at favorable rates. Increases in the cost of reinsurance would adversely affect our profitability. In addition, if we are unable to renew our expiring facilities or to obtain new reinsurance on favorable terms, either our net exposure to risk would increase or, if we are unwilling to bear an increase in net risk exposures, we would have to reduce the amount of risk we underwrite.
 
Our reinsurers may not pay on losses in a timely fashion, or at all, which may cause a substantial loss and increase our costs.
 
We purchase reinsurance by transferring part of the risk we have assumed (known as ceding) to a reinsurance company in exchange for part of the premium we receive in connection with the risk under pro-rata and excess-of-loss contracts. These reinsurance arrangements diversify our business and reduce our exposure to large losses or from hazards of an unusual nature. Although reinsurance makes the reinsurer liable to us to the extent the risk is transferred, the ceding of insurance does not discharge us of our primary liability to our policyholder. Therefore, we are subject to credit risk with respect to the obligations of our reinsurers. If our reinsurers fail to pay us or fail to pay on a timely basis, our financial results and financial condition could be adversely affected. In order to minimize our exposure to significant losses from reinsurer insolvencies, we evaluate the financial condition of our reinsurers and monitor the economic characteristics of the reinsurers on an ongoing basis and, if appropriate, we may require trust agreements to collateralize reinsurers’ financial obligation to us.
 
We may be adversely affected by interest rate changes.
 
Our investment portfolio is predominantly comprised of fixed income securities. These securities are sensitive to changes in interest rates. An increase in interest rates typically reduces the fair market value of fixed income securities. In addition, if interest rates decline, investment income earned from future investments in fixed income securities will be lower.
 
We generally hold our fixed income securities to maturity, so our interest rate exposure does not usually result in realized losses. However, as noted above, rising interest rates could result in a significant reduction of our book value.
 
Interest rates are highly sensitive to many factors beyond our control including general economic conditions, governmental monetary policy, and political conditions. As discussed above, fluctuations in interest rates may adversely impact our business. See “Item 7A. Qualitative and Quantitative Disclosures About Market Risk” for further discussion on interest rate risk.
 
Our investment portfolio is subject to market and credit risks, which could affect our financial results and ability to conduct business.
 
Our investment portfolio is subject to overall market risk and credit risk of the individual issuers of securities. The value of investments in marketable securities is subject to impairment as a result of deterioration in the creditworthiness of the issuer. Although we try to manage this risk by diversifying our portfolio and emphasizing credit quality, our investments are subject to losses as a result of a general downturn in the economy.  A severe economic downturn could have a material adverse impact on our results from operations and our financial condition.
 
We could be forced to sell investments to meet our liquidity requirements.
 
We invest the premiums we receive from customers until they are needed to pay policyholder claims or until they are recognized as profits. Consequently, we seek to match the duration of our investment portfolio with the duration of our loss and loss adjustment expense reserves to ensure strong liquidity and avoid having to liquidate securities to fund claims. As an example, we ladder the maturities of our investment portfolio to ensure we have adequate liquidity to fund anticipated liabilities that are coming due. We believe that we are currently well positioned from a liquidity perspective. That said, risk factors such as inadequate loss and loss adjustment reserves or unfavorable trends in litigation could potentially result in the need to sell investments to fund these liabilities. This could result in significant realized losses depending on the conditions of the general market, interest rates and credit issues with individual securities.
 
 
17

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
A decrease in our A.M. Best rating could negatively affect our business.
 
Insurance companies are subject to financial strength ratings produced by external rating agencies. Higher ratings generally indicate greater financial stability and a stronger ability to pay claims. Ratings are assigned by rating agencies to insurers based upon factors they believe are important to policyholders. Ratings are not recommendations to buy, hold, or sell our securities.
 
Our ability to write business is most influenced by our rating from A.M. Best. A.M. Best ratings are designed to assess an insurer’s financial strength and ability to meet continuing obligations to policyholders. Currently, our financial strength rating from A.M. Best is “A−” (Excellent) for our Insurance Company Subsidiaries. There can be no assurance that A.M. Best will not change this rating in the future. A rating downgrade from A.M. Best could materially adversely affect the business we write and our results of operations.
 
Because we are heavily regulated by the states in which we operate, we may be limited in the way we operate.
 
We are subject to extensive supervision and regulation in the states in which we operate. The supervision and regulation relate to numerous aspects of our business and financial condition. The primary purpose of the supervision and regulation is to maintain compliance with insurance regulations and to protect policyholders. The extent of regulation varies, but generally is governed by state statutes. These statutes delegate regulatory, supervisory and administrative authority to state insurance departments. This system of regulation covers, among other things:
 
 
standards of solvency, including risk-based capital measurements;
 
restrictions on the nature, quality and concentration of investments;
 
restrictions on the types of terms that we can include in the insurance policies we offer;
 
required methods of accounting;
 
required reserves for unearned premiums, losses and other purposes;
 
permissible underwriting and claims settlement practices; and
 
assessments for the provision of funds necessary for the settlement of covered claims under certain insurance policies provided by impaired, insolvent or failed insurance companies.
 
The regulations of the state insurance departments may affect the cost or demand for our products and may impede us from obtaining rate increases or taking other actions we might wish to take to increase our profitability. Furthermore, we may be unable to maintain all required licenses and approvals and our business may not fully comply with the wide variety of applicable laws and regulations or the relevant authority’s interpretation of the laws and regulations. Also, regulatory authorities have relatively broad discretion to grant, renew or revoke licenses and approvals. If we do not have the requisite licenses and approvals, or do not comply with applicable regulatory requirements, the insurance regulatory authorities could stop or temporarily suspend us from conducting some or all of our activities or monetarily penalize us.
 
Although the United States federal government does not directly regulate the insurance business, changes in federal legislation, regulation, and/or administrative policies in several areas, including changes in financial services regulation and federal taxation, can significantly harm the insurance industry.
 
Most states assess our Insurance Company Subsidiaries to provide funds for failing insurance companies and those assessments could be material.
 
Our Insurance Company Subsidiaries are subject to assessments in most states where we are licensed for the provision of funds necessary for the settlement of covered claims under certain policies provided by impaired, insolvent or failed insurance companies. Maximum contributions required by law in any one year vary by state, and have historically been less than one percent of annual premiums written. We cannot predict with certainty the amount of future assessments. Significant assessments could have a material adverse effect on our financial condition and results of operations.
 
Provisions of the Michigan Business Corporation Act, our articles of incorporation and other corporate governing documents and the insurance laws may discourage takeover attempts.
 
The Michigan Business Corporation Act contains “anti-takeover” provisions. Chapter 7A (the “Fair Price Act”) of the Business Corporation Act applies to us and may have an anti-takeover effect and may delay, defer or prevent a tender offer or takeover attempt that a shareholder might consider in their best interest, including those attempts that might result in shareholders receiving a premium over market price for their shares.
 
 
18

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
The Fair Price Act provides that a supermajority vote of ninety percent of the shareholders and no less than two-thirds of the votes of non interested shareholders must approve a “business combination.” The Fair Price Act defines a “business combination” to encompass any merger, consolidation, share exchange, sale of assets, stock issue, liquidation, or reclassification of securities involving an “interested shareholder” or certain “affiliates.” An “interested shareholder” is generally any person who owns ten percent or more of the outstanding voting shares of the company. An “affiliate” is a person who directly or indirectly controls, is controlled by, or is under common control with, a specified person. The supermajority vote required by the Fair Price Act does not apply to business combinations that satisfy certain conditions. These conditions include, among others: (i) the purchase price to be paid for the shares of the company in the business combination must be at least equal to the highest of either (a) the market value of the shares or (b) the highest per share price paid by the interested shareholder within the preceding two-year period or in the transaction in which the shareholder became an interested shareholder, whichever is higher; and (ii) once becoming an interested shareholder, the person may not become the beneficial owner of any additional shares of the company except as part of the transaction that resulted in the interested shareholder becoming an interested shareholder or by virtue of proportionate stock splits or stock dividends.
 
Our articles of incorporation allow our Board of Directors to issue one or more classes or series of preferred stock with voting rights, preferences and other privileges as the Board of Directors may determine. The possible issuance of preferred shares could adversely affect the holders of our common stock and could prevent, delay, or defer a change of control.
 
We are also subject to the laws of Michigan, Ohio, Texas, California, Washington D.C., and Missouri, which govern insurance holding companies. Under these laws, a person generally must obtain the applicable Insurance Department’s approval to acquire, directly or indirectly, five to ten percent or more of the outstanding voting securities of our Insurance Company Subsidiaries. An Insurance Department’s determination of whether to approve an acquisition would be based on a variety of factors, including an evaluation of the acquirer’s financial stability, the competence of its management, and whether competition in that state would be reduced. These laws may prevent, delay or defer a change of control of us or our Insurance Company Subsidiaries.
 
Our ability to meet ongoing cash requirements and pay dividends may be limited by our holding company structure and regulatory constraints.
 
We are a holding company that transacts the majority of our business through our Insurance Company Subsidiaries.  Our ability to meet our obligations on our outstanding debt, and to pay our expenses and shareholder dividends, may depend upon the dividend paying capacity of our Insurance Company Subsidiaries. Payments of dividends to us by our Insurance Company Subsidiaries are restricted by state insurance laws, including laws establishing minimum solvency and liquidity thresholds, and could be subject to revised restrictions in the future. As a result, at times, we may not be able to receive dividends from our Insurance Company Subsidiaries and we may not receive dividends in amounts necessary to meet our debt obligations or to pay shareholder dividends on our capital stock.
 
Although we have paid cash dividends in the past, we may not pay cash dividends in the future.
 
The declaration and payment of dividends is subject to the discretion of our Board of Directors and will depend on our financial condition, results of operations, cash flows, cash requirements, future prospects, regulatory and contractual restrictions on the payment of dividends by our Insurance Company Subsidiaries and other factors deemed relevant by our Board of Directors. There is no requirement that we must, and we cannot assure you that we will, declare and pay any dividends in the future. Our Board of Directors may determine to retain such capital for general corporate or other purposes.
 
We may require additional capital in the future, which may not be available or may only be available on unfavorable terms.
 
Our future capital requirements depend on many factors, including our ability to write new business successfully and to establish premium rates and reserves at levels sufficient to cover losses. To the extent that our present capital is insufficient to meet future operating requirements and/or cover losses, we may need to raise additional funds through financings. If we had to raise additional capital, equity or debt financing may not be available or may be on terms that are not favorable to us. In the case of equity financings, dilution to our shareholders could result, and in any case such securities may have rights, preferences and privileges that are senior to those of the shares currently outstanding. If we cannot obtain adequate capital on favorable terms or at all, our business, operating results and financial condition could be adversely affected.
 
 
19

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
We are exposed to goodwill impairment risk as part of our growth strategy.
 
Goodwill represents the excess of the amounts we paid to acquire subsidiaries and other businesses over the fair value of their net assets at the date of acquisition. We are required to perform a goodwill impairment analysis at least annually and whenever events or circumstances indicate that the carrying value of a reporting unit may not be recoverable from estimated future cash flows. If it is determined that the goodwill has been impaired, we would be required to write down the goodwill by the amount of the impairment, with a corresponding charge to net income. Such impairments could have a material adverse effect on our results of operations and our financial position.
 
Acquisitions and integration of acquired businesses may result in operating difficulties, which may prevent us from achieving the expected benefits.
 
At times, we may investigate and pursue acquisition opportunities if we believe such opportunities are consistent with our long-term objectives and that the expected benefits exceed the risks.  Achieving such benefits is subject to a number of uncertainties, including whether the combined businesses are integrated in an efficient and effective manner, as well as general competitive factors in the marketplace.  We believe we have a robust due diligence process; however, integrating an acquired company or business can be a complex and costly endeavor.  Sometimes we can be confronted with unexpected issues that may present significant risks, which could materially impact our business, financial condition, results of operations, and cash flows.
 
Our reliance upon producers subjects us to their credit risk.
 
With respect to agency-billed premiums and premiums generated by brokers, producers collect premiums from the policyholders and forward them to us. In certain jurisdictions, when the insured pays premium for these policies to producers for payment, the premium might be considered to have been paid under applicable insurance laws and the insured will no longer be liable to us for those amounts, whether or not we have actually received the premium from the producer. Consequently, we assume a degree of credit risk associated with producers. Although producers’ failures to remit premiums to us have not caused a material adverse impact on us to date, there may be instances where producers collect premium but do not remit it to us and we may be required under applicable law to provide the coverage set forth in the policy despite the actual lack of collection of the premium by us. Because the possibility of these events is dependent in large part upon the financial condition, cash flows, and internal operations of our producers, we may not be able to quantify any potential exposure presented by the risk. If we are unable to collect premium from our producers in the future, our financial condition and results of operations could be materially and adversely affected.
 
One of our core selected producers accounts for a large portion of our premium volume, loss of business provided by this entity could adversely affect us.
 
Our largest producer in 2010 was Midwest General Agency, which accounted for 14.4% of our gross written premium. No other producer was responsible for more than 10% of our gross written premium. A significant decrease in business from this producer could have an adverse impact on our operating results.
 
Our performance is dependent on the continued services and performance of our senior management and other key personnel.
 
The success of our business is dependent on our ability to retain and motivate our senior management and key management personnel and their efforts. The loss of the services of any of our executive officers or other key employees could have a material adverse effect on our business, financial condition, results of operations, and cash flows. We have existing employment or severance agreements with Robert S. Cubbin, Christopher J. Timm, Karen M. Spaun, Michael G. Costello, and other senior executives.  We maintain a “key person” life insurance policy on Robert S. Cubbin, our President and CEO.  The loss of any of these officers or other key personnel could cause our ability to implement our business strategies to be delayed or hindered.
 
Our future success also will depend on our ability to attract, train, motivate and retain other highly skilled technical, managerial, marketing, and customer service personnel. Competition for these employees is strong and we may not be able to successfully attract, integrate or retain sufficiently qualified personnel. In addition, our future success depends on our ability to attract, retain and motivate our agents and other producers. Our failure to attract and retain the necessary personnel and producers could have a material adverse effect on our business, financial condition, results of operations, and cash flows.
 
 
20

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
We rely on our information technology and telecommunications systems to conduct our business.

Our business is dependent upon the uninterrupted functioning of our information technology and telecommunication systems. We rely upon our systems, as well as the systems of our vendors, to underwrite and process our business; make claim payments; provide customer service; provide policy administration services, such as endorsements, cancellations and premium collections; comply with insurance regulatory requirements; and perform actuarial and other analytical functions necessary for pricing and product development. Our operations are dependent upon our ability to timely and efficiently process our business and protect our information and telecommunications systems from physical loss, telecommunications failure or other similar catastrophic events, as well as from security breaches. While we have implemented business contingency plans and other reasonable and appropriate internal controls to protect our systems from interruption, loss or security breaches, a sustained business interruption or system failure could adversely impact our ability to process our business, provide customer service, pay claims in a timely manner or perform other necessary business functions. Likewise, a security breach of our computer systems could also interrupt or damage our operations or harm our reputation in the event confidential customer information is disclosed to third–parties. We could also be subject to fines and penalties from a security breach. The cost to remedy a severe security breach could also be substantial.  These circumstances could have a material adverse effect upon our financial condition, results of operations, cash flows, and reputation.

Managing technology initiatives and obtaining the efficiencies anticipated with technology implementation may present significant challenges.

While technological enhancements and initiatives can streamline several business processes and ultimately reduce the costs of operations, these initiatives can present short-term costs and implementation risks. Projections of associated costs, implementation timelines, and the benefits of those results may be inaccurate and such inaccuracies could increase over time. In addition, there are risks associated with not achieving the anticipated efficiencies from technology implementation that could impact our financial condition, results of operations, and cash flows.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

In 1998, we purchased land in Southfield, Michigan for a cost of $3.2 million.  In 2004, the construction of our corporate headquarters was completed on half of this land and in December 2004 we relocated to the new office building.  Our corporate headquarters are approximately 72,000 square feet.  The total construction cost of the building approximated $12.0 million, which was paid in full at the closing on January 19, 2005.

In 2003, we entered into a Purchase and Sale Agreement, whereby we agreed to sell the remaining portion of the land to an unaffiliated third party for the purpose of constructing an office building adjacent to our corporate headquarters.   Under the Purchase and Sale Agreement, the third party agreed to pay $2.1 million for the land, $1.2 million for their share of the costs related to the common areas of the building, and other related costs of approximately $226,000.  In May 2005, we closed on the transaction.

The unaffiliated third party had until July 2007 to pay the principal balance, however we negotiated an extension through May 1, 2009.  Subsequent to the expiration of the extension, it was determined the unaffiliated third party did not intend to pay the remaining principal balance.  Therefore, in 2010 we foreclosed on the property, and retained all previous payments made by the third-party. Also, we now have legal title to the property.

With the ProCentury merger, we assumed the lease of their corporate headquarters, an approximately 44,000 square foot office building located in Westerville, Ohio.  The lease agreement for this building has an initial term of ten years that expires in 2013.

We are also a party to various leases, including other leases acquired from ProCentury, for other locations in which we have offices. We do not consider any of these leases to be material.
 
 
21

 

MEADOWBROOK INSURANCE GROUP, INC.
 
ITEM 3. LEGAL PROCEEDINGS
 
We are subject at times to various claims, lawsuits and proceedings relating principally to alleged errors or omissions in the placement of insurance, claims administration, consulting services and other business transactions arising in the ordinary course of business. Where appropriate, we vigorously defend such claims, lawsuits and proceedings. Some of these claims, lawsuits and proceedings seek damages, including consequential, exemplary or punitive damages, in amounts that could, if awarded, be significant. Most of the claims, lawsuits and proceedings arising in the ordinary course of business are covered by the policy at issue, errors and omissions insurance or other appropriate insurance. In terms of deductibles associated with such insurance, we have established provisions against these items, which are believed to be adequate in light of current information and legal advice. In accordance with accounting guidance, if it is probable that an asset has been impaired or a liability has been incurred as of the date of the financial statements and the amount of loss is estimable, an accrual for the costs to resolve these claims is recorded in our consolidated financial statements. Period expenses related to the defense of such claims are included in other operating expenses in the accompanying consolidated statements of income. With the assistance of outside counsel, we adjust such provisions according to new developments or changes in the strategy in dealing with such matters. On the basis of current information, we do not expect the outcome of the claims, lawsuits and proceedings to which we are subject to, either individually, or in the aggregate, will have a material adverse effect on our financial condition. However, it is possible that future results of operations or cash flows for any particular quarter or annual period could be materially affected by an unfavorable resolution of any such matters.

ITEM 4. RESERVED
 
 
22
 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
PART II

ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
 
 
 
   
Shareholder Information    
Corporate Headquarters Transfer Agent & Registrar Annual Meeting
26255 American Drive BNY Mellon Shareowner Services The Annual Meeting of
Southfield, MI  48034-6112 P.O. Box 358015 Shareholders
Phone:  (248) 358-1100 Pittsburgh, PA 15252-8015 will be held at:
    2:00 p.m.
Independent Registered   May 19, 2011
Public Accounting Firm    
Ernst & Young LLP
One Kennedy Square, Suite 1000
777 Woodward Avenue
Stock Listing
New York Stock Exchange
Corporate Headquarters
26255 American Drive
Detroit, MI 48226-5495 Symbol: MIG Southfield,  MI 48304-6112
     
Corporate Counsel    
Howard & Howard PLLC
450 West Fourth Street
   
Royal Oak, MI 48067-2557    
 
Shareholder Relations and Form 10-K


A copy of our 2010 Annual Report and Form 10-K, as filed with the Securities and Exchange Commission, may be obtained upon written request to our Financial Reporting Department at our corporate headquarters, or contact:
 
Karen M. Spaun, Senior Vice President and Chief Financial Officer
(248) 204-8178 karen.spaun@meadowbrook.com

Shareholder Investment Plan

Our Shareholder Investment Plan (“Plan”) offers a simple and systematic way to purchase our common stock without paying brokerage fees or commissions.  With the Plan’s many flexible features, an account may be customized to reflect individual financial and investment objectives.  If you would like additional information including a prospectus and an application, please contact:

BNY Mellon Shareowner Services
1-800-442-8134

Or visit their website at www.bnymellon.com/shareowner/isd

 
23

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
Share Price and Dividend Information

Our common stock is traded on the New York Stock Exchange under the symbol “MIG.”  The following table sets forth the high and low sale prices of our common shares as reported by the NYSE and our quarterly dividends declared for each period shown:

December 31, 2010
 
High
   
Low
   
Dividends
 
First Quarter
  $ 8.21     $ 6.01     $ 0.03  
Second Quarter
    9.20       7.51       0.03  
Third Quarter
    9.29       8.10       0.04  
Fourth Quarter
    10.46       8.45       0.04  

December 31, 2009
 
High
   
Low
   
Dividends
 
First Quarter
  $ 7.01     $ 5.08     $ 0.02  
Second Quarter
    7.64       5.70       0.02  
Third Quarter
    8.21       6.27       0.03  
Fourth Quarter
    7.75       6.53       0.03  

For additional information regarding dividend restrictions, refer to the Liquidity and Capital Resources section of Management’s Discussion and Analysis.

When evaluating the declaration of a dividend, our Board of Directors considers a variety of factors, including but not limited to, our cash flow, liquidity needs, results of operations strategic plans, industry conditions, our overall financial condition and other relevant factors.  As a holding company, the ability to pay cash dividends is partially dependent on dividends and other permitted payments from our subsidiaries.  In 2010 and 2009, the Insurance Company Subsidiaries paid dividends to our holding company of $42.0 million and $39.5 million, respectively.
 
Shareholders of Record

As of March 10, 2011, there were approximately 256 shareholders of record of our common stock.  For purposes of this determination, Cede & Co., the nominee for the Depositary Trust Company is treated as one holder.

Purchase of Equity Securities by the Issuer

In July 2008, our Board of Directors authorized management to purchase up to 3.0 million shares of our common stock in market transactions for a period not to exceed twenty-four months.  On February 12, 2010, our Board of Directors authorized us to purchase up to 5.0 million shares of our common stock in market transactions for a period not to exceed twenty-four months.  This share repurchase plan replaced the existing share repurchase plan authorized in July 2008.

The following table presents information with respect to repurchases of our common stock made during the quarterly period ended December 31, 2010:

Period
 
Total
Number of Shares
   
Average
Price Paid
Per Share
   
Total Number
of Shares Purchased as Part of Publicly Announced
Plans or Programs
   
Maximum Number of Shares that may still be Repurchased Under the Plans or Programs
 
October 1 - October 31, 2010
        $             2,519,000  
November 1 - November 30, 2010
        $             2,519,000  
December 1 - December 31, 2010
        $               2,519,000  
Total
        $                
 
 
24

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
Performance Graph
 
The following graph sets forth, for the five year period ended December 31, 2010, the cumulative total stockholder return for the Company’s common stock, the Russell 2000 Index, and a Peer Group index.  The graph assumes the investment of $100 on December 31, 2005 in Common Stock of the Company, the Russell 2000 Index, and a Peer Group index.  The stock price performance represented on the following graph is not necessarily indicative of future stock price performance.
 
The performance graph shall not be deemed “soliciting material” or to be “filed” with the Securities and Exchange Commission, nor shall such information be deemed to be incorporated by reference into any future filing of the Company under the Securities  Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent the Company specifically incorporates it by reference into such filing.
 
Meadowbrook Insurance Group, Inc.
 
 
    Period Ending  
Index
 
12/31/05
   
12/31/06
   
12/31/07
   
12/31/08
   
12/31/09
   
12/31/10
 
Meadowbrook Insurance Group, Inc.
    100.00       169.35       161.13       111.71       130.16       183.01  
Russell 2000
    100.00       118.37       116.51       77.15       98.11       124.46  
SNL Insurance $1B-$2.5B
    100.00       125.53       121.72       100.22       109.45       140.93  
 
 
25

 
 
MEADOWBROOK INSURANCE GROUP, INC.
 
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
 
MEADOWBROOK INSURANCE GROUP, INC.
SELECTED CONSOLIDATED FINANCIAL DATA
                               
    For the Years Ended December 31,  
   
2010
   
2009 (1)
   
2008 (1)
   
2007 (1)
   
2006 (1)
 
   
(In thousands, except per share and ratio data)
       
Income Statement Data:
                             
Gross written premiums
  $ 801,900     $ 688,687     $ 457,683     $ 346,451     $ 330,872  
Net written premiums
    693,599       580,018       375,194       280,211       262,668  
Net earned premiums
    659,840       539,602       369,721       268,197       254,920  
Net commissions and fees
    34,239       37,881       42,904       45,988       41,172  
Net investment income
    54,173       50,366       36,624       26,400       22,075  
Net realized (losses) gains
    1,817       (225 )     (11,422 )     150       69  
Total revenue
    750,069       627,624       437,827       340,735       318,236  
Net losses and LAE
    399,650       327,426       229,181       164,027       158,846  
Policy acquisition and other underwriting expenses
    227,031       175,134       117,006       93,490       89,914  
General selling & administrative expenses
    22,494       29,601       29,282       31,370       27,325  
General corporate expense
    5,668       5,977       4,572       4,501       4,080  
Amortization expense
    4,966       5,781       6,310       1,930       590  
Interest expense
    9,458       10,596       7,681       6,030       5,976  
Income before income taxes and equity earnings
    80,802       73,109       43,795       39,387       31,505  
Equity earnings of affiliates, net of tax
    2,263       874                    
Equity earnings of unconsolidated subsidiaries, net of tax
    473       (12 )     269       331       128  
Net income
    59,721       52,650       27,397       27,992       22,034  
Earnings per share - Diluted
  $ 1.10     $ 0.92     $ 0.61     $ 0.85     $ 0.75  
Dividends paid per common share
  $ 0.13     $ 0.09     $ 0.08     $     $  
                                         
Balance Sheet Data:
                                       
Total investments and cash and cash equivalents
  $ 1,345,257     $ 1,203,215     $ 1,085,648     $ 651,601     $ 527,600  
Total assets
    2,177,641       1,989,816       1,813,916       1,113,966       969,000  
Loss and LAE reserves
    1,065,056       949,177       885,697       540,002       501,077  
Debt
    37,750       49,875       60,250             7,000  
Debentures
    80,930       80,930       80,930       55,930       55,930  
Shareholders equity
    547,101       502,881       438,170       301,894       201,693  
Book value per share
  $ 10.28     $ 9.06     $ 7.64     $ 8.16     $ 6.93  
                                         
Other Data:
                                       
GAAP ratios (insurance companies only):
                                       
Net loss and LAE ratio
    60.6 %     60.7 %     62.0 %     61.2 %     62.3 %
Expense ratio
    34.4 %     32.5 %     31.6 %     34.9 %     35.3 %
Combined ratio
    95.0 %     93.2 %     93.6 %     96.1 %     97.6 %
Accident year combined ratio (2)
    99.7 %     98.5 %     98.1 %     98.7 %     98.7 %
                                         
Total (favorable) adverse development on prior years
  $ (31,003 )   $ (28,670 )   $ (16,772 )   $ (7,091 )   $ (2,719 )
 
(1) During the first quarter of 2010, the Company made certain reclassifications to the expense classifications on the Consolidated Statement of Income.  These reclassifications were made to enable the user of the financial statements to calculate the GAAP combined ratio directly from the Consolidated Statement of Income. As a result, the Consolidated Statement of Income for the years ended December 31, 2009, 2008, 2007, and 2006 have been reclassified to conform to this revised presentation. These reclassifications do not change total expenses or consolidated net income as originally reported.
 
(2) The accident year combined ratio is the sum of the expense ratio and accident year loss ratio.  The accident year loss ratio measures loss and LAE occurring in a particular year, regardless of when they are reported and does not take into consideration changes in estimates in loss reserves from prior accident years.
 
The merger with ProCentury was completed following the close of business on July, 31, 2008.  Therefore, the above table includes only five months of financial results for ProCentury for the year ended December 31, 2008 and twelve months of financial results for the years ended December 31, 2009 and 2010.
 
 
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MEADOWBROOK INSURANCE GROUP, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS
 
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

This Form 10-K may provide information including certain statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  These include statements regarding the intent, belief, or current expectations of management, including, but not limited to, those statements that use the words “believes,” “expects,” “anticipates,” “estimates,” or similar expressions.  You are cautioned that any such forward-looking statements are not guarantees of future performance and involve a number of risks and uncertainties, and results could differ materially from those indicated by such forward-looking statements.  Among the important factors that could cause actual results to differ materially from those indicated by such forward-looking statements are: the frequency and severity of claims; uncertainties inherent in reserve estimates; catastrophic events; a change in the demand for, pricing of, availability or collectability of reinsurance; increased rate pressure on premiums; ability to obtain rate increases in current market conditions; investment rate of return; changes in and adherence to insurance regulation; actions taken by regulators, rating agencies or lenders; attainment of certain processing efficiencies; changing rates of inflation; general economic conditions and other risks identified in our reports and registration statements filed with the Securities and Exchange Commission.  We are not under any obligation to (and expressly disclaim any such obligation to) update or alter our forward-looking statements whether as a result of new information, future events or otherwise.

Business Overview

We are a publicly traded specialty niche focused commercial insurance underwriter and insurance administration services company.  We market and underwrite specialty property and casualty insurance programs and products on both an admitted and non-admitted basis through a broad and diverse network of independent retail agents, wholesalers, program administrators and general agents, who value service, specialized knowledge, and focused expertise.  Program business refers to an aggregation of individually underwritten risks that have some unique characteristic and are distributed through a select group of agents. We seek to combine profitable underwriting, income from our net commissions and fees, investment returns and efficient capital management to deliver consistent long-term growth in shareholder value.

Through our retail property and casualty agencies, we also generate commission revenue, which represents 1.5% of our total consolidated revenues. Our agencies are located in Michigan, California, and Florida and produce commercial, personal lines, life and accident and health insurance that is placed with more than fifty unaffiliated insurance carriers. These agencies produce a minimal amount of business for our affiliated Insurance Company Subsidiaries.

We recognize revenue related to the services and coverages within the following categories: net earned premiums, management fees, claims fees, loss control fees, reinsurance placement, investment income, commission revenue, and net realized gains (losses).

We compete in the specialty insurance market. Our wide range of specialty niche insurance expertise allows us to accommodate a diverse distribution network ranging from specialized program agents to retail agents. In the specialty market, competition tends to place considerable focus on availability, service and other tailored coverages in addition to price. Moreover, our broad geographical footprint enables us to function with a local presence on both a regional and national basis. We also have the capacity to write specialty insurance in both the admitted and non-admitted markets. These unique aspects of our business model enable us to compete on factors other than price.

Critical Accounting Policies
 
General
 
In certain circumstances, we are required to make estimates and assumptions that affect amounts reported in our consolidated financial statements and related footnotes. We evaluate these estimates and assumptions on an on-going basis based on a variety of factors.  There can be no assurance, however, the actual results will not be materially different than our estimates and assumptions, and that reported results of operation will not be affected by accounting adjustments needed to reflect changes in these estimates and assumptions.  We believe the following policies, along with those disclosed in Note 1 ~ Summary of Significant Accounting Policies, are the most sensitive to estimates and judgments.
 
 
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MEADOWBROOK INSURANCE GROUP, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS - continued
 
Losses and Loss Adjustment Expenses
 
Significant periods of time can elapse between the occurrence of a loss, the reporting of the loss to the insurer, and the insurer’s payment of that loss.  To recognize liabilities for unpaid losses and loss adjustment expenses (“LAE”), insurers establish reserves as balance sheet liabilities representing estimates of amounts needed to pay reported and unreported net losses and LAE.

We establish a liability for losses and LAE, which represents case based estimates of reported unpaid losses and LAE and actuarial estimates of incurred but not reported (“IBNR”) losses and LAE.  Such liabilities, by necessity, are based upon estimates and, while we believe the amount of our reserves is adequate, the ultimate liability may be greater or less than the estimate.  As of December 31, 2010 and 2009, we have accrued $1,065.1 million and $949.2 million of gross loss and LAE reserves, respectively.

Components of Losses and Loss Adjustment Expense

The following table sets forth our gross and net reserves for losses and LAE based upon an underlying source of data, at December 31, 2010 (in thousands):
 
   
Case
   
IBNR
   
Total
 
Direct
  $ 342,653     $ 618,847     $ 961,500  
Assumed-Directly Managed (1)
    33,285       37,937       71,222  
Assumed-Residual Markets (2)
    9,022       9,941       18,963  
Assumed-Retroceded
    825       303       1,128  
Assumed-Other (3)
    8,823       3,420       12,243  
Gross
    394,608       670,448       1,065,056  
Less Ceded
    79,926       200,928       280,854  
Net
  $ 314,682     $ 469,520     $ 784,202  
 
(1) Directly managed represents business managed and processed by our underwriting, claims, and loss control departments, utilizing our internal systems and related controls.

(2) Residual markets represent mandatory pooled workers’ compensation business allocated to individual insurance company writers based on the insurer’s market share in a given state.

(3) We analyze Assumed-Other reserves with the same level of detail as Assumed-Directly Managed.

The reserves referenced in the above table related to our direct and assumed business, which we directly manage and are established through transactions processed through our internal systems and related controls.  Accordingly, the case reserves are established on a current basis, therefore there is no delay or lag in reporting of losses from a ceding company, and IBNR is determined utilizing various actuarial methods based upon historical data.  Ultimate reserve estimates related to assumed business from residual markets are provided by individual states on a two quarter lag between the date of the evaluation and the receipt of the estimate from the National Council on Compensation Insurance (“NCCI”), and include an estimated reserve based upon actuarial methods for this lag.  Assumed business, which is subsequently 100% retroceded to participating reinsurers, relates to business previously discontinued and now is in run-off.  Relative to assumed business from other sources, we receive case and paid loss data within a forty-five day reporting period and develop our estimates for IBNR based on both current and historical data.

The completeness and accuracy of data received from cedants on assumed business that we do not manage directly is verified through monthly reconciliations to detailed statements, inception to date rollforwards of claim data, actuarial estimates of historical trends, field audits and a series of management oversight reports on a program basis.
 
 
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MEADOWBROOK INSURANCE GROUP, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS - continued
 
The following table sets forth our net case and IBNR reserves for losses and LAE by line of business at December 31, 2010 (in thousands):

   
Net Case
   
Net IBNR
   
Total
 
                         
Workers Compensation
  $ 143,623     $ 141,446     $ 285,069  
Residual Markets
    9,022       9,941       18,963  
Commercial Multiple Peril/General Liability
    89,735       241,115       330,850  
Commercial Automobile
    52,387       60,001       112,388  
Other
    19,915       17,017       36,932  
Total
  $ 314,682     $ 469,520     $ 784,202  

Claim Reserving Process and Methodology

For the majority of claims, our claims personnel within our risk management subsidiary will establish a case reserve for the estimated amount of the ultimate payment for claims reported to one of our Insurance Company Subsidiaries.  The amount of the reserve is primarily based upon a case-by-case evaluation of the type of claim involved, the circumstances surrounding each claim, and the policy provisions relating to the type of losses.  The estimate reflects the informed judgment of such personnel based on general insurance reserving practices, which focus on the ultimate probable cost of each reported claim, as well as the experience and knowledge of the claims person.  Until the claim is resolved, these estimates are revised as deemed necessary by the responsible claims personnel based on subsequent developments, new information or periodic reviews of the claims.

In addition to case reserves and in accordance with industry practice, we maintain estimates of reserves for losses and LAE incurred but not yet reported.  We project an estimate of ultimate losses and LAE at each reporting date.  The difference between the projected ultimate loss and LAE reserves and the case loss reserves and LAE reserves, is carried as IBNR reserves.  By using both estimates of reported claims and IBNR determined using generally accepted actuarial reserving techniques, we estimate the ultimate liability for losses and LAE, net of reinsurance recoverables.

In developing claim and claim adjustment expense reserve estimates, we perform a complete and detailed reserve analyses each quarter. To perform this analysis, the data is organized at a “reserve category” level. A reserve category can be a line of business such as commercial automobile liability, or it may be a particular geographical area within a line of business such as Nevada workers’ compensation. The reserves within a reserve category level are characterized as either short tail or long tail.  About 96% of our reserves can be characterized as coming from long tail lines of business. For long tail business, several years may lapse between the time the business is written and the time when all claims are settled. Our long-tail exposures include workers’ compensation, commercial automobile liability, general liability, professional liability, products liability, excess, and umbrella. Short-tail exposures include property, commercial automobile physical damage, a portion of ocean marine, and inland marine. The analyses generally review losses both gross and net of reinsurance.

The standard actuarial methods that we use to project ultimate losses for both long-tail and short-tail exposures include, but are not limited to, the following:

 
Paid Development Method
 
Incurred Development Method
 
Paid Bornhuetter-Ferguson Method
 
Reported Bornhuetter-Ferguson Method
 
Initial Expected Loss Method
 
Paid Roll-forward Method
 
Incurred Roll-forward Method

     All of these methods are consistently applied to every reserve category where they are applicable and they create indications for each accident year.  We use judgment selecting the best estimate from within these estimates or adjusted estimates.  As such, no one method or group of methods is strictly used for any line of business or reserve category within a line of business.  The individual selections by year are our best judgments based on the strengths and weaknesses of the method, indications, the inherent variability in the data and the specific modifications to selections for data characteristics.
 
 
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MEADOWBROOK INSURANCE GROUP, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS - continued
 
A brief description of the methods and some discussion of their inherent strengths, weaknesses and uses are as follows:

Paid Development Method.    This method uses historical, cumulative paid losses by accident year and develops those actual losses to estimated ultimate losses based upon the assumption that each accident year will develop to estimated ultimate cost in a manner that is analogous to prior years, adjusted as deemed appropriate for the expected effects of known changes in the claim payment environment, and to the extent necessary supplemented by analyses of the development of broader industry data.

Selection of the paid loss pattern requires analysis of several factors including the impact of inflation on claims costs, the rate at which claims professionals make claim payments and close claims, the impact of judicial decisions, the impact of underwriting changes, the impact of large claim payments and other factors. Claim cost inflation itself requires evaluation of changes in the cost of repairing or replacing property, changes in the cost of medical care, changes in the cost of wage replacement, judicial decisions, legislative changes and other factors. Because this method assumes that losses are paid at a consistent rate, changes in any of these factors can impact the results. Since the method does not rely on case reserves, it is not directly influenced by changes in the adequacy of case reserves.

Incurred Development Method.    This method uses historical, cumulative reported loss dollars by accident year and develops those actual losses to estimated ultimate losses based upon the assumption that each accident year will develop to estimated ultimate cost in a manner that is analogous to prior years, adjusted as deemed appropriate for the expected effects of known changes in the claim payment and case reserving environment, and to the extent necessary supplemented by analyses of the development of broader industry data.

Since the method uses more data (case reserves in addition to paid losses) than the paid development method, the incurred development patterns may be less variable than paid patterns. However, selection of the incurred loss pattern requires analysis of all of the factors listed in the description of the paid development method. In addition, the inclusion of case reserves can lead to distortions if changes in case reserving practices have taken place and the use of case incurred losses may not eliminate the issues associated with estimating the incurred loss pattern subsequent to the most mature point available.

Paid Bornhuetter-Ferguson Method.    This is a method that assigns partial weight to initial expected losses for each accident year and partial weight to observed paid losses. The weights assigned to the initial expected losses decrease as the accident year matures.

The method assumes that only future losses will develop at the expected loss ratio level. The percent of paid loss to ultimate loss implied from the paid development method is used to determine what percentage of ultimate loss is yet to be paid. The use of the pattern from the paid development method requires consideration of all factors listed in the description of the paid development method. The estimate of losses yet to be paid is added to current paid losses to estimate the ultimate loss for each year. This method will react very slowly if actual ultimate loss ratios are different from expectations due to changes not accounted for by the expected loss ratio calculation.

Reported Bornhuetter-Ferguson Method.    This is a method that assigns partial weight to the initial expected losses and partial weight to observed reported loss dollars (paid losses plus case reserves). The weights assigned to the initial expected losses decrease as the accident year matures.

The use of case incurred losses instead of paid losses can result in development patterns that are less variable than paid patterns. However, the inclusion of case reserves can lead to distortions if changes in case reserving have taken place, and the method requires analysis of all the factors that need to be reviewed for the expected loss ratio and incurred development methods.

Initial Expected Loss Method.    This method is used directly, and as an input to the Bornhuetter-Ferguson methods. Initial expected losses for an accident year are based on adjusting prior accident year projections to the current accident year levels using underlying loss trends, rate changes, benefit changes, reinsurance structure and cost changes and other pertinent adjustments specific to the line of business.
 
 
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MEADOWBROOK INSURANCE GROUP, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS - continued
 
This method may be useful if loss development patterns are inconsistent, losses emerge very slowly, or there is relatively little loss history from which to estimate future losses. The selection of the expected loss ratio requires analysis of loss ratios from earlier accident years or pricing studies and analysis of inflationary trends, frequency trends, rate changes, underwriting changes, and other applicable factors.

Paid Roll-forward Method.    This method adjusts prior estimates of ultimate losses based on the actual paid loss emergence in the quarter compared to the expected emergence. It is useful in determining reserves that avoid overreacting to ordinary fluctuations in the development patterns.

Incurred Roll-forward Method.    This method adjusts prior estimates of ultimate losses based on the actual case incurred loss emergence in the quarter compared to the expected emergence. It may also be useful in determining reserves that avoid overreacting to ordinary fluctuations in the development patterns and generally reacts faster than the paid roll-forward method.

Claims for short-tail lines of business settle more quickly than long-tail lines of business, and in general, loss development factors for short-tail lines are smaller than long-tail lines.  For long-tail lines, we tend to rely on initial expected loss methods throughout the current accident year then move to development factor based methods for older accident years.    Development methods on short-tail lines are generally reliable in the third and fourth quarter of the initial accident year and recorded loss ratios reflect a blend of the development and forecast methods.  Short-tail lines represent 4% of our total reserves at December 31, 2010.

The reserve categories where the above methods are not applicable are few.  The largest of these is our workers’ compensation residual market reserve category, where we utilize detailed reserve analyses performed by the industry statistical agency NCCI in making our estimates.  We adjust these estimates for timing differences in the reporting of the data.  The other reserve categories that deviate from the above methods are smaller; as a group constituting approximately one percent of the total reserves.

Each of the methods listed above requires the selection and application of parameters and assumptions.  For all but the initial expected loss method, the key assumptions are the patterns with which our aggregate claims data will be paid or will emerge over time (“development patterns”).  These patterns incorporate inherent assumptions of claims cost inflation rates and trends in the frequency of claims, both overall and by severity of claim.  These are affected by underlying loss trends, rate changes, benefit changes, reinsurance structure and cost changes and other pertinent adjustments which are explicit key assumptions underlying the initial expected loss method.  Each of these key assumptions is discussed in the following paragraphs.

To analyze the development patterns, we compile, to the extent available, long-term and short-term historical data for our insurance subsidiaries, organized in a manner which provides an indication of the historical development patterns.  To the extent that the historical data may provide insufficient information about future patterns—whether due to environmental changes such as legislation or due to the small volume or short history of data for some segments of our business—benchmarks based on industry data, and forecasts made by industry rating bureaus regarding the effect of legislative benefit changes on such patterns, may be used to supplement, adjust, or replace patterns based on our insurance companies’ historical data.

Actuarial judgment is required in selecting the patterns to apply to each segment of data being analyzed, and our views regarding current and future claim patterns are among the factors that enter into our establishment of the reserve for losses and LAE at each balance sheet date. When short-term averages or external rate bureau analyses indicate the claims patterns are changing from historical company or industry patterns, the new or forecasted information typically is factored into the methodologies. When new claims emergence or payment patterns have appeared in the actual data repeatedly over multiple evaluations, those new patterns are given greater weight in the selection process.

Because some claims are paid over many years, the selection of claim emergence and payment patterns involves judgmentally estimating the manner in which recently occurring claims will develop for many years and at times, decades in the future.  When it is likely the actual development will occur in the distant future, the potential for actual development to differ substantially from historical patterns or current projections is increased.
 
 
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MEADOWBROOK INSURANCE GROUP, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS - continued
 
This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events.  In particular, the development factor based methods all have as a key assumption that the development of losses in the future will follow a pattern similar to those measured by past experience and as adjusted either explicitly or by actuarial judgment.  There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of reserves, because the eventual deficiency or redundancy is affected by multiple and varied factors.  With respect to the ultimate estimates for losses and LAE, the key assumptions remained consistent for the years ended December 31, 2010 and 2009.

Variability of Claim Reserve Estimates

By its nature, the estimate of ultimate losses and LAE is subject to variability due to differences between our assumptions and actual events in the future.  Although many factors influence the actual cost of claims and our corresponding reserve estimates, we do not measure and estimate values for all of these variables individually.  This is due to the fact that many of the factors known to impact the cost of claims cannot be measured directly, such as the impact on claim costs due to economic inflation, coverage interpretations and jury determinations.  In most instances, we rely on our historical experience or industry information to estimate the values for the variables that are explicitly used in our reserve analyses.  We assume that the historical effect of these unmeasured factors, which is embedded in our experience or industry experience, is representative of the future effects of these factors.  Where we have reason to expect a change in the effect of one of these factors, we perform analyses to perform the necessary adjustments.

One implicit assumption underlying development patterns is that the claims inflation trends will continue into the future similar to their past patterns. To estimate the sensitivity of the estimated ultimate loss and settlement expense payments to an unexpected change in inflationary trends, our actuarial department derives expected payment patterns separately for each major line of business. These patterns were applied to the December 31, 2010 loss and settlement expense reserves to generate estimated annual incremental loss and settlement expense payments for each subsequent calendar year. Then, for the purpose of sensitivity testing, an explicit annual inflationary variance of one percent was added to the inflationary trend that is implicitly embedded in the estimated payment pattern, and revised incremental loss and settlement expense payments were calculated. General inflation trends have been fairly stable over the past several years but there have been fluctuations of one to two percent over the past ten years and therefore we used a one percent annual inflation variance factor. The effect differed by line of business but overall was a three and a half percent change in reserve adequacy or approximately $17.6 million effect on after tax net income.  A variance of this type would typically be recognized in loss and settlement expense reserves and, accordingly, would not have a material effect on liquidity because the claims have not been paid.

An explicit assumption used in the analysis is the set of initial expected loss ratios (“IELRs”) used in the current accident year reserve projections and in some of the prior accident year ultimate loss indications.  To estimate the sensitivity of the estimated ultimate loss to a change in IELRs, the actuarial department recasted the loss reserve indications using a set of IELRs all one percent higher than the final IELRs. The overall impact of a one percent change in IELRS would be a corresponding one percent change in reserve adequacy or a $4.8 million effect on after tax net income.  Often the loss ratios by line of business will vary from the IELR in different directions causing them to partially offset each other.  A variance of this type would typically be recognized in loss and settlement expense reserves and, accordingly, would not have a material effect on liquidity because the claims have not been paid.

The other factors having influence upon the loss and LAE reserve levels are too numerous and interdependent to efficiently model and test for sensitivity.  Likewise, the development factors by reserve category and age are too numerous to model and test for sensitivity.  Instead, ranges are estimated by reserve category considering past history, fluctuations in the development patterns, emerging issues, trends and other factors.  The ranges are compiled and the total range is estimated considering the sensitivity to all of the underlying factors together.  The resulting range is our best estimate of the expected ongoing variability in the loss reserves.

Historic development as shown within the “Analysis of Loss and Loss Adjustment Expense Development” table has been nine percent or less in the last five years but was eleven percent in the year prior to the underwriting and reserving shift in 2002.  At that time, we concentrated our efforts on eliminating underwriting relationships where we had substantial liabilities above an aggregate exposure retained by risk sharing associations and captives.  For a large share of our business, we also accelerated the pace at which we brought the claim administration to our employees and away from outside third party administrators.  This change enabled us to more rapidly recognize trends and underlying loss patterns, and establish more accurate reserves in a timely manner.
 
 
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MEADOWBROOK INSURANCE GROUP, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS - continued
 
Our range of loss and LAE reserves table shows that presently we estimate them as going from favorable development of 8.8% to unfavorable of 6.2%.  The range was evaluated based on the ultimate loss estimates from the actuarial methods described above.

Pre-tax Impact on Earnings from a Variance in Future Loss Payments and Case Reserves as of December 31, 2010
 
(in thousands)
 
Line of Business
 
Minimum Reserve
Range
   
Maximum Reserve
Range
 
Workers Compensation (including Residual Markets)
  ($ 21,460 )     -7.1 %   $ 15,797       5.2 %
Commercial Multiple Peril / General Liability
    (38,404 )     -11.6 %     25,502       7.7 %
Commercial Automobile
    (7,112 )     -6.3 %     5,607       5.0 %
Other
    (1,916 )     -5.2 %     1,778       4.8 %
Total
  ($ 68,892 )     -8.8 %   $ 48,684       6.2 %

The sensitivity around our workers’ compensation reserves primarily reflects the size and the maturity of the underlying book of business.  Our workers’ compensation reserves represent 39% of our total reserves at December 31, 2010.

The sensitivity around our commercial multiple peril / general liability reserves primarily reflects the longer duration of reserves relating to our liability excess program, which started in 2003, and construction defect exposure, which together represent approximately 36% of the $330.9 million reserves in this line of business as of December 31, 2010.  These lines of business are subject to greater uncertainty than the remainder of our book of business.

The sensitivity around our commercial automobile reserves primarily reflects the speed of reporting of the underlying losses, as well as the maturity of the case law surrounding automobile liability.

The sensitivity around the other lines of business primarily reflects the size of the underlying book of business.  Our other reserves represent 5% of total reserves at December 31, 2010.  A large portion of these reserves represent professional liability programs which tend to be claims-made and reinsured at lower limits, therefore reducing the volatility that is inherent in a smaller book of business.  Another large portion represents property claims, which have a shorter reporting and payout pattern than liability and workers’ compensation claims.

All of our reserves are sensitive to changes in the underlying claim payment and case reserving practices, as well as the other sources of variations mentioned above.

Reinsurance Recoverables

Reinsurance recoverables represent (1) amounts currently due from reinsurers on paid losses and LAE, (2) amounts recoverable from reinsurers on case basis estimates of reported losses and LAE, and (3) amounts recoverable from reinsurers on actuarial estimates of IBNR losses and LAE.  Such recoverables, by necessity, are based upon estimates.  Reinsurance does not legally discharge us from our legal liability to our insureds, but it does make the assuming reinsurer liable to us to the extent of the reinsurance ceded.  Instead of being netted against the appropriate liabilities, ceded unearned premiums and reinsurance recoverables on paid and unpaid losses and LAE are reported separately as assets in our consolidated balance sheets.  Reinsurance recoverable balances are also subject to credit risk associated with the particular reinsurer.  In our selection of reinsurers, we continually evaluate their financial stability.  While we believe our reinsurance recoverables are collectible, the ultimate recoverable may be greater or less than the amount accrued.  At December 31, 2010 and 2009, reinsurance recoverables on paid and unpaid losses were $294.2 million and $274.5 million, respectively.
 
 
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MEADOWBROOK INSURANCE GROUP, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS - continued
 
In our risk-sharing programs, we are subject to credit risk with respect to the payment of claims by our clients’ captive, rent-a-captive, large deductible programs, indemnification agreements, or on the portion of risk either ceded to the captives, or retained by the clients.  The capitalization and credit worthiness of prospective risk-sharing partners is one of the factors we consider upon entering into and renewing risk-sharing programs.  We collateralize balances due from our risk-sharing partners through funds withheld trusts or stand-by letters of credit issued by highly rated banks.  We have historically maintained an allowance for the potential uncollectibility of certain reinsurance balances due from some risk-sharing partners, some of which may be in dispute.  At the end of each quarter, an analysis of these exposures is conducted to determine the potential exposure to uncollectibility.  At December 31, 2010, we believe this allowance is adequate. To date, we have not, in the aggregate, experienced material difficulties in collecting balances from our risk-sharing partners.  No assurance can be given, however, regarding the future ability of our risk-sharing partners to meet their obligations.

Legal Contingencies
 
We are subject at times to various claims, lawsuits and proceedings relating principally to alleged errors or omissions in the placement of insurance, claims administration, consulting services and other business transactions arising in the ordinary course of business.  Where appropriate, we vigorously defend such claims, lawsuits and proceedings.  Some of these claims, lawsuits and proceedings seek damages, including consequential, exemplary or punitive damages, in amounts that could, if awarded, be significant.   Most of the claims, lawsuits and proceedings arising in the ordinary course of business are covered by the policy at issue, errors and omissions insurance or other appropriate insurance.  In terms of deductibles associated with such insurance, we have established provisions against these items, which are believed to be adequate in light of current information and legal advice.  In accordance with accounting guidance, if it is probable that an asset has been impaired or a liability has been incurred as of the date of the financial statements and the amount of loss is estimable; an accrual is provided for the costs to resolve these claims in our consolidated accompanying financial statements.  Period expenses related to the defense of such claims are included in other operating expenses in the accompanying consolidated statements of income.  We, with the assistance of outside counsel, adjust such provisions according to new developments or changes in the strategy in dealing with such matters.  On the basis of current information, we do not expect the outcome of the claims, lawsuits and proceedings to which we are subject to, either individually, or in the aggregate, will have a material adverse effect on our financial condition.  However, it is possible that future results of operations or cash flows for any particular quarter or annual period could be materially affected by an unfavorable resolution of any such matters.

Results of Operations

Executive Overview

Our results for the year ended December 31, 2010, include the positive impact from continued selective growth, coupled with our adherence to strict corporate underwriting guidelines as well as a focus on current accident year price adequacy and the benefits derived from leveraging of fixed costs.  Our generally accepted accounting principles (“GAAP”) combined ratio was 95.0% for the year ended December 31, 2010, compared to 93.2% in 2009.   Net operating income increased $4.7 million, or 8.8%, from $53.5 million for the year ended December 31, 2009, to $58.2 million for the year ended December 31, 2010.

Gross written premium increased $113.2 million, or 16.4%, to $801.9 million in 2010, compared to $688.7 million in 2009.  Our growth strategy has been to develop specialty niche expertise in a range of select areas. Through this approach, we have developed a book of business that is broadly diversified by line of business, customer, and geography. Current year growth is largely from workers’ compensation initiatives that were implemented in the second half of 2009 primarily in the Midwest and Western United States, and the expansion of our transportation business in the Southeast.  The majority of the new business we wrote in 2009 had a historical and proven track record of producing an underwriting profit, and we have been able to achieve rate increases on top of what had previously been charged.

During 2010 we re-evaluated our operating segments.  As a result of this re-evaluation, we concluded that the previously reported Agency Operations segment should no longer be considered a separate segment as Agency Operations now represents less than 2% of our consolidated revenues and less than 1% of our consolidated pre-tax profits.  As such, we will only report one operating segment – Specialty Insurance Operations.

Results of Operations 2010 compared to 2009:

Net income for the year ended December 31, 2010, was $59.7 million, or $1.10 per dilutive share, compared to net income of $52.7 million, or $0.92 per dilutive share, for the comparable period of 2009.  Net operating income, a non-GAAP measure, increased $4.7 million, or 8.8%, to $58.2 million, compared to net operating income of $53.5 million in 2009; this equates to an increase in operating income per share of 15.1% to $1.07 per dilutive share, compared to $0.93 per dilutive share in 2009, on lower weighted average shares outstanding.  Total weighted average shares outstanding for the year ended December 31, 2010, were 54,289,131, compared to 57,413,391 for the comparable period in 2009.  This decrease reflects the impact of our Share Repurchase Plan  (the “Plan”) in which we repurchased 2.5 million shares during 2010.  We currently have approximately 2.5 million more shares within the Plan authorized for repurchase.
 
 
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MEADOWBROOK INSURANCE GROUP, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS - continued
 
Net operating income and net operating income per share are non-GAAP measures that represent net income excluding net realized gains or loss, net of tax. The most directly comparable financial GAAP measures to net operating income and net operating income per share are net income and net income per share.  Net operating income and net operating income per share are intended as supplemental information and are not meant to replace net income nor net income per share. Net operating income and net operating income per share should be read in conjunction with the GAAP financial results.  The following is a reconciliation of net operating income to net income, as well as net operating income per share to net income per share:

   
For the Years Ended December 31,
 
   
2010
   
2009
 
   
(In thousands, except share and per share data)
 
Operating income, net of tax
  $ 58,216     $ 53,515  
Net realized gains (losses), net of tax
    1,505       (865 )
Net income
  $ 59,721     $ 52,650  
                 
Diluted earnings per common share:
               
Net operating income
  $ 1.07     $ 0.93  
Net income
  $ 1.10     $ 0.92  
Diluted weighted average common shares outstanding
    54,289,131       57,413,391  
 
We use net operating income and net operating income per share as components to assess our performance and as measures to evaluate the results of our business. We believe these measures provide investors with valuable information relating to our ongoing performance that may be obscured by the net effect of realized gains and losses as a result of our market risk sensitive instruments, which primarily relate to fixed income securities that are available for sale and not held for trading purposes. Realized gains and losses may vary significantly between periods and are generally driven by external economic developments, such as capital market conditions. Accordingly, net operating income excludes the effect of items that tend to be highly variable from period to period and highlights the results from our ongoing business operations and the underlying profitability of our business. Therefore, we believe that it is useful for investors to evaluate net operating income and net operating income per share, along with net income and net income per share when reviewing and evaluating our performance.

Revenues - 2010 compared to 2009

Revenues for the year ended December 31, 2010, increased $122.5 million, or 19.5%, to $750.1 million, from $627.6 million for the comparable period in 2009.  This increase primarily reflects overall growth within our existing programs and new business that was implemented in 2009 and 2010.
 
 
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MEADOWBROOK INSURANCE GROUP, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS - continued
 
The following table sets forth the components of revenues (in thousands):

   
For the Years Ended December 31,
 
   
2010
   
2009
 
Revenue:                
Net earned premiums                                                                                               
  $ 659,840     $ 539,602  
Management administrative fees                                                                                               
    16,240       19,697  
Claims fees                                                                                               
    6,806       7,427  
Investment income                                                                                               
    54,173       50,366  
Commission revenue                                                                                               
    11,193       10,757  
Net realized gains (losses)                                                                                               
    1,817       (225 )
Total revenue                                                                                               
  $ 750,069     $ 627,624  

Net earned premiums increased $120.2 million, or 22.3%, to $659.8 million for the year ended December 31, 2010, from $539.6 million in the comparable period in 2009.  This increase was primarily the result of growth within our existing programs and the new business we began writing in 2009.

Management fees decreased $3.5 million, or 17.6%, to $16.2 million for the year ended December 31, 2010, from $19.7 million for the comparable period in 2009.  This decrease primarily reflects the impact of a program we previously managed that decided to perform its own policy administration services, the conversion of an existing program into an insured program within the Company’s underwriting subsidiary during 2010, as well as a decrease in fees for self-insured programs, caused by a decrease in premium volume from continued competition, economic conditions, and higher unemployment.

Claim fees decreased $0.6 million, or 8.4%, to $6.8 million for the year ended December 31, 2010, from $7.4 million for the comparable period in 2009.  This decrease is primarily due to the previously mentioned program above is now administering their claims in house and an anticipated decrease resulting from the termination of one unprofitable program.

Net investment income increased $3.8 million, or 7.6%, to $54.2 million for the year ended December 31, 2010, from $50.4 million in 2009.  This increase primarily reflects the increase in average invested assets from $1.1 billion in 2009 to $1.3 billion in 2010.  The increase in our average investment balance is because of growth in underwriting profits, growth in investment income, and a slight lengthening of our loss and LAE reserve duration.  The average investment yield for December 31, 2010 was 4.3% compared to 4.4% in 2009.  The current pre-tax book yield was 4.2% compared to 4.4% in 2009.  The current after-tax book yield was 3.1% compared to 3.4% in 2009. The effective duration of the investment portfolio was 5.0 years at December 31, 2010 and 5.1 years at December 30, 2009.

Net realized gains (losses) improved by $2.0 million, to a $1.8 million gain for the year ended December 31, 2010, from a ($0.2) million loss for the comparable period in 2009. The loss in 2009 reflected both the realized losses on the sale of securities sold during the prior year and other-than-temporary impairments pertaining to certain corporate bonds, asset-backed and mortgage-backed securities, compared to the realized gains on the sale of securities sold in 2010.
 
 
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MEADOWBROOK INSURANCE GROUP, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS - continued
 
Expenses - 2010 compared to 2009

In 2010, we completed an in-depth cost allocation study and made refinements to our process to track these costs on a functional basis. The purpose of the study was to align o