e10vq
 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q
     
þ     Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2011
OR
     
o   Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from                      to                     .
Commission File Number 000-51130
 
National Interstate Corporation
(Exact name of registrant as specified in its charter)
     
Ohio   34-1607394
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
 

3250 Interstate Drive
Richfield, Ohio 44286-9000
(330) 659-8900

(Address and telephone number of principal executive offices)
 
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. þ Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). þ Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):
             
Large Accelerated Filer o   Accelerated Filer þ   Non-Accelerated Filer o (Do not check if a smaller reporting company)   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). oYes þ No
The number of shares outstanding of the registrant’s sole class of common shares as of August 3, 2011 was 19,442,191.
 
 
 

 


 

National Interstate Corporation
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PART I — FINANCIAL INFORMATION
ITEM 1.   Financial Statements
National Interstate Corporation and Subsidiaries
Consolidated Balance Sheets (In thousands, except per share data)
                 
    June 30,     December 31,  
    2011     2010  
    (Unaudited)          
ASSETS
               
 
               
Investments:
               
Fixed maturities available-for-sale, at fair value (amortized cost — $897,887 and $901,209, respectively)
  $ 914,698     $ 907,575  
Equity securities available-for-sale, at fair value (amortized cost — $20,351 and $13,424, respectively)
    22,829       16,675  
Other investments
    27,362       13,833  
Short-term investments, at cost which approximates fair value
    68       67  
 
           
Total investments
    964,957       938,150  
Cash and cash equivalents
    39,427       27,054  
Accrued investment income
    9,330       8,650  
Premiums receivable, net of allowance for doubtful accounts of $1,785 and $1,435, respectively
    202,929       162,906  
Reinsurance recoverable on paid and unpaid losses
    201,351       208,590  
Prepaid reinsurance premiums
    39,996       35,065  
Deferred policy acquisition costs
    30,453       23,488  
Deferred federal income taxes
    24,452       27,333  
Property and equipment, net
    23,827       24,469  
Funds held by reinsurer
    3,847       3,788  
Intangible assets, net
    8,816       8,972  
Amounts refundable on estimated purchase price of Vanliner
          14,256  
Prepaid expenses and other assets
    3,405       5,884  
 
           
Total assets
  $ 1,552,790     $ 1,488,605  
 
           
 
               
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Liabilities:
               
Unpaid losses and loss adjustment expenses
  $ 795,396     $ 798,645  
Unearned premiums and service fees
    259,257       221,903  
Long-term debt
    22,000       20,000  
Amounts withheld or retained for accounts of others
    60,561       58,691  
Reinsurance balances payable
    28,135       16,180  
Accounts payable and other liabilities
    40,040       49,605  
Commissions payable
    11,914       9,295  
Assessments and fees payable
    5,046       4,708  
 
           
Total liabilities
    1,222,349       1,179,027  
Shareholders’ equity:
               
Preferred shares — no par value
               
Authorized — 10,000 shares
               
Issued — 0 shares
           
Common shares — $0.01 par value
               
Authorized — 50,000 shares
               
Issued — 23,350 shares, including 3,982 and 3,993 shares, respectively, in treasury
    234       234  
Additional paid-in capital
    50,604       50,273  
Retained earnings
    272,702       258,473  
Accumulated other comprehensive income
    12,538       6,251  
Treasury shares
    (5,637 )     (5,653 )
 
           
Total shareholders’ equity
    330,441       309,578  
 
           
Total liabilities and shareholders’ equity
  $ 1,552,790     $ 1,488,605  
 
           
See notes to consolidated financial statements.

3


 

National Interstate Corporation and Subsidiaries
Consolidated Statements of Income
(Unaudited)
(In thousands, except per share data)
                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2011     2010     2011     2010  
Revenues:
                               
Premiums earned
  $ 106,464     $ 69,233     $ 211,603     $ 139,414  
Net investment income
    7,796       5,012       14,698       9,971  
Net realized gains on investments (*)
    1,316       1,669       2,516       2,551  
Other
    854       976       1,970       1,794  
 
                       
Total revenues
    116,430       76,890       230,787       153,730  
Expenses:
                               
Losses and loss adjustment expenses
    78,570       46,032       153,229       89,136  
Commissions and other underwriting expenses
    21,196       14,735       41,521       29,571  
Other operating and general expenses
    4,095       3,996       8,636       7,622  
Expense on amounts withheld
    979       926       1,819       1,735  
Interest expense
    55       92       109       104  
 
                       
Total expenses
    104,895       65,781       205,314       128,168  
 
                       
Income before income taxes
    11,535       11,109       25,473       25,562  
Provision for income taxes
    3,332       3,491       7,742       7,358  
 
                       
Net income
  $ 8,203     $ 7,618     $ 17,731     $ 18,204  
 
                       
 
                               
Net income per share — basic
  $ 0.42     $ 0.39     $ 0.92     $ 0.94  
 
                       
Net income per share — diluted
  $ 0.42     $ 0.39     $ 0.91     $ 0.94  
 
                       
 
                               
Weighted average of common shares outstanding — basic
    19,368       19,343       19,367       19,336  
 
                       
Weighted average of common shares outstanding — diluted
    19,482       19,456       19,479       19,424  
 
                       
 
                               
Cash dividends per common share
  $ 0.09     $ 0.08     $ 0.18     $ 0.16  
 
                       
 
(*)   Consists of the following:
Consolidated Statements of Income
                                 
Net realized gains before impairment losses
  $ 1,316     $ 1,770     $ 2,516     $ 2,652  
 
                               
Total losses on securities with impairment charges
                       
Non-credit portion in other comprehensive income
          (101 )           (101 )
 
                       
Net impairment charges recognized in earnings
          (101 )           (101 )
 
                       
Net realized gains on investments
  $ 1,316     $ 1,669     $ 2,516     $ 2,551  
 
                       
See notes to consolidated financial statements.

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National Interstate Corporation and Subsidiaries
Consolidated Statements of Shareholders’ Equity
(Unaudited)
(Dollars in thousands)
                                                 
                            Accumulated Other              
            Additional Paid-In             Comprehensive              
    Common Stock     Capital     Retained Earnings     Income (Loss)     Treasury Stock     Total  
Balance at January 1, 2011
  $ 234     $ 50,273     $ 258,473     $ 6,251     $ (5,653 )   $ 309,578  
Net income
                    17,731                       17,731  
Unrealized appreciation of investment securities, net of tax of $3.4 million
                            6,287               6,287  
 
                                             
Comprehensive income
                                            24,018  
Dividends on common stock
                    (3,502 )                     (3,502 )
Issuance of 11,502 treasury shares upon exercise of options and restricted stock issued, net of forfeitures
            (136 )                     16       (120 )
Net tax effect from exercise/vesting of stock-based compensation
            54                               54  
Stock compensation expense
            413                               413  
 
                                   
Balance at June 30, 2011
  $ 234     $ 50,604     $ 272,702     $ 12,538     $ (5,637 )   $ 330,441  
 
                                   
 
                                               
Balance at January 1, 2010
  $ 234     $ 49,264     $ 225,195     $ 2,353     $ (5,729 )   $ 271,317  
Net income
                    18,204                       18,204  
Unrealized appreciation of investment securities, net of tax of $2.4 million
                            4,375               4,375  
 
                                             
Comprehensive income
                                            22,579  
Dividends on common stock
                    (3,115 )                     (3,115 )
Issuance of 41,579 treasury shares upon exercise of options, stock award grants and restricted stock issued, net of forfeitures
            387                       57       444  
Net tax effect from exercise/vesting of stock-based compensation
            (50 )                             (50 )
Stock compensation expense
            485                               485  
 
                                   
Balance at June 30, 2010
  $ 234     $ 50,086     $ 240,284     $ 6,728     $ (5,672 )   $ 291,660  
 
                                   
See notes to consolidated financial statements.

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National Interstate Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
(Dollars in thousands)
                 
    Six Months Ended June 30,  
    2011     2010  
Operating activities
               
Net income
  $ 17,731     $ 18,204  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Net amortization of bond premiums and discounts
    4,999       1,368  
Provision for depreciation and amortization
    1,806       1,112  
Net realized gains on investment securities
    (2,516 )     (2,551 )
Deferred federal income taxes
    (504 )     (1,522 )
Stock compensation expense
    413       485  
Increase in deferred policy acquisition costs, net
    (6,965 )     (4,669 )
(Decrease) increase in reserves for losses and loss adjustment expenses
    (3,249 )     5,858  
Increase in premiums receivable
    (40,023 )     (41,315 )
Increase in unearned premiums and service fees
    37,354       42,413  
Decrease in interest receivable and other assets
    1,740       981  
Increase in prepaid reinsurance premiums
    (4,931 )     (14,325 )
(Decrease) increase in accounts payable, commissions and other liabilities and assessments and fees payable
    (6,608 )     6,005  
Increase in amounts withheld or retained for accounts of others
    1,870       647  
Decrease in reinsurance recoverable
    7,239       4,919  
Increase in reinsurance balances payable
    11,955       11,786  
Other
    (69 )     (58 )
 
           
Net cash provided by operating activities
    20,242       29,338  
 
           
 
               
Investing activities
               
Purchases of fixed maturities
    (158,400 )     (191,247 )
Purchases of equity securities
    (10,814 )      
Proceeds from sale of fixed maturities
    10,022       70,911  
Proceeds from sale of equity securities
    5,164       156  
Proceeds from maturities and redemptions of investments
    147,410       216,940  
Change in other investments, net
    (13,000 )      
Collection of amounts refundable on purchase price of Vanliner
    14,256        
Deposit in advance of acquisition
          (128,059 )
Capital expenditures
    (939 )     (1,131 )
 
           
Net cash used in investing activities
    (6,301 )     (32,430 )
 
           
 
               
Financing activities
               
Excess tax benefit realized from vesting of restricted stock
    54        
Additional long-term borrowings
    2,000       30,000  
Issuance of common shares from treasury upon exercise of stock options or stock award grants
    (120 )     444  
Cash dividends paid on common shares
    (3,502 )     (3,115 )
 
           
Net cash (used in) provided by financing activities
    (1,568 )     27,329  
 
           
Net increase in cash and cash equivalents
    12,373       24,237  
Cash and cash equivalents at beginning of period
    27,054       18,589  
 
           
Cash and cash equivalents at end of period
  $ 39,427     $ 42,826  
 
           
See notes to consolidated financial statements.

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NATIONAL INTERSTATE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements of National Interstate Corporation (the “Company”) and its subsidiaries have been prepared in accordance with the instructions to Form 10-Q, which differ in some respects from statutory accounting principles permitted by state regulatory agencies.
The unaudited consolidated financial statements include the accounts of the Company and its subsidiaries, National Interstate Insurance Company (“NIIC”), Hudson Indemnity, Ltd. (“HIL”), National Interstate Insurance Company of Hawaii, Inc. (“NIIC-HI”), Triumphe Casualty Company (“TCC”), National Interstate Insurance Agency, Inc. (“NIIA”), Hudson Management Group, Ltd. (“HMG”), Vanliner Group Inc. (“Vanliner”), Vanliner Insurance Company (“VIC”), Vanliner Reinsurance Company (“VRC”), American Highways Insurance Agency, Inc., Safety, Claims and Litigation Services, Inc., Explorer RV Insurance Agency, Inc., Safety, Claims and Litigation Services, LLC and TransProtection Service Company. Significant intercompany transactions have been eliminated.
These interim unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. The interim financial statements reflect all adjustments which are, in the opinion of management, necessary for the fair presentation of the results for the periods presented. Such adjustments are of a normal recurring nature. Operating results for the three and six month periods ended June 30, 2011 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2011.
The unaudited consolidated financial statements include the results of operations and cash flows of Vanliner and its subsidiaries for the three and six months ended June 30, 2011, as Vanliner was acquired on July 1, 2010. As such, Vanliner and its subsidiaries are not included in the results of operations and cash flows for the three and six months ended June 30, 2010.
The preparation of the financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Changes in circumstances could cause actual results to differ materially from those estimates. Certain reclassifications have been made to financial information presented for prior years to conform to the current year’s presentation.
2. Recent Accounting Pronouncements
In October 2010, the FASB issued Accounting Standards Update No. 2010-26, Financial Services - Insurance (“ASU 2010-26”). ASU 2010-26 amends ASC 944, Financial Services — Insurance, limiting the capitalization of costs incurred in the acquisition of new and renewal contracts to incremental direct costs of contract acquisition and certain costs related directly to certain acquisition activities performed by the insurer of the contract. ASU 2010-26 is effective for interim and annual reporting periods beginning after December 15, 2011, with retrospective application permitted, but not required. The Company will adopt ASU 2010-26 on January 1, 2012. This guidance will result in fewer acquisition costs being capitalized by the Company. Management is still in the process of evaluating the impact such adoption will have on financial condition, results of operations and liquidity.
In June 2011, the FASB issued Accounting Standards Update No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income (“ASU 2011-05”). ASU 2011-05 eliminates the option to report other comprehensive income and its components in the statement of shareholders’ equity. ASU 2011-05 requires that all non-owner changes in shareholders’ equity be presented in either a single continuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. ASU 2011-05 is effective for interim and annual reporting periods beginning after December 15, 2011. The Company will adopt ASU 2011-05 on January 1, 2012. The updated guidance only requires a change in the format of information already disclosed; the adoption will not impact our cash flows, financial condition, or net income.
3. Fair Value Measurements
The Company must determine the appropriate level in the fair value hierarchy for each applicable fair value measurement. The fair value hierarchy prioritizes the inputs, which refer broadly to assumptions market participants would use in pricing an asset or

7


 

liability, into three levels. It gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The level in the fair value hierarchy within which a fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety. Fair values for the Company’s investment portfolio are reviewed by company personnel using data from nationally recognized pricing services as well as non-binding broker quotes on a limited basis.
Pricing services use a variety of observable inputs to estimate the fair value of fixed maturities that do not trade on a daily basis. These inputs include, but are not limited to, recent reported trades, benchmark yields, issuer spreads, bids or offers, reference data and measures of volatility. Included in the pricing of mortgage-backed securities are estimates of the rate of future prepayments and defaults of principal over the remaining life of the underlying collateral. Inputs from brokers and independent financial institutions include, but are not limited to, yields or spreads of comparable investments which have recent trading activity, credit quality, duration, credit enhancements, collateral value and estimated cash flows based on inputs including delinquency rates, estimated defaults and losses, and estimates of the rate of future prepayments. Valuation techniques utilized by pricing services and values obtained from brokers and independent financial institutions are reviewed by company personnel who are familiar with the securities being priced and the markets in which they trade to ensure that the fair value determination is representative of an exit price, as defined by accounting standards.
Level 1 inputs are quoted prices (unadjusted) in active markets for identical securities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices within Level 1 that are observable for the security, either directly or indirectly. Level 2 inputs include quoted prices for similar securities in active markets, quoted prices for identical or similar securities that are not active and observable inputs other than quoted prices, such as interest rate and yield curves. Level 3 inputs are unobservable inputs for the asset or liability.
Level 1 consists of publicly traded equity securities whose fair value is based on quoted prices that are readily and regularly available in an active market. Level 2 primarily consists of financial instruments whose fair value is based on quoted prices in markets that are not active and include U.S. government and government agency securities, fixed maturity investments, perpetual preferred stock and certain publicly traded common stocks that are not actively traded. Included in Level 2 are $6.0 million of securities, which are valued based upon a non-binding broker quote and validated with other observable market data by management. Level 3 consists of financial instruments that are not traded in an active market, whose fair value is estimated by management based on inputs from independent financial institutions, which include non-binding broker quotes, for which the Company believes reflects fair value, but for which the Company is unable to verify inputs to the valuation methodology. The Company obtained at least one quote or price per instrument from its brokers and pricing services for all Level 3 securities and did not adjust any quotes or prices that it obtained. Management reviews these broker quotes using any recent trades, if such information is available, or market prices of similar investments. The Company primarily uses the market approach valuation technique for all investments.
The following table presents the Company’s investment portfolio, categorized by the level within the fair value hierarchy in which the fair value measurements fall as of June 30, 2011:
                                 
    Level 1     Level 2     Level 3     Total  
    (Dollars in thousands)  
Fixed maturities:
                               
U.S. Government and government agency obligations
  $     $ 130,943     $     $ 130,943  
Foreign government obligations
          5,713             5,713  
State and local government obligations
          287,152       4,301       291,453  
Residential mortgage-backed securities
          198,911             198,911  
Commercial mortgage-backed securities
          7,724             7,724  
Corporate obligations
          267,510       2,216       269,726  
Redeemable preferred stocks
    9,638       143       447       10,228  
 
                       
Total fixed maturities
    9,638       898,096       6,964       914,698  
Equity securities:
                               
Common stocks
    21,195       16             21,211  
Perpetual preferred stocks
    325       897       396       1,618  
 
                       
Total equity securities
    21,520       913       396       22,829  
Short-term investments
          68             68  
 
                       
Total investments
    31,158       899,077       7,360       937,595  
Cash and cash equivalents
    39,427                   39,427  
 
                       
Total investments and cash and cash equivalents at fair value
  $ 70,585     $ 899,077     $ 7,360     $ 977,022  
 
                       

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The following table presents the Company’s investment portfolio, categorized by the level within the fair value hierarchy in which the fair value measurements fall as of December 31, 2010:
                                 
    Level 1     Level 2     Level 3     Total  
    (Dollars in thousands)  
Fixed maturities:
                               
U.S. Government and government agency obligations
  $     $ 184,857     $     $ 184,857  
Foreign government obligations
          5,676             5,676  
State and local government obligations
          266,023       3,992       270,015  
Residential mortgage-backed securities
          196,738             196,738  
Commercial mortgage-backed securities
          5,570             5,570  
Corporate obligations
          230,287       2,290       232,577  
Redeemable preferred stocks
    9,238       475       2,429       12,142  
 
                       
Total fixed maturities
    9,238       889,626       8,711       907,575  
Equity securities:
                               
Common stocks
    15,275       37             15,312  
Perpetual preferred stocks
    840       127       396       1,363  
 
                       
Total equity securities
    16,115       164       396       16,675  
Short-term investments
          67             67  
 
                       
Total investments
    25,353       889,857       9,107       924,317  
Cash and cash equivalents
    27,054                   27,054  
 
                       
Total investments and cash and cash equivalents at fair value
  $ 52,407     $ 889,857     $ 9,107     $ 951,371  
 
                       
The tables above exclude investments in limited partnerships accounted for under the equity method of $27.4 million and $13.8 million (included in “other investments”) at June 30, 2011 and December 31, 2010, respectively. As such, they are not reported at fair value.

9


 

The Company uses the end of the reporting period as its policy for determining transfers into and out of each level. There were no significant transfers between Level 1 and Level 2 during the three and six months ended June 30, 2011. The following table presents a reconciliation of the beginning and ending balances for all investments measured at fair value on a recurring basis using Level 3 inputs for the three and six months ended June 30, 2011:
                                 
    Three Months Ended June 30, 2011  
    State and Local                    
    Government     Corporate     Redeemable     Perpetual Preferred  
    Obligations     Obligations     Preferred Stock     Stock  
    (Dollars in thousands)  
Beginning balance at April 1, 2011
  $ 4,210     $ 2,268     $ 2,423     $ 396  
Total gains or (losses):
                               
Included in earnings
                       
Included in other comprehensive income
    91       11       24        
Purchases and issuances
                       
Sales, settlements and redemptions
          (63 )     (2,000 )      
Transfers in and/or (out) of Level 3
                       
 
                       
Ending balance at June 30, 2011
  $ 4,301     $ 2,216     $ 447     $ 396  
 
                       
 
                               
The amount of total gains or (losses) for the period included in earnings and attributable to the change in unrealized gains or (losses) relating to assets still held at the reporting date
  $     $     $     $  
 
                       
                                 
    Six Months Ended June 30, 2011  
    State and Local                    
    Government     Corporate     Redeemable     Perpetual Preferred  
    Obligations     Obligations     Preferred Stock     Stock  
    (Dollars in thousands)  
Beginning balance at January 1, 2011
  $ 3,992     $ 2,290     $ 2,429     $ 396  
Total gains or (losses):
                               
Included in earnings
                       
Included in other comprehensive income
    309       61       18        
Purchases and issuances, sales and settlements:
                       
Sales, settlements and redemptions
          (135 )     (2,000 )      
Transfers in and/or (out) of Level 3
                       
 
                       
Ending balance at June 30, 2011
  $ 4,301     $ 2,216     $ 447     $ 396  
 
                       
 
                               
The amount of total gains or (losses) for the period included in earnings and attributable to the change in unrealized gains or (losses) relating to assets still held at the reporting date
  $     $     $     $  
 
                       
The following table presents a reconciliation of the beginning and ending balances for all investments measured at fair value on a recurring basis using Level 3 inputs for the three and six months ended June 30, 2010:
                                         
    Three Months Ended June 30, 2010
    State and Local             Residential              
    Government     Corporate     Mortgage-Backed     Redeemable     Perpetual Preferred  
    Obligations     Obligations     Securities     Preferred Stock     Stock  
                    (Dollars in thousands)                  
Beginning balance at April 1, 2010
  $ 6,387     $ 5,840     $ 2,367     $ 2,368     $ 396  
Total gains or (losses):
                                       
Included in earnings
                             
Included in other comprehensive income
    577       (101 )     54       39        
Purchases, issuances, sales and settlements:
                                       
Sales
    (3,000 )     (178 )     (354 )            
Transfers in and/or (out) of Level 3
                             
 
                             
Ending balance at June 30, 2010
  $ 3,964     $ 5,561     $ 2,067     $ 2,407     $ 396  
 
                             
 
                                       
The amount of total gains or (losses) for the period included in earnings and attributable to the change in unrealized gains or (losses) relating to assets still held at the reporting date
  $     $     $     $     $  
 
                             

10


 

                                         
    Six Months Ended June 30, 2010
    State and Local             Residential              
    Government     Corporate     Mortgage-Backed     Redeemable     Perpetual Preferred  
    Obligations     Obligations     Securities     Preferred Stock     Stock  
                    (Dollars in thousands)                  
Beginning balance at January 1, 2010
  $ 6,369     $ 5,842     $ 2,384     $ 2,353     $ 396  
Total gains or (losses):
                                       
Included in earnings
                             
Included in other comprehensive income
    595       12       201       54        
Purchases and issuances
                                       
Sales, settlements and redemptions
    (3,000 )     (293 )     (518 )            
Transfers in and/or (out) of Level 3
                             
 
                             
Ending balance at June 30, 2010
  $ 3,964     $ 5,561     $ 2,067     $ 2,407     $ 396  
 
                             
 
                                       
The amount of total gains or (losses) for the period included in earnings and attributable to the change in unrealized gains or (losses) relating to assets still held at the reporting date
  $     $     $     $     $  
 
                             
4. Investments
Under current other-than-temporary impairment accounting guidance, if management can assert that it does not intend to sell an impaired fixed maturity security and it is not more likely than not that it will have to sell the security before recovery of its amortized cost basis, then an entity may separate the other-than-temporary impairments into two components: 1) the amount related to credit losses (recorded in earnings) and 2) the amount related to all other factors (recorded in other comprehensive income (loss)). The credit related portion of an other-than-temporary impairment is measured by comparing a security’s amortized cost to the present value of its current expected cash flows discounted at its effective yield prior to the impairment charge. If management intends to sell an impaired security, or it is more likely than not that it will be required to sell the security before recovery, an impairment charge recorded in earnings is required to reduce the amortized cost of that security to fair value.

11


 

The cost or amortized cost and fair value of investments in fixed maturities and equity securities are as follows:
                                 
    Cost or     Gross Unrealized     Gross Unrealized        
    Amortized Cost     Gains     Losses     Fair Value  
    (Dollars in thousands)  
June 30, 2011:
                               
Fixed Maturities:
                               
U.S. Government and government agency obligations
  $ 128,185     $ 3,046     $ (288 )   $ 130,943  
Foreign government obligations
    5,702       11             5,713  
State and local government obligations
    285,008       7,337       (892 )     291,453  
Residential mortgage-backed securities
    198,105       3,722       (2,916 )     198,911  
Commercial mortgage-backed securities
    7,799       10       (85 )     7,724  
Corporate obligations
    262,834       7,314       (422 )     269,726  
Redeemable preferred stocks
    10,254       179       (205 )     10,228  
 
                       
Total fixed maturities
    897,887       21,619       (4,808 )     914,698  
Equity securities:
                               
Common stocks
    19,042       2,575       (406 )     21,211  
Perpetual preferred stocks
    1,309       309             1,618  
 
                       
Total equity securities
    20,351       2,884       (406 )     22,829  
Short-term investments
    68                   68  
 
                       
Total investments
  $ 918,306     $ 24,503     $ (5,214 )   $ 937,595  
 
                       
 
                               
December 31, 2010:
                               
Fixed Maturities:
                               
U.S. Government and government agency obligations
  $ 183,370     $ 2,463     $ (976 )   $ 184,857  
Foreign government obligations
    5,741             (65 )     5,676  
State and local government obligations
    267,966       4,611       (2,562 )     270,015  
Residential mortgage-backed securities
    196,644       3,126       (3,032 )     196,738  
Commercial mortgage-backed securities
    5,798             (228 )     5,570  
Corporate obligations
    229,263       4,400       (1,086 )     232,577  
Redeemable preferred stocks
    12,427       126       (411 )     12,142  
 
                       
Total fixed maturities
    901,209       14,726       (8,360 )     907,575  
Equity securities:
                               
Common stocks
    12,115       3,197             15,312  
Perpetual preferred stocks
    1,309       88       (34 )     1,363  
 
                       
Total equity securities
    13,424       3,285       (34 )     16,675  
Short-term investments
    67                   67  
 
                       
Total investments
  $ 914,700     $ 18,011     $ (8,394 )   $ 924,317  
 
                       
The table above excludes investments in limited partnerships accounted for under the equity method of $27.4 million and $13.8 million (included in “other investments”) at June 30, 2011 and December 31, 2010, respectively. As such, they are not reported at fair value.
The amortized cost and fair value of fixed maturities at June 30, 2011, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The average life of mortgage-backed securities is 3.8 years in the Company’s investment portfolio.
Amortized cost and fair value of the fixed maturities in the Company’s investment portfolio were as follows:
                 
    Amortized Cost     Fair Value  
    (Dollars in thousands)  
Due in one year or less
  $ 27,399     $ 28,023  
Due after one year through five years
    246,622       253,350  
Due after five years through ten years
    302,150       310,386  
Due after ten years
    115,812       116,304  
 
           
 
    691,983       708,063  
Mortgage-backed securities
    205,904       206,635  
 
           
Total
  $ 897,887     $ 914,698  
 
           

12


 

Gains and losses on the sale of investments, including other-than-temporary impairment charges and other investments’ gains or losses, were as follows:
                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2011     2010     2011     2010  
    (Dollars in thousands)     (Dollars in thousands)  
Fixed maturity gains
  $ 275     $ 1,949     $ 708     $ 2,408  
Fixed maturity losses
          (102 )           (102 )
Equity security gains
    706             1,278       30  
Equity security losses
                       
Other investments, net gains (losses)
    335       (178 )     530       215  
 
                       
Net realized gains on investments
  $ 1,316     $ 1,669     $ 2,516     $ 2,551  
 
                       
Pre-tax net realized gains were $1.3 million and $2.5 million for the three and six months ended June 30, 2011, respectively. The net realized gains for both the three and six months ended June 30, 2011 were generated from realized gains associated with the sales or calls of securities of $1.0 million and $2.0 million, respectively, which were primarily from common stocks and corporate obligations, and net gains associated with equity in earnings of limited partnerships (included in “other investments”) of $0.3 million and $0.5 million, respectively. There were no impairment charges taken during the three and six months ended June 30, 2011.
Pre-tax net realized gains were $1.7 million and $2.6 million for the three and six months ended June 30, 2010, respectively. The net realized gains for both the three and six month periods ended June 30, 2010 were primarily generated from net realized gains associated with the sales of securities of $2.0 million and $2.5 million, respectively. The gains on sales of equity and fixed maturity securities were primarily due to favorable market conditions that increased the value of the securities over book value, and the Company sold these securities in order to generate funds for the July 1, 2010 purchase of Vanliner. Included in the six months ended June 30, 2010 were gains associated with other investments of $0.4 million, which occurred during the first three months of 2010. Partially offsetting these gains were losses on other investments of $0.2 million during the three months ended June 30, 2011 and an other-than-temporary impairment charge of $0.1 million for both the three and six months ended June 30, 2010.

13


 

The following table summarizes the Company’s gross unrealized losses on fixed maturities and equity securities and the length of time that individual securities have been in a continuous unrealized loss position:
                                                                 
    Less than Twelve Months     Twelve Months or More  
                    Fair                             Fair        
                    Value     Number                     Value     Number  
    Fair     Unrealized     as % of     of     Fair     Unrealized     as % of     of  
    Value     Losses     Cost     Holdings     Value     Losses     Cost     Holdings  
    (Dollars in thousands)  
June 30, 2011:
                                                               
Fixed maturities:
                                                               
U.S. Government and government agency obligations
  $ 32,003     $ (288 )     99.1 %     17     $     $              
State and local government obligations
    22,720       (313 )     98.6 %     20       5,569       (579 )     90.6 %     4  
Residential mortgage-backed securities
    54,588       (561 )     99.0 %     20       6,361       (2,355 )     73.0 %     6  
Commercial mortgage-backed securities
    2,064       (11 )     99.5 %     1       3,631       (74 )     98.0 %     1  
Corporate obligations
    37,019       (389 )     99.0 %     66       2,967       (33 )     98.9 %     2  
Redeemable preferred stocks
    3,731       (125 )     96.8 %     7       920       (80 )     92.0 %     2  
 
                                                   
Total fixed maturities
    152,125       (1,687 )     98.9 %     131       19,448       (3,121 )     86.2 %     15  
Equity securities:
                                                               
Common stocks
    3,142       (406 )     88.6 %     4                          
 
                                                   
Total equity securities
    3,142       (406 )     88.6 %     4                          
 
                                                   
Total fixed maturities and equity securities
  $ 155,267     $ (2,093 )     98.7 %     135     $ 19,448     $ (3,121 )     86.2 %     15  
 
                                                   
 
                                                               
December 31, 2010:
                                                               
Fixed maturities:
                                                               
U.S. Government and government agency obligations
  $ 76,781     $ (976 )     98.7 %     35     $     $              
Foreign government obligations
    5,676       (65 )     98.9 %     3                          
State and local government obligations
    124,938       (1,599 )     98.7 %     108       5,194       (963 )     84.4 %     4  
Residential mortgage-backed securities
    78,332       (1,056 )     98.7 %     25       7,317       (1,976 )     78.7 %     5  
Commercial mortgage-backed securities
    2,034       (48 )     97.7 %     1       3,536       (180 )     95.2 %     1  
Corporate obligations
    62,158       (652 )     99.0 %     61       6,311       (434 )     93.6 %     7  
Redeemable preferred stocks
    3,326       (266 )     92.6 %     8       3,691       (145 )     96.2 %     5  
 
                                                   
Total fixed maturities
    353,245       (4,662 )     98.7 %     241       26,049       (3,698 )     87.6 %     22  
Equity securities:
                                                               
Perpetual preferred stocks
    605       (34 )     94.7 %     4                          
 
                                                   
Total equity securities
    605       (34 )     94.7 %     4                          
 
                                                   
Total fixed maturities and equity securities
  $ 353,850     $ (4,696 )     98.7 %     245     $ 26,049     $ (3,698 )     87.6 %     22  
 
                                                   
The gross unrealized losses on the Company’s fixed maturities and equity securities portfolios decreased from $8.4 million at December 31, 2010 to $5.2 million at June 30, 2011. The improvement in gross unrealized losses was driven by a decrease in market yields and a general tightening of credit spreads from December 31, 2010. The $5.2 million in gross unrealized losses at June 30, 2011 was primarily on fixed maturity holdings in residential mortgage-backed securities, and to a lesser extent, state and local government obligations and corporate obligations. The gross unrealized losses on common stocks are minimal and are considered to be temporary. There were no gross unrealized losses on perpetual preferred stocks. Investment grade securities (as determined by nationally recognized rating agencies) represented 86.5% of all fixed maturity securities with unrealized losses.
At June 30, 2011, gross unrealized losses on residential mortgage-backed securities were $2.9 million and represented 60.6% of the total gross unrealized losses on fixed maturities. There were six securities with gross unrealized losses of $2.4 million that were in an unrealized loss position for 12 months or more. Three of these securities previously had both credit and non-credit other-than-temporary impairment charges and were in a gross unrealized loss position of $1.5 million at June 30, 2011. Based on historical payment data and analysis of expected future cash flows of the underlying collateral, independent credit ratings and other facts and analysis, including management’s current intent and ability to hold these securities for a period of time sufficient to allow for anticipated recovery, management believes that, based upon information currently available, the Company will recover its cost basis in all these securities and no additional charges for other-than-temporary impairments will be required.
At June 30, 2011, the state and local government obligations, with gross unrealized losses of $0.9 million, had 20 holdings that were in an unrealized loss position of $0.3 million for less than 12 months and four holdings that were in an unrealized loss position of $0.6 million for more than 12 months. Investment grade securities represented 86.5% of all state and local government obligations with unrealized losses greater than 12 months. The corporate obligations had gross unrealized losses totaling $0.4 million at June 30, 2011. The gross unrealized losses on corporate obligations consisted of 66 holdings with gross unrealized

14


 

losses of $0.4 million that were in an unrealized loss position for less than 12 months. Investment grade securities represented 66.7% of all corporate obligations with unrealized losses greater than 12 months.
Management concluded that no additional charges for other-than-temporary impairment were required on the fixed maturity holdings based on many factors, including the Company’s ability and current intent to hold these investments for a period of time sufficient to allow for anticipated recovery of its amortized cost, the length of time and the extent to which fair value has been below cost, analysis of company-specific financial data and the outlook for industry sectors and credit ratings. The Company believes these unrealized losses are primarily due to temporary market and sector-related factors and does not consider these securities to be other-than-temporarily impaired. If the Company’s strategy was to change or these securities were determined to be other-than-temporarily impaired, the Company would recognize a write-down in accordance with its stated policy.
The following table is a progression of the amount related to credit losses on fixed maturity securities for which the non-credit portion of an other-than-temporary impairment has been recognized in other comprehensive income.
                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2011     2010     2011     2010  
    (Dollars in thousands)     (Dollars in thousands)  
Beginning balance
  $ 2,017     $ 1,910     $ 2,017     $ 1,910  
Additional credit impairments on:
                               
Previously impaired securities
          101             101  
Securities without prior impairments
                       
Reductions
          (37 )           (37 )
 
                       
Ending balance
  $ 2,017     $ 1,974     $ 2,017     $ 1,974  
 
                       
5. Income Taxes
A reconciliation of the provision for income taxes for financial reporting purposes and the provision for income taxes calculated at the statutory rate of 35% is as follows:
                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2011     2010     2011     2010  
    (Dollars in thousands)     (Dollars in thousands)  
Federal income tax expense at statutory rate
  $ 4,037     $ 3,888     $ 8,915     $ 8,947  
Effect of:
                               
Tax-exempt investment income
    (756 )     (377 )     (1,389 )     (751 )
Change in valuation allowance on net capital losses
                      (810 )
Other items, net
    51       (20 )     216       (28 )
 
                       
 
  $ 3,332     $ 3,491     $ 7,742     $ 7,358  
 
                       
The tax effects of temporary differences that give rise to significant portions of the net deferred tax assets and liabilities in the Consolidated Balance Sheets were as follows:
                 
    June 30, 2011     December 31, 2010  
    (Dollars in thousands)  
Deferred Tax Assets:
               
Unearned premiums
  $ 15,395     $ 13,103  
Unpaid losses and loss adjustment expenses
    18,869       18,700  
Assignments and assessments
    1,568       1,474  
Realized losses on investments, primarily impairments
    5,457       6,092  
Accrued compensation
    2,601       3,156  
Other, net
    3,803       2,129  
 
           
 
    47,693       44,654  
Deferred Tax Liabilities:
               
Deferred policy acquisition costs
    (10,658 )     (8,221 )
Unrealized gains on investments
    (6,751 )     (3,366 )
Intangible assets
    (3,073 )     (3,122 )
Other, net
    (2,759 )     (2,612 )
 
           
Total deferred tax liabilities
    (23,241 )     (17,321 )
 
           
Net deferred income tax assets
  $ 24,452     $ 27,333  
 
           
Management has reviewed the recoverability of the deferred tax assets and believes that the amount will be recoverable against future earnings.

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6. Shareholders’ Equity and Stock-Based Compensation
The Company grants options and other stock awards to officers and key employees of the Company under the Long Term Incentive Plan (“LTIP”). At June 30, 2011, there were options for 620,550 shares outstanding and 776,536 of the Company’s common shares reserved for issuance under the LTIP. Treasury shares are used to fulfill the options exercised and other awards granted. Options and restricted shares vest pursuant to the terms of a written grant agreement. Options must be exercised no later than the tenth anniversary of the date of grant. As set forth in the LTIP, the Compensation Committee of the Board of Directors may accelerate vesting and exercisability of options.
For the three months ended June 30, 2011, the Company recognized stock-based compensation expense of $0.1 million with related income tax benefits of approximately $32 thousand, as compared to stock-based compensation expense of $0.1 million with related income tax benefits of approximately $48 thousand for the same period in 2010. For both the six months ended June 30, 2011 and 2010, the Company recognized stock-based compensation expense of $0.4 million and $0.5 million, respectively, with related income tax benefits of approximately $0.1 million.
7. Earnings Per Common Share
The following table sets forth the computation of basic and diluted net income per share:
                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2011     2010     2011     2010  
    (In thousands, except per share data)     (In thousands, except per share data)  
Net income
  $ 8,203     $ 7,618     $ 17,731     $ 18,204  
 
                       
 
                               
Weighted average shares outstanding during period
    19,368       19,343       19,367       19,336  
Additional shares issuable under employee common stock option plans using treasury stock method
    114       113       112       88  
 
                       
 
                               
Weighted average shares outstanding assuming exercise of stock options
    19,482       19,456       19,479       19,424  
 
                       
 
                               
Net income per share:
                               
Basic
  $ 0.42     $ 0.39     $ 0.92     $ 0.94  
Diluted
  $ 0.42     $ 0.39     $ 0.91     $ 0.94  
For the three months ended June 30, 2011 and 2010, there were 279,598 and 344,113, respectively, outstanding options and restricted shares excluded from diluted earnings per share because they were anti-dilutive. For the six months ended June 30, 2011 and 2010, there were 227,152 and 438,550, respectively, outstanding options and restricted shares excluded from diluted earnings per share because they were anti-dilutive.
8. Transactions with Related Parties
The Company’s principal insurance subsidiary, NIIC, is involved in both the cession and assumption of reinsurance. NIIC is a party to a reinsurance agreement, and NIIA, a wholly-owned subsidiary of the Company, is a party to an underwriting management agreement with Great American Insurance Company (“Great American”). As of June 30, 2011, Great American owned 52.5% of the outstanding shares of the Company. The reinsurance agreement calls for the assumption by NIIC of all of the risk on Great American’s net premiums written for public transportation and recreational vehicle risks underwritten pursuant to the reinsurance agreement. NIIA provides administrative services to Great American in connection with Great American’s underwriting of these risks. The Company also cedes premium through reinsurance agreements with Great American to reduce exposure in certain of its property and casualty insurance programs.
The table below summarizes the reinsurance balance and activity with Great American:
                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2011     2010     2011     2010  
    (Dollars in thousands)     (Dollars in thousands)  
Assumed premiums written
  $ 1,350     $ 1,241     $ 2,558     $ 2,287  
Assumed premiums earned
    1,029       799       2,009       1,571  
Assumed losses and loss adjustment expense incurred
    932       544       2,019       649  
Ceded premiums written
    144       694       477       1,383  
Ceded premiums earned
    379       623       844       1,303  
Ceded losses and loss adjustment expense recoveries
    348       1,434       1,135       1,701  
Payable to Great American as of period end
    129       540       129       540  

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Great American or its parent, American Financial Group, Inc., perform certain services for the Company without charge including, without limitation, actuarial services and on a consultative basis, as needed, internal audit, legal, accounting and other support services. If Great American no longer controlled a majority of the Company’s common shares, it is possible that many of these services would cease or, alternatively, be provided at an increased cost to the Company. This could impact the Company’s personnel resources, require the Company to hire additional professional staff and generally increase the Company’s operating expenses. Management believes, based on discussions with Great American, that these services will continue to be provided by the affiliated entity in future periods and the relative impact on operating results is not material.
9. Reinsurance
Premiums and reinsurance activity consisted of the following:
                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2011     2010     2011     2010  
    (Dollars in thousands)     (Dollars in thousands)  
Direct premiums written
  $ 153,473     $ 108,239     $ 285,323     $ 212,365  
Reinsurance assumed
    3,012       2,487       5,475       4,165  
Reinsurance ceded
    (22,742 )     (24,799 )     (46,804 )     (49,149 )
 
                       
Net premiums written
  $ 133,743     $ 85,927     $ 243,994     $ 167,381  
 
                       
 
                               
Direct premiums earned
  $ 124,728     $ 85,103     $ 248,215     $ 170,821  
Reinsurance assumed
    2,526       1,884       5,010       3,417  
Reinsurance ceded
    (20,790 )     (17,754 )     (41,622 )     (34,824 )
 
                       
Total premiums earned
  $ 106,464     $ 69,233     $ 211,603     $ 139,414  
 
                       
The Company cedes premiums through reinsurance agreements with reinsurers to reduce exposure in certain of its property-casualty insurance programs. Ceded losses and loss adjustment expense recoveries recorded for the three months ended June 30, 2011 and 2010 were $16.0 million and $15.9 million, respectively, and were $29.5 million and $25.0 million for the six months ended June 30, 2011 and 2010, respectively. The Company remains primarily liable as the direct insurer on all risks reinsured and a contingent liability exists to the extent that the reinsurance companies are unable to meet their obligations for losses assumed. To minimize its exposure to significant losses from reinsurer insolvencies, the Company seeks to do business with only reinsurers rated “Excellent” or better by A.M. Best Company and regularly evaluates the financial condition of its reinsurers.
10. Commitments and Contingencies
The Company and its subsidiaries are subject at times to various claims, lawsuits and legal proceedings arising in the ordinary course of business. All legal actions relating to claims made under insurance policies are considered in the establishment of our loss and loss adjustment expense (“LAE”) reserves. In addition, regulatory bodies, such as state insurance departments, the Securities and Exchange Commission (“SEC”), the Department of Labor and other regulatory bodies may make inquiries and conduct examinations or investigations concerning the Company’s compliance with insurance laws, securities laws, labor laws and the Employee Retirement Income Security Act of 1974, as amended.
The Company’s subsidiaries also have lawsuits pending in which the plaintiff seeks extra-contractual damages from the Company in addition to damages claimed or in excess of the available limits under an insurance policy. These lawsuits, which are in various stages, generally mirror similar lawsuits filed against other carriers in the industry. Although the Company is vigorously defending these lawsuits, the outcomes of these cases cannot be determined at this time. The Company has established loss and LAE reserves for lawsuits as to which the Company has determined that a loss is both probable and estimable. In addition to these case reserves, the Company also establishes reserves for claims incurred but not reported to cover unknown exposures and adverse development on known exposures. Based on currently available information, the Company believes that reserves for these lawsuits are reasonable and that the amounts reserved did not have a material effect on the Company’s financial condition or results of operations. However, if any one or more of these cases results in a judgment against or settlement by the Company for an amount that is significantly greater than the amount so reserved, the resulting liability could have a material effect on the Company’s financial condition, cash flows and results of operations.
As a direct writer of insurance, the Company receives assessments by state funds to cover losses to policyholders of insolvent or rehabilitated companies and other authorized fees. These mandatory assessments may be partially recovered through a reduction in future premium taxes in some states over several years. At June 30, 2011 and December 31, 2010, the liability for such assessments was $5.0 million and $4.7 million, respectively, and will be paid over several years as assessed by the various state funds.

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11. Segment Information
The Company operates its business as one segment, property and casualty insurance. The Company manages this segment through a product management structure. The following table shows revenues summarized by the broader business component description, which were determined based primarily on similar economic characteristics, products and services. Vanliner’s premiums earned are included in the table below as part of the Company’s transportation component for the three and six months ended June 30, 2011.
                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2011     2010     2011     2010  
    (Dollars in thousands)     (Dollars in thousands)  
Revenue:
                               
Premiums Earned:
                               
Alternative Risk Transfer
  $ 49,509     $ 35,003     $ 95,617     $ 72,373  
Transportation
    38,221       14,984       78,608       29,183  
Specialty Personal Lines
    13,551       14,538       27,413       28,684  
Hawaii and Alaska
    3,492       3,361       6,854       6,680  
Other
    1,691       1,347       3,111       2,494  
 
                       
Total premiums earned
    106,464       69,233       211,603       139,414  
Net investment income
    7,796       5,012       14,698       9,971  
Net realized gains on investments
    1,316       1,669       2,516       2,551  
Other
    854       976       1,970       1,794  
 
                       
Total revenues
  $ 116,430     $ 76,890     $ 230,787     $ 153,730  
 
                       
12. Comprehensive Income
Comprehensive income includes the Company’s net income plus the changes in the unrealized gains or losses (net of income taxes) on the Company’s available-for-sale securities. There was total comprehensive income for the three months ended June 30, 2011 and 2010 of $14.8 million and $8.7 million, respectively. Total comprehensive income for the six months ended June 30, 2011 and 2010 was $24.0 million and $22.6 million, respectively.
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This document, including information incorporated by reference, contains “forward-looking statements” (within the meaning of the Private Securities Litigation Reform Act of 1995). All statements, trend analyses and other information contained in this Form 10-Q relative to markets for our products and trends in our operations or financial results, as well as other statements including words such as “may,” “target,” “anticipate,” “believe,” “plan,” “estimate,” “expect,” “intend,” “project,” and other similar expressions, constitute forward-looking statements. We made these statements based on our plans and current analyses of our business and the insurance industry as a whole. We caution that these statements may and often do vary from actual results and the differences between these statements and actual results can be material. Factors that could contribute to these differences include, among other things:
    general economic conditions, weakness of the financial markets and other factors, including prevailing interest rate levels and stock and credit market performance, which may affect or continue to affect (among other things) our ability to sell our products and to collect amounts due to us, our ability to access capital resources and the costs associated with such access to capital and the market value of our investments;
    our ability to manage our growth strategy;
    customer response to new products and marketing initiatives;
    tax law and accounting changes;
    increasing competition in the sale of our insurance products and services and the retention of existing customers;
    changes in legal environment;
    regulatory changes or actions, including those relating to the regulation of the sale, underwriting and pricing of insurance products and services and capital requirements;

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    levels of natural catastrophes, terrorist events, incidents of war and other major losses;
    adequacy of insurance reserves; and
    availability of reinsurance and ability of reinsurers to pay their obligations.
The forward-looking statements herein are made only as of the date of this report. We assume no obligation to publicly update any forward-looking statements.
General
We underwrite and sell traditional and alternative risk transfer (“ART”) property and casualty insurance products primarily to the passenger transportation industry and the trucking industry, general commercial insurance to small businesses in Hawaii and Alaska and personal insurance to owners of recreational vehicles and commercial vehicles throughout the United States. We also underwrite and sell insurance products for moving and storage transportation companies.
Effective July 1, 2010, we and our principal insurance subsidiary, National Interstate Insurance Company (“NIIC”), completed the acquisition of Vanliner Group, Inc. (“Vanliner”) from UniGroup, Inc. (“UniGroup”) whereby NIIC acquired all of the issued and outstanding capital stock of Vanliner and we acquired certain information technology assets. As part of this acquisition, UniGroup agreed to provide us with comprehensive financial guarantees, including a four and a half-year balance sheet guaranty whereby both favorable and unfavorable balance sheet developments inure to UniGroup. Through the acquisition of Vanliner, NIIC acquired Vanliner Insurance Company (“VIC”), a market leader in providing insurance for the moving and storage industry. Obtaining a presence in this industry was our primary strategic objective associated with the acquisition. Beginning July 1, 2010, Vanliner’s results are included as part of our transportation component, with the exception of VIC’s moving and storage group ART programs, which are part of our ART component. Additional disclosures regarding the Vanliner acquisition are contained in Note 3 to the Consolidated Financial Statements of our Annual Report on Form 10-K for the year ended December 31, 2010.
We have five property and casualty insurance subsidiaries: NIIC, VIC, National Interstate Insurance Company of Hawaii, Inc. (“NIIC-HI”), Triumphe Casualty Company (“TCC”), Hudson Indemnity, Ltd. (“HIL”) and six active agency and service subsidiaries. We write our insurance policies on a direct basis through NIIC, VIC, NIIC-HI and TCC. NIIC and VIC are licensed in all 50 states and the District of Columbia. NIIC-HI is licensed in Ohio, Hawaii, Michigan and New Jersey. TCC, a Pennsylvania domiciled company, holds licenses for multiple lines of authority, including auto-related lines, in 25 states and the District of Columbia. HIL is domiciled in the Cayman Islands and provides reinsurance for NIIC, VIC, NIIC-HI and TCC primarily for the ART component. Insurance products are marketed through multiple distribution channels, including independent agents and brokers, program administrators, affiliated agencies and agent internet initiatives. We use our six active agency and service subsidiaries to sell and service our insurance business.
As of June 30, 2011, Great American Insurance Company (“Great American”) owned 52.5% of our outstanding common shares. Great American is a wholly-owned subsidiary of American Financial Group, Inc.
Results of Operations
Overview
Through the operations of our subsidiaries, we are engaged in property and casualty insurance operations. We generate underwriting profits by providing what we view as specialized insurance products, services and programs not generally available in the marketplace. We focus on niche insurance markets where we offer insurance products designed to meet the unique needs of targeted insurance buyers that we believe are underserved by the insurance industry.
We derive our revenues primarily from premiums generated by our insurance policies and income from our investment portfolio. Our expenses consist primarily of losses and loss adjustment expenses (“LAE”), commissions and other underwriting expenses and other operating and general expenses.

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The following table sets forth our June 30, 2011 and 2010 net income from operations, after-tax net realized gains from investments, change in valuation allowance on deferred tax assets related to net capital losses and the after-tax impact from the operating results of Vanliner’s guaranteed runoff business, all of which are non-GAAP financial measures that we believe are useful tools for investors and analysts in analyzing ongoing operating trends.
                                 
    Three Months Ended June 30,  
    2011     2010  
    Amount     Per Share     Amount     Per Share  
    (Dollars in thousands, except per share data)  
Net income from operations
  $ 7,806     $ 0.40     $ 6,534     $ 0.33  
After-tax net realized gain from investments
    855       0.04       1,084       0.06  
Impact from balance sheet guaranty for Vanliner
    (458 )     (0.02 )            
 
                       
Net income
  $ 8,203     $ 0.42     $ 7,618     $ 0.39  
 
                       
                                 
    Six Months Ended June 30,  
    2011     2010  
    Amount     Per Share     Amount     Per Share  
    (Dollars in thousands, except per share data)  
Net income from operations
  $ 17,825     $ 0.92     $ 15,736     $ 0.81  
After-tax net realized gain from investments
    1,635       0.08       1,658       0.09  
Change in valuation allowance related to net capital losses
                810       0.04  
Impact from balance sheet guaranty for Vanliner
    (1,729 )     (0.09 )            
 
                       
Net income
  $ 17,731     $ 0.91     $ 18,204     $ 0.94  
 
                       
As discussed above, UniGroup provided us with comprehensive financial guarantees related to the runoff of Vanliner’s final balance sheet whereby both favorable and unfavorable balance sheet development inures to the seller. In accordance with purchase accounting requirements we were required to determine the fair value of the future economic benefit of the financial guarantees and acquired loss reserves as of the date of acquisition, despite the fact that certain gains and losses related to the financial guaranty would be reflected in operations as they are incurred in future periods. As a result, the recognition of the revenues and expenses associated with the guaranteed runoff business will not occur in the same period and will result in combined ratios which are inconsistent with the negotiated combined ratio which was to approximate 100% for the Vanliner guaranteed business. As such, the after-tax impact from the runoff business guaranteed by the seller for the three and six months ended June 30, 2011 of $0.5 million ($0.02 per share diluted) and $1.7 million ($0.09 per share diluted), respectively, has been removed from the net after-tax earnings from operations to reflect only those results of the ongoing business.
Our net income from operations for the three and six months ended June 30, 2011 was $7.8 million ($0.40 per share diluted) and $17.8 million ($0.92 per share diluted), respectively, compared to $6.5 million ($0.33 per share diluted) and $15.7 million ($0.81 per share diluted) for the same periods in 2010. These increases were primarily driven by the growth in net investment income, which was attributable to the $300 million net increase to our investment portfolio associated with the Vanliner acquisition and the reinvestment of cash flows from matured securities into higher-yielding corporate obligations. Partially offsetting these increases were elevated loss and LAE ratios from ongoing operations for the three and six months ended June 30, 2011 of 72.2% and 69.7%, respectively, which excludes the impact from the runoff of the guaranteed Vanliner business, as compared to 66.5% and 63.9% for the same periods in 2010. These increases are primarily concentrated in our specialty personal lines component, which experienced higher than expected claims results in the second quarter and first half of 2011.
After-tax net realized gains from investments of $0.9 million ($0.04 per share diluted) and $1.6 million ($0.08 per share diluted) for the second quarter and first six months of 2011, respectively, were relatively flat compared to the $1.1 million ($0.06 per share diluted) and $1.7 million ($0.09 per share diluted) reported for both comparative periods in 2010. During the first quarter of 2010, we recorded a reduction of $0.8 million ($0.04 per share diluted) to our valuation allowance related to net realized losses due to both available tax strategies and the future realizability of previously impaired securities. No valuation allowance against deferred tax assets was necessary subsequent to March 31, 2010.

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Gross Premiums Written
We operate our business as one segment, property and casualty insurance. We manage this segment through a product management structure. The following table sets forth an analysis of gross premiums written by business component during the periods indicated:
                                 
    Three Months Ended June 30,  
    2011     2010  
    Amount     Percent     Amount     Percent  
            (Dollars in thousands)          
Alternative Risk Transfer
  $ 88,584       56.6 %   $ 68,217       61.6 %
Transportation
    46,322       29.6 %     19,038       17.2 %
Specialty Personal Lines
    15,130       9.7 %     17,784       16.1 %
Hawaii and Alaska
    4,515       2.9 %     4,175       3.8 %
Other
    1,934       1.2 %     1,512       1.3 %
 
                       
Gross premiums written
  $ 156,485       100.0 %   $ 110,726       100.0 %
 
                       
                                 
    Six Months Ended June 30,  
    2011     2010  
    Amount     Percent     Amount     Percent  
            (Dollars in thousands)          
Alternative Risk Transfer
  $ 169,445       58.3 %   $ 134,162       62.0 %
Transportation
    80,419       27.7 %     37,090       17.1 %
Specialty Personal Lines
    29,790       10.2 %     34,673       16.0 %
Hawaii and Alaska
    8,193       2.8 %     8,176       3.8 %
Other
    2,951       1.0 %     2,429       1.1 %
 
                       
Gross premiums written
  $ 290,798       100.0 %   $ 216,530       100.0 %
 
                       
Gross premiums written includes both direct and assumed premium. During the second quarter of 2011, our gross premiums written increased $45.8 million, or 41.3%, compared to the same period in 2010, primarily attributable to the growth experienced in our transportation and ART components. Gross premiums written in our transportation component increased $27.3 million, or 143.3%, during the second quarter of 2011 compared to the same period in 2010 due to the addition of Vanliner’s moving and storage products, which totaled $27.6 million for the three months ended June 30, 2011. Our ART component’s gross premiums written increased by $20.4 million, or 29.9%, in the second quarter of 2011 compared to the same period in 2010, due to a combination of growth in existing ART programs including the addition of a new customer to our large account ART product, the introduction of our second group ART program for Vanliner’s moving and storage business and near 100% member retention in group ART programs renewing during the period. The decrease of $2.7 million, or 14.9%, in our specialty personal lines component was primarily related to the pricing and underwriting actions associated with the commercial vehicle product which were first initiated in late 2009 and have continued into 2011. We also experienced a decrease in our recreational vehicle product due to a decline in the number of agents’ quotes, as we are seeing a trend toward recreational vehicle owners going directly to insurance companies for quotes versus using an agent.
During the first six months of 2011, our gross premiums written increased $74.3 million, or 34.3%, compared to the same period in 2010. This increase is primarily attributable to our transportation component, which increased $43.3 million, or 116.8%, driven by the Vanliner moving and storage products’ gross premiums written of $46.4 million during the first half of 2011. This growth was partially offset by a decrease in certain of our traditional passenger and trucking transportation products, which were impacted by increasingly competitive pricing in the continued soft insurance market. Our ART component grew by $35.3 million, or 26.3%, during the first six months of 2011 compared to the first half of 2010, while our specialty personal lines component decreased $4.9 million, or 14.1%. The period-over-period changes in both of these components were due to the same factors discussed above for the three month period.
Our group ART programs, which focus on specialty or niche businesses, provide various services and coverages tailored to meet specific requirements of defined client groups and their members. These services include risk management consulting, claims administration and handling, loss control and prevention and reinsurance placement, along with providing various types of property and casualty insurance coverage. Insurance coverage is provided primarily to companies with similar risk profiles and to specified classes of business of our agent partners.
As part of our ART programs, we have analyzed, on a quarterly basis, members’ loss performance on a policy year basis to determine if there would be a premium assessment to participants or if there would be a return of premium to participants as a result of less-than-expected losses. Assessment premium and return of premium are recorded as adjustments to premiums written (assessments increase premiums written; returns of premium reduce premiums written). For the second quarter of 2011 and 2010,

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we recorded a $0.5 million premium assessment and a $1.2 million return of premium, respectively. For the first half of 2011 and 2010, we recorded a $1.7 million premium assessment and a $0.3 million return of premium, respectively.
Premiums Earned
Three months ended June 30, 2011 compared to June 30, 2010. The following table shows premiums earned summarized by the broader business component description, which were determined based primarily on similar economic characteristics, products and services:
                                 
    Three Months Ended June 30,     Change  
    2011     2010     Amount     Percent  
            (Dollars in thousands)          
Premiums earned:
                               
Alternative Risk Transfer
  $ 49,509     $ 35,003     $ 14,506       41.4 %
Transportation
    38,221       14,984       23,237       155.1 %
Specialty Personal Lines
    13,551       14,538       (987 )     (6.8 )%
Hawaii and Alaska
    3,492       3,361       131       3.9 %
Other
    1,691       1,347       344       25.5 %
 
                         
Total premiums earned
  $ 106,464     $ 69,233     $ 37,231       53.8 %
 
                         
Our premiums earned increased $37.2 million, or 53.8%, to $106.5 million during the three months ended June 30, 2011 compared to $69.2 million for the same period in 2010 primarily attributable to the transportation and ART components. Our transportation component grew $23.2 million, or 155.1%, over the second quarter of 2010 mainly due to Vanliner’s moving and storage products. Approximately $8.2 million of the Vanliner premiums earned relate to the runoff of the business covered by the balance sheet guaranty. Our ART component increased $14.5 million, or 41.4%, reflecting the continued growth experienced in this component throughout 2010 and the first six months of 2011. These increases were partially offset by a decrease of $1.0 million, or 6.8%, in the specialty personal lines component attributable to the decline in premiums written in our commercial vehicle and recreational vehicle products beginning in the fourth quarter of 2010 and continuing into the first half of 2011.
Six months ended June 30, 2011 compared to June 30, 2010. The following table shows premiums earned summarized by the broader business component description, which were determined based primarily on similar economic characteristics, products and services:
                                 
    Six Months Ended June 30,     Change  
    2011     2010     Amount     Percent  
            (Dollars in thousands)          
Premiums earned:
                               
Alternative Risk Transfer
  $ 95,617     $ 72,373     $ 23,244       32.1 %
Transportation
    78,608       29,183       49,425       169.4 %
Specialty Personal Lines
    27,413       28,684       (1,271 )     (4.4 )%
Hawaii and Alaska
    6,854       6,680       174       2.6 %
Other
    3,111       2,494       617       24.7 %
 
                         
Total premiums earned
  $ 211,603     $ 139,414     $ 72,189       51.8 %
 
                         
Our premiums earned increased $72.2 million, or 51.8%, to $211.6 million during the six months ended June 30, 2011 compared to $139.4 million for the same period in 2010 primarily attributable to the transportation and ART components. Our transportation component grew $49.4 million, or 169.4%, over 2010 mainly due to Vanliner’s moving and storage products. Approximately $23.5 million of the Vanliner premiums earned relate to the runoff of the business covered by the balance sheet guaranty. Our ART component increased $23.2 million, or 32.1%, while our specialty personal lines component decreased $1.3 million, or 4.4%. The period-over-period changes in both of these components were due to the same factors discussed above for the three month period.
Underwriting and Loss Ratio Analysis
Underwriting profitability, as opposed to overall profitability or net earnings, is measured by the combined ratio. The combined ratio is the sum of the loss and LAE ratio and the underwriting expense ratio. A combined ratio under 100% is indicative of an underwriting profit.
Losses and LAE are a function of the amount and type of insurance contracts we write and of the loss experience of the underlying risks. We seek to establish case reserves at the maximum probable exposure based on our historical claims experience. Our ability to accurately estimate losses and LAE at the time of pricing our contracts is a critical factor in determining our profitability. The amount reported under losses and LAE in any period includes payments in the period net of the change in reserves for unpaid losses and LAE between the beginning and the end of the period.

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Our underwriting expense ratio includes commissions and other underwriting expenses and other operating and general expenses, offset by other income. Commissions and other underwriting expenses consist principally of brokerage and agent commissions reduced by ceding commissions received from assuming reinsurers, and vary depending upon the amount and types of contracts written and, to a lesser extent, premium taxes.
Our underwriting approach is to price our products to achieve an underwriting profit even if we forgo volume as a result. Since 2007, we have experienced modest single digit decreases in rate levels on our renewal business overall due to a continued soft market. However, during the first six months of 2011, we have begun to see some rate level increases on new and renewal business among several of our products.
The table below presents our net premiums earned and combined ratios for the periods indicated:
                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2011     2010     2011     2010  
    (Dollars in thousands)     (Dollars in thousands)  
Gross premiums written
  $ 156,485     $ 110,726     $ 290,798     $ 216,530  
Ceded reinsurance
    (22,742 )     (24,799 )     (46,804 )     (49,149 )
 
                       
Net premiums written
    133,743       85,927       243,994       167,381  
Change in unearned premiums, net of ceded
    (27,279 )     (16,694 )     (32,391 )     (27,967 )
 
                       
Total premiums earned
  $ 106,464     $ 69,233     $ 211,603     $ 139,414  
 
                       
 
                               
Combined Ratios:
                               
Loss and LAE ratio (1)
    73.8 %     66.5 %     72.4 %     63.9 %
Underwriting expense ratio (2)
    23.0 %     25.6 %     22.8 %     25.4 %
 
                       
Combined ratio
    96.8 %     92.1 %     95.2 %     89.3 %
 
                       
 
(1)    The ratio of losses and LAE to premiums earned.
 
(2)    The ratio of the sum of commissions and other underwriting expenses, other operating expenses less other income to premiums earned.
Three months ended June 30, 2011 compared to June 30, 2010. Our consolidated loss and LAE ratio for the second quarter of 2011 increased 7.3 percentage points to 73.8% compared to 66.5% in the same period in 2010. The loss and LAE ratio for our ongoing operations, which excludes the impact from the runoff of the guaranteed Vanliner business, was 72.2% for the three months ended June 30, 2011. This increase over the prior period is primarily attributable to our recreational vehicle product, which continued to experience higher than expected claims activity in the second quarter of 2011, and claims on our commercial vehicle product attributable to policies predominantly written prior to our pricing and underwriting actions. For the second quarter of 2011, we had favorable development from prior years’ loss reserves of $0.7 million, or 0.7 percentage points, compared to favorable development of $1.5 million, or 2.2 percentage points, in the second quarter of 2010. This favorable development was primarily related to settlements below the established case reserves and revisions to our estimated future settlements on an individual case by case basis. The prior years’ loss reserve development for both periods is not considered to be unusual or significant to prior years’ reserves based on the history of our business and the timing of events in the claims adjustment process.
The consolidated underwriting expense ratio for the three months ended June 30, 2011 decreased 2.6 percentage points to 23.0% compared to 25.6% for the same period in 2010, primarily attributable to leveraging existing operating expenses over an increase in earned premium. Included in the underwriting expense ratio for the three months ended June 30, 2010 are costs associated with the Vanliner acquisition totaling 0.8 percentage points.
Six months ended June 30, 2011 compared to June 30, 2010. Our consolidated loss and LAE ratio for the six months ended June 30, 2011 increased 8.5 percentage points to 72.4% compared to 63.9% in the same period in 2010. The loss and LAE ratio for our ongoing operations, which excludes the impact from the runoff of the guaranteed Vanliner business, was 69.7% for the first six months of 2011. This increase over the prior period is primarily due to our specialty personal lines component as discussed above for the three month period. For the first half of 2011, we had favorable development from prior years’ loss reserves of $0.5 million, or 0.3 percentage points, compared to favorable development of prior years’ loss reserves of $3.2 million, or 2.3 percentage points, in the first six months of 2010.
The consolidated underwriting expense ratio for the six months ended June 30, 2011 decreased 2.6 percentage points to 22.8% compared to 25.4% for the same period in 2010, primarily due to the factors discussed above for the three month period. Included in the underwriting expense ratio for the six months ended June 30, 2011 are costs associated with the Vanliner acquisition totaling 0.6 percentage points.

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Net Investment Income
2011 compared to 2010. For the three and six month periods ended June 30, 2011, net investment income was $7.8 million and $14.7 million, respectively, compared to $5.0 million and $10.0 million for the same periods in 2010. The increase in investment income for both the three and six months ended June 30, 2011 is primarily due to a net increase in the portfolio of approximately $300 million associated with the Vanliner acquisition. While the yield on the acquired Vanliner portfolio was lower than the yield on the existing investment portfolio, cash flows, including those from matured investments, have been invested in higher yielding securities primarily corporate obligations, state and local obligations and agency residential mortgage-backed securities.
Net Realized Gains (Losses) on Investments
2011 compared to 2010. Pre-tax net realized gains on investments were $1.3 million for the second quarter of 2011 compared to $1.7 million for the second quarter of 2010. For the six months ended June 30, 2011 and 2010, pre-tax net realized gains were $2.5 million and $2.6 million, respectively. The pre-tax net realized gains for both the three and six months ended June 30, 2011 were primarily generated from net realized gains associated with sales of securities totaling $1.0 million and $2.0 million, respectively. Additionally, we recorded gains of $0.3 million and $0.5 million associated with equity partnership investments for the three and six months ended June 30, 2011, respectively. There were no other-than-temporary impairment charges taken during three and six months ended June 30, 2011. The pre-tax net realized gains for both the three and six months ended June 30, 2010 were primarily generated from net realized gains associated with sales of securities to generate funds for the Vanliner acquisition totaling $2.0 million and $2.5 million, respectively. Additionally, we recorded net gains of $0.2 million from equity in earnings of a limited partnership investment for the six months ended June 30, 2010. Offsetting these gains was an other-than-temporary impairment credit loss of $0.1 million relating to one mortgage-backed security, both recorded during the second quarter of 2010.
Commissions and Other Underwriting Expenses
2011 compared to 2010. During the second quarter of 2011, commissions and other underwriting expenses of $21.2 million increased $6.5 million, or 43.8%, from $14.7 million in the comparable period in 2010. For the six months ended June 30, 2011 and 2010, commissions and other underwriting expenses were $41.5 million and $29.6 million, respectively, increasing $11.9 million, or 40.4%. Both the quarter and year-to-date increases are primarily a result of the growth in premiums during 2011 compared to 2010.
Other Operating and General Expenses
2011 compared to 2010. Other operating and general expenses were relatively flat for the quarter ended June 30, 2011 compared to the same period in 2010, increasing $0.1 million, or 2.5%, to $4.1 million from $4.0 million in the prior period. For the six months ended June 30, 2011 and 2010, other operating and general expenses were $8.6 million and $7.6 million, respectively, increasing $1.0 million, or 13.3%. This year-to-date increase was primarily due to additional expenses associated with growth in our employee headcount which began in the second quarter of 2010 and was driven by the acquisition of Vanliner.
Income Taxes
2011 compared to 2010. The effective tax rate of 28.9% for the three month period ended June 30, 2011 decreased 2.5 percentage points, from 31.4%, as compared to the same period in 2010, primarily attributable to an increase in tax-exempt income. The 2011 year-to-date effective tax rate increased 1.6 percentage points to 30.4%, as compared to 28.8% for the same period in 2010. Our 2010 income tax expense was favorably impacted by 3.2 percentage points related to a first quarter of 2010 reduction to our valuation allowance related to net realized losses due to both available tax strategies and the future realizability of previously impaired securities. No valuation allowance against deferred tax assets was necessary subsequent to March 31, 2010. The remaining change in the year-to-date 2011 effective tax rate is attributable to an increase in tax-exempt income as compared to the same period in 2010.
Financial Condition
Investments
At June 30, 2011, our investment portfolio contained $914.7 million in fixed maturity securities and $22.8 million in equity securities, all carried at fair value, with unrealized gains and losses reported as a separate component of shareholders’ equity and $27.4 million in other investments, which are limited partnership investments accounted for in accordance with the equity method. At June 30, 2011, we had pre-tax net unrealized gains of $16.8 million on fixed maturities and $2.5 million on equity securities.

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Our investment portfolio allocation is based on diversification among primarily high quality fixed maturity investments and guidelines in our investment policy.
At June 30, 2011, 94.3% of the fixed maturities in our portfolio were rated “investment grade” (credit rating of AAA to BBB-) by nationally recognized rating agencies. Investment grade securities generally bear lower degrees of risk and corresponding lower yields than those that are unrated or non-investment grade.
Summary information for securities with unrealized gains or losses at June 30, 2011 is shown in the following table. Approximately $4.1 million of fixed maturities had no unrealized gains or losses at June 30, 2011.
                 
    Securities with     Securities with  
    Unrealized Gains     Unrealized Losses  
    (Dollars in thousands)  
Fixed Maturities:
               
Fair value of securities
  $ 738,979     $ 171,573  
Amortized cost of securities
    717,360       176,381  
Gross unrealized gain or (loss)
  $ 21,619     $ (4,808 )
Fair value as a % of amortized cost
    103.0 %     97.3 %
Number of security positions held
    672       146  
Number individually exceeding $50,000 gain or (loss)
    146       16  
Concentration of gains or losses by type or industry:
               
U.S. Government and government agencies
  $ 3,046     $ (288 )
Foreign governments
    11        
State, municipalities and political subdivisions
    7,337       (892 )
Residential mortgage-backed securities
    3,722       (2,916 )
Commercial mortgage-backed securities
    10       (85 )
Banks, insurance and brokers
    3,113       (313 )
Industrial and other
    4,380       (314 )
Percent rated investment grade (a)
    96.1 %     86.5 %
Equity Securities:
               
Fair value of securities
  $ 19,687     $ 3,142  
Cost of securities
    16,803       3,548  
Gross unrealized gain or (loss)
  $ 2,884     $ (406 )
Fair value as a % of cost
    117.2 %     88.6 %
Number individually exceeding $50,000 gain or (loss)
    9       1  
 
(a)     Investment grade of AAA to BBB- by nationally recognized rating agencies.
The table below sets forth the scheduled maturities of available for sale fixed maturity securities at June 30, 2011, based on their fair values. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid by the issuers.
                 
    Securities with     Securities with  
    Unrealized Gains     Unrealized Losses  
Maturity:
               
One year or less
    3.7 %     0.6 %
After one year through five years
    30.7 %     13.4 %
After five years through ten years
    34.5 %     32.2 %
After ten years
    12.2 %     15.0 %
 
           
 
    81.1 %     61.2 %
Mortgage-backed securities
    18.9 %     38.8 %
 
           
 
    100.0 %     100.0 %
 
           

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The table below summarizes the unrealized gains and losses on fixed maturities and equity securities by dollar amount:
                         
    At June 30, 2011  
            Aggregate     Fair Value  
    Aggregate     Unrealized     as % of  
    Fair Value     Gain (Loss)     Cost Basis  
    (Dollars in thousands)  
Fixed Maturities:
                       
Securities with unrealized gains:
                       
Exceeding $50,000 and for:
                       
Less than one year (86 issues)
  $ 163,926     $ 6,353       104.0 %
More than one year (60 issues)
    102,191       6,808       107.1 %
Less than $50,000 (526 issues)
    472,862       8,458       101.8 %
 
                   
 
  $ 738,979     $ 21,619          
 
                   
 
                       
Securities with unrealized losses:
                       
Exceeding $50,000 and for:
                       
Less than one year (6 issues)
  $ 21,951     $ (432 )     98.1 %
More than one year (10 issues)
    14,142       (3,025 )     82.4 %
Less than $50,000 (130 issues)
    135,480       (1,351 )     99.0 %
 
                   
 
  $ 171,573     $ (4,808 )        
 
                   
 
                       
Equity Securities:
                       
Securities with unrealized gains:
                       
Exceeding $50,000 and for:
                       
Less than one year (0 issues)
  $     $       0.0 %
More than one year (9 issues)
    7,801       2,399       144.4 %
Less than $50,000 (36 issues)
    11,886       485       104.3 %
 
                   
 
  $ 19,687     $ 2,884          
 
                   
 
                       
Securities with unrealized losses:
                       
Exceeding $50,000 and for:
                       
Less than one year (1 issues)
  $ 2,411     $ (384 )     86.3 %
More than one year (0 issues)
                0.0 %
Less than $50,000 (3 issues)
    731       (22 )     97.1 %
 
                   
 
  $ 3,142     $ (406 )        
 
                   
When a decline in the value of a specific investment is considered to be other-than-temporary, a provision for impairment is charged to earnings (accounted for as a realized loss) and the cost basis of that investment is reduced. The determination of whether unrealized losses are other-than-temporary requires judgment based on subjective as well as objective factors. Factors considered and resources used by management include those discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Other-Than-Temporary Impairment.”
Premiums and Reinsurance
In the ART component, under most group ART programs, all members of the group share a common renewal date. These common renewal dates are scheduled throughout the year. However, we have several large ART programs that renew during the first six months of a given fiscal year. These renewals in the first six months have historically resulted in a large increase in premiums receivable, unearned premiums, prepaid reinsurance premiums and reinsurance balances payable during the first half of a given fiscal year. These increases continually decrease through the year. The acquisition of Vanliner has created a shift in these trends on a consolidated basis from December 31, 2010 to June 30, 2011, which may change in future periods based on Vanliner’s growth, the timing of its premium writings during a given year and the runoff of the guaranteed business.
Premiums receivable increased $40.0 million, or 24.6%, and unearned premiums increased $37.4 million, or 16.8%, from December 31, 2010 to June 30, 2011. Excluding the runoff of the balances associated with the guaranteed Vanliner business, premiums receivable increased $54.8 million, or 37.5%, and unearned premiums increased $53.4 million, or 25.9%. These increases in premiums receivable and unearned premiums are primarily due to the increase in direct premiums written in our ART and transportation components during the second quarter of 2011 as compared to the fourth quarter of 2010. The increase in the transportation component was driven by Vanliner’s moving and storage products.
Prepaid reinsurance premiums increased $4.9 million, or 14.1%, and reinsurance balances payable increased $12.0 million, or 73.9%, from December 31, 2010 to June 30, 2011. The increases in prepaid reinsurance premiums and reinsurance balances payable are primarily due to an increase in ceded premium for the second quarter of 2011 as compared to the fourth quarter of

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2010. Vanliner did not significantly affect these trends due to its reinsurance structure, as Vanliner retains a greater portion of its direct premiums written and the associated underwriting risks when compared to our historical operations.
Liquidity and Capital Resources
The liquidity requirements of our insurance subsidiaries relate primarily to the liabilities associated with their products as well as operating costs and payments of dividends and taxes to us from insurance subsidiaries. Historically and during the first six months of 2011, cash flows from premiums and investment income have provided sufficient funds to meet these requirements, without requiring significant liquidation of investments. If our cash flows change dramatically from historical patterns, for example as a result of a decrease in premiums, an increase in claims paid or operating expenses, or financing an acquisition, we may be required to sell securities before their maturity and possibly at a loss, or borrow against our credit facility. Our insurance subsidiaries generally hold a significant amount of highly liquid, short-term investments or cash and cash equivalents to meet their liquidity needs. Our historic pattern of using receipts from current premium writings for the payment of liabilities incurred in prior periods provides us with the option to extend the maturities of our investment portfolio beyond the estimated settlement date of our loss reserves. Funds received in excess of cash requirements are generally invested in additional marketable securities.
We believe that our insurance subsidiaries maintain sufficient liquidity to pay claims and operating expenses, as well as meet commitments in the event of unforeseen events such as reserve deficiencies, inadequate premium rates or reinsurer insolvencies. Our principal sources of liquidity are our existing cash, cash equivalents and short-term investments. Cash, cash equivalents and short-term investments increased $12.4 million from $27.1 million at December 31, 2010 to $39.5 million at June 30, 2011. We generated net cash from operations of $20.2 million for the six months ended June 30, 2011, compared to $29.3 million during the comparable period in 2010. This decrease of $9.1 million primarily relates to a large amount of claim payments made during the first six months of 2011 associated with the runoff of the guaranteed Vanliner business. Additionally, in the first half of 2011, we made an estimated federal income tax payment which included approximately $8.4 million (included in the line item “Accounts payable and other liabilities” on our Consolidated Balance Sheet at December 31, 2010) associated with the Vanliner acquisition. This payment is offset by cash received of an equal amount which is included in “Collection of amounts refundable on the purchase price of Vanliner” in the investing activities section of our Consolidated Statements of Cash Flows.
Net cash used in investing activities was $6.3 million and $32.4 million for the six months ended June 30, 2011 and 2010, respectively. This $26.1 million decrease in cash used in investing activities was primarily related to the $128.1 million deposited on June 30, 2010 for the July 1, 2010 purchase of Vanliner, a $32.8 million decrease in the purchases of fixed maturity investments and receiving the $14.3 million refund in 2011 on the purchase price of Vanliner related to making the election under Section 338(h)(10) of the Internal Revenue Code and the finalization of the tangible book value, which were partially offset by a $130.4 million decrease in the proceeds from sales, maturities and redemptions of fixed maturity investments and $13.0 million from the purchase of other investments, which are comprised of limited partnership investments, in 2011. The decreases in the purchases of fixed maturities and the proceeds from sales, maturities and redemptions of fixed maturity investments in the first half of 2011 as compared to the same period in 2010 were primarily due to the positioning of our portfolio which took place during the first six months of 2010 to generate funds to finance the Vanliner acquisition. The net purchases of fixed maturities during the first half of 2011 were primarily concentrated in corporate obligations, state and local obligations and agency residential mortgage-backed securities. The purchases of limited partnership investments during the six months ended June 30, 2011 were due to rebalancing Vanliner’s investment portfolio, which was entirely comprised of fixed maturity securities at December 31, 2010.
Net cash used in financing activities was $1.6 million for the six months ended June 30, 2011 as compared to net cash provided by financing activities of $27.3 million for the same period in 2010. This $28.9 million decrease in cash provided by financing activities was primarily driven by a $30 million draw on our credit facility in June 2010 to help fund the purchase of Vanliner.
We have continuing cash needs for administrative expenses, the payment of principal and interest on borrowings, shareholder dividends and taxes. Funds to meet these obligations will come primarily from parent company cash, dividends and other payments from our insurance company subsidiaries and from our remaining line of credit.
We have a $50.0 million unsecured Credit Agreement (the “Credit Agreement”) that terminates in December 2012, which includes a sublimit of $10.0 million for letters of credit. We have the ability to increase the line of credit to $75.0 million subject to the Credit Agreement’s accordion feature. At June 30, 2011 there was $22.0 million drawn on this credit facility. Amounts borrowed bear interest at either (1) a rate per annum equal to the greater of the administrative agent’s prime rate or 0.5% in excess of the federal funds effective rate or (2) rates ranging from 0.45% to 0.90% over LIBOR based on our A.M. Best insurance group rating, or 0.65% at June 30, 2011. As of June 30, 2011, the interest rate on this debt is equal to the six-month LIBOR (0.375% at June 30, 2011) plus 65 basis points, with interest payments due quarterly.

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The Credit Agreement requires us to maintain specified financial covenants measured on a quarterly basis, including consolidated net worth, fixed charge coverage ratio and debt-to-capital ratio. In addition, the Credit Agreement contains certain affirmative and negative covenants, including negative covenants that limit or restrict our ability to, among other things, incur additional indebtedness, effect mergers or consolidations, make investments, enter into asset sales, create liens, enter into transactions with affiliates and other restrictions customarily contained in such agreements. As of June 30, 2011, we were in compliance with all financial covenants.
We believe that funds generated from operations, including dividends from insurance subsidiaries, parent company cash and funds available under our Credit Agreement will provide sufficient resources to meet our liquidity requirements for at least the next 12 months. However, if these funds are insufficient to meet fixed charges in any period, we would be required to generate cash through additional borrowings against our credit facility, sale of assets, sale of portfolio securities or similar transactions. If we were required to sell portfolio securities early for liquidity purposes rather than holding them to maturity, we would recognize gains or losses on those securities earlier than anticipated. Our ongoing corporate initiatives include actively evaluating potential acquisitions. At such time that we would execute an agreement to enter into an acquisition, such a transaction, depending upon the structure and size, could have an impact on our liquidity. If we were forced to borrow additional funds under our Credit Agreement in order to meet liquidity needs, we would incur additional interest expense, which could have a negative impact on our earnings. Since our ability to meet our obligations in the long-term (beyond a 12-month period) is dependent upon factors such as market changes, insurance regulatory changes and economic conditions, no assurance can be given that the available net cash flow will be sufficient to meet our operating needs. We are not aware of any trends or uncertainties affecting our liquidity, including any significant future reliance on short-term financing arrangements.
Critical Accounting Policies
The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect amounts reported in the financial statements. As more information becomes known, these estimates and assumptions could change and thus impact amounts reported in the future. Management believes that the establishment of losses and LAE reserves and the determination of “other-than-temporary” impairment on investments are the two areas where the degree of judgment required in determining amounts recorded in the financial statements make the accounting policies critical. For a more detailed discussion of these policies, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2010.
Losses and LAE Reserves
Significant periods of time can elapse between the occurrence of an insured loss, the reporting of that loss to us and our final payment of that loss and its related LAE. To recognize liabilities for unpaid losses, we establish reserves as balance sheet liabilities. At both June 30, 2011 and December 31, 2010, we had $795.4 million and $798.6 million, respectively, of gross loss and LAE reserves, representing management’s best estimate of the ultimate loss. Management records, on a monthly and quarterly basis, its best estimate of loss reserves. For purposes of computing the recorded reserves, management utilizes various data inputs, including analysis that is derived from a review of prior quarter results performed by actuaries employed by Great American. In addition, on an annual basis, actuaries from Great American review the recorded reserves for NIIC, VIC, NIIC-HI and TCC utilizing current period data and provide a Statement of Actuarial Opinion, required annually in accordance with state insurance regulations, on the statutory reserves recorded by these U.S. insurance subsidiaries. The actuarial analysis of NIIC’s, VIC’s, NIIC-HI’s and TCC’s net reserves for the year ending December 31, 2010 reflected point estimates that were within 2% of management’s recorded net reserves as of such dates. Using this actuarial data along with its other data inputs, management concluded that the recorded reserves appropriately reflect management’s best estimates of the liability as of June 30, 2011 and December 31, 2010.
The quarterly reviews of unpaid loss and LAE reserves by Great American actuaries are prepared using standard actuarial techniques. These may include (but may not be limited to):
    the Case Incurred Development Method;
    the Paid Development Method;
    the Bornhuetter-Ferguson Method; and
    the Incremental Paid LAE to Paid Loss Methods.

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The period of time from the occurrence of a loss through the settlement of the liability is referred to as the “tail.” Generally, the same actuarial methods are considered for both short-tail and long-tail lines of business because most of them work properly for both. The methods are designed to incorporate the effects of the differing length of time to settle particular claims. For short-tail lines, management tends to give more weight to the Case Incurred and Paid Development methods, although the various methods tend to produce similar results. For long-tail lines, more judgment is involved and more weight may be given to the Bornhuetter-Ferguson method. Liability claims for long-tail lines are more susceptible to litigation and can be significantly affected by changing contract interpretation and the legal environment. Therefore, the estimation of loss reserves for these classes is more complex and subject to a higher degree of variability.
Supplementary statistical information is reviewed to determine which methods are most appropriate and whether adjustments are needed to particular methods. This information includes:
    open and closed claim counts;
    average case reserves and average incurred on open claims;
    closure rates and statistics related to closed and open claim percentages;
    average closed claim severity;
    ultimate claim severity;
    reported loss ratios;
    projected ultimate loss ratios; and
    loss payment patterns.
Other-Than-Temporary Impairment
Our investments are exposed to at least one of three primary sources of investment risk: credit, interest rate and market valuation risks. The financial statement risks are those associated with the recognition of impairments and income, as well as the determination of fair values. We evaluate whether impairments have occurred on a case-by-case basis. Management considers a wide range of factors about the security issuer and uses its best judgment in evaluating the cause and amount of decline in the estimated fair value of the security and in assessing the prospects for near-term recovery. Inherent in management’s evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Considerations we use in the impairment evaluation process include, but are not limited to:
    the length of time and the extent to which the market value has been below amortized cost;
    whether the issuer is experiencing significant financial difficulties;
    economic stability of an entire industry sector or subsection;
    whether the issuer, series of issuers or industry has a catastrophic type of loss;
    the extent to which the unrealized loss is credit-driven or a result of changes in market interest rates;
    historical operating, balance sheet and cash flow data;
    internally and externally generated financial models and forecasts;
    our ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value; and
    other subjective factors, including concentrations and information obtained from regulators and rating agencies.

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Under current other-than-temporary impairment accounting guidance, if management can assert that it does not intend to sell an impaired fixed maturity security and it is not more likely than not that it will have to sell the security before recovery of its amortized cost basis, then an entity may separate the other-than-temporary impairments into two components: 1) the amount related to credit losses (recorded in earnings) and 2) the amount related to all other factors (recorded in other comprehensive income (loss)). The credit related portion of an other-than-temporary impairment is measured by comparing a security’s amortized cost to the present value of its current expected cash flows discounted at its effective yield prior to the impairment charge. Both components are required to be shown in the Consolidated Statements of Income. If management intends to sell an impaired security, or it is more likely than not that it will be required to sell the security before recovery, an impairment charge is required to reduce the amortized cost of that security to fair value. Additional disclosures required by this guidance are contained in Note 4 — “Investments.”
We closely monitor each investment that has a fair value that is below its amortized cost and make a determination each quarter for other-than-temporary impairment for each of those investments. There were no impairment charges taken during the three and six months ended June 30, 2011.
During both the three and six months ended June 30, 2010, we recorded an other-than-temporary impairment charge on one mortgage-backed security, for which a previous impairment charge had been recorded. The other-than-temporary impairment charge on this security was separated into: a credit loss of $0.1 million, which is recognized in earnings, and a reduction in the non-credit loss of $0.1 million, which was previously included in other comprehensive income. The credit loss of $0.1 million was the result of management’s analysis that we may not receive the full principal amounts due to potential defaults on the mortgage loans underlying the mortgage-backed security and that the recovery of expected principal will take longer than previously expected. While it is not possible to accurately predict if or when a specific security will become impaired, given the inherent uncertainty in the market, charges for other-than-temporary impairment could be material to net income in subsequent quarters. Management believes it is not likely that future impairment charges will have a significant effect on our liquidity. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition — Investments.”
Contractual Obligations/Off-Balance Sheet Arrangements
During the first six months of 2011, our contractual obligations did not change materially from those discussed in our Annual Report on Form 10-K for the year ended December 31, 2010.
We do not currently have any relationships with unconsolidated entities of financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
As of June 30, 2011, there were no material changes to the information provided in our Annual Report on Form 10-K for the year ended December 31, 2010 under Item 7A “Quantitative and Qualitative Disclosures About Market Risk.”
ITEM 4. Controls and Procedures
Our management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. Our management, with participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e)) as of June 30, 2011. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2011, to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
There have been no significant changes in our internal controls over financial reporting or in other factors that have occurred during the quarter ended June 30, 2011 that have materially affected, or are reasonably likely to affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION
ITEM 1. Legal Proceedings
There are no material changes from the legal proceedings previously reported in our Annual Report on Form 10-K for the year ended December 31, 2010. For more information regarding such legal matters please refer to Item 3 of our Annual Report on Form 10-K for the year ended December 31, 2010, Note 16 to the Consolidated Financial Statements included therein and Note 10 to the Consolidated Financial Statements contained in this quarterly report.
ITEM 1A. Risk Factors
There are no material changes to the risk factors previously reported in our Annual Report on Form 10-K for the year ended December 31, 2010. For more information regarding such risk factors, please refer to Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
ITEM 3. Defaults Upon Senior Securities
None.
ITEM 4. [RESERVED]
ITEM 5. Other Information
None.
ITEM 6. Exhibits
     
3.1
  Amended and Restated Articles of Incorporation (1)
3.2
  Amended and Restated Code of Regulations (1)
31.1
  Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
  Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
  Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
  Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
   
101.INS
  XBRL Instance Document (2)
 
   
101.SCH
  XBRL Taxonomy Extension Schema Document (2)
 
   
101.CAL
  XBRL Taxonomy Extension Calculation Linkbase Document (2)
 
   
101.DEF
  XBRL Taxonomy Extension Definition Linkbase Document (2)
 
   
101.LAB
  XBRL Taxonomy Extension Label Linkbase Document (2)
 
   
101.PRE
  XBRL Taxonomy Extension Presentation Linkbase Document (2)
 
(1)   These exhibits are incorporated by reference to our Registration Statement on Form S-1 (Registration No. 333-119270).
 
(2)   In accordance with Regulation S-T, the XBRL-related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall be deemed “furnished” not “filed.”

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
  NATIONAL INTERSTATE CORPORATION
 
 
Date: August 5, 2011  /s/ David W. Michelson    
  David W. Michelson   
  President and Chief Executive Officer
(Duly Authorized Officer and Principal Executive Officer) 
 
 
     
Date: August 5, 2011  /s/ Julie A. McGraw    
  Julie A. McGraw   
  Vice President and Chief Financial Officer
(Duly Authorized Officer and Principal Financial Officer) 
 
 

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