AMTRUST FINANCIAL SERVICES, INC. – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Edgar Online, Inc.

 The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This Form 10-K contains certain forward-looking statements that are intended to be covered by the safe harbors created by The Private Securities Litigation Reform Act of 1995. See "Note on Forward-Looking Statements."  

Overview

  We are a multinational specialty property and casualty insurer focused on generating consistent underwriting profits. We provide insurance coverage for small businesses and products with high volumes of insureds and loss profiles that we believe are predictable. We target lines of insurance that we believe generally are underserved by the market. We have grown by hiring teams of underwriters with expertise in our specialty lines, through acquisitions of companies and assets that, in each case, provide access to distribution networks and renewal rights to established books of specialty insurance business. We have operations in four business segments:  

• Small Commercial Business. We provide workers' compensation, commercial

package and other commercial insurance lines produced by wholesale agents,

retail agents and brokers in the United States.

• Specialty Risk and Extended Warranty. We provide coverage for consumer and

commercial goods and custom designed coverages, such as accidental damage

plans and payment protection plans offered in connection with the sale of

consumer and commercial goods, in the United States and Europe, and certain

niche property, casualty and specialty liability risks in the United States

       and Europe, including general liability, employers' liability and        professional and medical liability.  

• Specialty Program. We write commercial insurance for narrowly defined

classes of insureds, requiring an in-depth knowledge of the insured's

industry segment, through general and other wholesale agents.

• Personal Lines Reinsurance. We reinsure 10% of the net premiums of the

GMACI personal lines business, pursuant to the Personal Lines Quota Share

with the GMACI personal lines insurance companies. See discussion below

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We transact business primarily through our eleven Insurance Subsidiaries:

  [[Image Removed]]   [[Image Removed]]   [[Image Removed]]   [[Image Removed]]   [[Image Removed]] Company                   A.M.            Coverage Type         Coverage            Domiciled                        Best Rated            Offered             Market Technology            A (Excellent)     Small commercial,     United States            New Insurance                               specialty program                           Hampshire Company, Inc.                           and specialty ("TIC")                                 risk & extended                                         warranty Rochdale              A (Excellent)     Small commercial,     United States         New York Insurance                               specialty program Company ("RIC")                         and specialty                                         risk & extended                                         warranty Wesco Insurance       A (Excellent)     Small commercial,     United States         Delaware Company ("WIC")                         specialty program                                         and specialty                                         risk & extended                                         warranty Associated            A (Excellent)     Workers'              United States          Florida Industries                              compensation Insurance Company, Inc. ("AIIC") Milwaukee             A (Excellent)     Small Commercial      United States         Wisconsin Casualty                                Business Insurance Co. ("MCIC") Security National     A (Excellent)     Small Commercial      United States           Texas Insurance                               Business Company ("SNIC") AmTrust Insurance     A (Excellent)     Small Commercial      United States          Kansas Company of                              Business Kansas, Inc. ("AICK") AmTrust Lloyd's       A (Excellent)     Small Commercial      United States           Texas Insurance Company                       Business ("ALIC") AmTrust               A (Excellent)     Specialty Risk          European             Ireland International                           and Extended            Union and Underwriters                            Warranty;             United States Limited                                 specialty program ("AIU") AmTrust Europe,       A (Excellent)     Specialty Risk          European             England Ltd.                                    and Extended              Union ("AEL")                                 Warranty AmTrust               A (Excellent)     Reinsurance           United States          Bermuda International                                                 and European Insurance Ltd.                                                    Union ("AII")   Insurance, particularly workers' compensation, is, generally, affected by seasonality. The first quarter generally produces greater premiums than subsequent quarters. Nevertheless, the impact of seasonality on our Small Commercial Business and Specialty Program segments has not been significant. We believe that this is because we serve many small businesses in different geographic locations. In addition, we believe seasonality may be muted by our acquisition activity.  We evaluate our operations by monitoring key measures of growth and profitability, including return on equity and net combined ratio. Our return on equity was 21.2%, 22.2% and 21.5% for the years ended December 31, 2011, 2010 and 2009, respectively. Our overall financial objective is to produce a return on equity of 15.0% or more over the long term. In addition, we target a net combined ratio of 95.0% or lower over the long term, while seeking to maintain optimal operating leverage in our Insurance Subsidiaries commensurate with our A.M. Best rating objectives. Our net combined ratio was 89.0%, 85.3% and 79.8% for the years ended December 31, 2011, 2010 and 2009, respectively. A key factor in achieving our targeted net combined ratio is a continuous focus on our net expense ratio. Our strategy across our segments is to maintain premium rates, deploy capital judiciously, manage our expenses and focus on the sectors in which we have expertise, which we believe should provide opportunities for greater returns.                                         64  --------------------------------------------------------------------------------

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  Investment income is also an important part of our business. Because the period of time between our receipt of premiums and the ultimate settlement of claims is often several years or longer, we are able to invest cash from premiums for significant periods of time. Our net investment income was $55.5 million, $50.5 million and $55.3 million for the years ended 2011, 2010 and 2009, respectively. We held 21.1% and 13.6% of total invested assets in cash and cash equivalents as of December 31, 2011 and 2010, respectively. This relatively high concentration of cash and cash equivalents as of December 31, 2011 resulted primarily from the issuance of $175 million of convertible senior notes in December 2011.  Our most significant balance sheet liability is our reserves for loss and loss adjustment expense. We record reserves for estimated losses under insurance policies that we write and for loss adjustment expenses related to the investigation and settlement of policy claims. Our reserves for loss and loss adjustment expenses represent the estimated cost of all reported and unreported loss and loss adjustment expenses incurred and unpaid at any given point in time based on known facts and circumstances. Our reserves for loss and loss adjustment expenses incurred and unpaid are not discounted using present value factors. Our loss reserves are reviewed at least annually by our external actuaries. Reserves are based on estimates of the most likely ultimate cost of individual claims. These estimates are inherently uncertain. Judgment is required to determine the relevance of our historical experience and industry information under current facts and circumstances. The interpretation of this historical and industry data can be impacted by external forces, principally frequency and severity of future claims, length of time to achieve ultimate settlement of claims, inflation of medical costs and wages, insurance policy coverage interpretations, jury determinations and legislative changes. Accordingly, our reserves may prove to be inadequate to cover our actual losses. If we change our estimates, these changes would be reflected in our results of operations during the period in which they are made, with increases in our reserves resulting in decreases in our earnings.  

Acquisitions

AHL

  During 2011 and 2010, AmTrust Holdings Luxembourg S.A.R.L ("AHL") (formerly called AmTrust Captive Holdings Limited) completed a series of acquisitions described below. AHL is a holding company that purchases Luxembourg captive insurance entities that allows us to obtain the benefit of the captives' capital and utilization of their existing and future loss reserves through a series of reinsurance arrangements with one of our subsidiaries. AHL is included in our Specialty Risk and Extended Warranty segment.  In December 2011, AHL acquired all the issued and outstanding stock of Reaal Reassurantie S.A., a Luxembourg domiciled captive insurance company, from SNS REAAL N.V. and REAAL N.V. The purchase price of Reaal Reassurantie S.A. was approximately $72 million. We recorded approximately $79 million of cash, intangible assets of $15 million and a deferred tax liability of $22 million. Reaal Reassurantie S.A. subsequently changed its name to AmTrust Re Kappa.  In December 2011, AHL acquired all the issued and outstanding stock of Vandermoortele International Reinsurance Company SA, a Luxembourg domiciled captive insurance company, from NV Vandermoortele, Vandemoortele International Finance SA and NV Safinco. The purchase price of Vandermoortele International Reinsurance Company SA was approximately $66 million. We recorded approximately $71 million of cash, intangible assets of $11 million and a deferred tax liability of $16 million. Vandermoortele International Reinsurance Company SA subsequently changed its name to AmTrust Re Zeta.  In June 2011, AHL acquired all the issued and outstanding stock of International Crédit Mutuel Reinsurance SA ("ICM Re"), a Luxembourg domiciled captive insurance company, from Assurance du Credit Mutuel IARD SA. The purchase price of ICM Re was approximately $315 million. We recorded approximately $347 million of cash, intangible assets of $56 million and a deferred tax liability of $88 million. ICM Re subsequently changed its name to AmTrust Re Alpha.                                         65  --------------------------------------------------------------------------------

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  In May 2010, AHL acquired all the issued and outstanding stock of Euro International Reinsurance S.A., a Luxembourg domiciled captive insurance company, from TALANX AG. The purchase price of Euro International Reinsurance S.A. was approximately $58 million. We recorded approximately $66 million of cash, intangible assets of $9 million and a deferred tax liability of $16 million. Euro International Reinsurance S.A. subsequently was merged into AmTrust Re 2007.  

We have classified the intangible assets as contractual use rights and they will be amortized based on the actual use of the related loss reserves.

Cardinal Comp

  In September 2008, we entered into a managing general agency agreement with Cardinal Comp, LLC ("Cardinal Comp"), a workers' compensation managing general agent for which we paid the agency a commission for the placement of insurance policies. The agency operated in eight states and primarily in the state of New York. In September 2011, one of our subsidiaries entered into a renewal rights and asset purchase agreement with Cardinal Comp and Cook Inlet Alternative Risk LLC. The existing managing general agency agreement entered into in 2008 was terminated as part of the new agreement and will enable us to reduce commissions on written premium generated from the renewal rights agreement. In accordance with FASB ASC 805-10 Business Combinations, we recorded a purchase price of $30.4 million primarily for goodwill and intangible assets consisting of distribution networks, renewal rights and a trademark. The intangible assets have a life of between 2 and 16 years and are included as a component of the Small Commercial Business segment.  

Majestic

  One of our subsidiaries and the Insurance Commissioner of the State of California, acting solely in the capacity as the statutory conservator (the "Conservator") of Majestic Insurance Company ("Majestic"), entered into a Rehabilitation Agreement that set forth a plan for the rehabilitation of Majestic (the "Rehabilitation Plan") by which we acquired the business of Majestic through a Renewal Rights and Asset Purchase Agreement (the "Purchase Agreement"), and a Loss Portfolio Transfer and Quota Share Reinsurance Agreement (the "Reinsurance Agreement"). On July 1, 2011, one of our subsidiaries entered into the Reinsurance Agreement, which was effective June 1, 2011, and assumed all of Majestic's liability for losses and loss adjustment expenses under workers' compensation insurance policies of approximately $331.7 million on a gross basis (approximately $183.5 million on a net basis), without any aggregate limit, and certain contracts related to Majestic's workers' compensation business, including leases for Majestic's California office space. In addition, we assumed 100% of the unearned premium reserve of approximately $26 million on all in-force Majestic policies. In connection with this transaction, we received approximately $224.5 million of cash and investments, which included $26 million for a reserve deficiency and also included the assignment of Majestic's reinsurance recoverables of approximately $51.8 million. The Reinsurance Agreement also contains a profit sharing provision whereby we will pay Majestic up to 3% of net earned premium related to current Majestic policies that we renew in the three year period commencing on the closing date should the loss ratio on such policies for the three year period be 65% or less. The insurance premiums, which are included in our Small Commercial Business segment, have been recorded since the acquisition date and were approximately $43 million for the year ended December 31, 2011.  We have completed our purchase price accounting related to the Reinsurance Agreement and, in accordance with ASC 944-805 Business Combinations, we are required to adjust to fair value Majestic's loss and LAE reserves by taking the acquired loss reserves recorded and discounting them based on expected reserve payout patterns using a current risk-free rate of interest. This risk free interest rate is then adjusted based on different cash flow scenarios that use different payout and ultimate reserve assumptions deemed to be reasonably possible based upon the inherent uncertainties present in determining the amount and timing of payment of such reserves. The difference between the acquired loss and LAE reserves and the our best estimate of the fair value of such reserves at acquisition date is amortized ratably over the payout period of the acquired loss and LAE reserves. We determined the fair value of the loss reserves to be $328.9 million. Accordingly, the amortization will be recorded as an expense on our income statement until fully amortized.                                         66  --------------------------------------------------------------------------------

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  In consideration for our assumption of (i) Majestic's losses and loss adjustment expenses under its workers' compensation insurance policies pursuant to the Reinsurance Agreement and (ii) Majestic's leases for its California offices, pursuant to the Purchase Agreement, we acquired the right to offer, quote and solicit the renewals of in-force workers' compensation policies written by Majestic, certain assets required to conduct such business, including intellectual property and information technology, certain fixed assets, and the right to offer employment to Majestic's California-based employees.  As a result of entering into the Purchase Agreement, in accordance with FASB ASC 805 Business Combinations, we recorded $3.9 million of intangible assets related to distribution networks and trademarks. The distribution networks have a life of 13 years and the trademarks have a life of two years. Additionally, we recorded a liability for approximately $0.4 million related to an unfavorable lease assumed in the transaction and a liability for approximately $0.8 million related to the above mentioned profit sharing provision.  

BTIS

  In December 2011, we acquired the California-based Builders & Tradesmen's Insurance Services, Inc. ("BTIS"), an insurance wholesaler and general agent specializing in insurance policies and bonds for small artisan contractors. Our initial purchase price was $5.0 million, which does not include potential incentives to the sellers based on future profitability of the business. The transaction did not have a material impact on our results of operations or financial condition in 2011.  

Warrantech

  In August 2010, we, through our wholly-owned subsidiary AMT Warranty Corp., acquired 100% of the issued and outstanding capital stock of Warrantech Corporation and its subsidiaries ("Warrantech") from WT Acquisition Holdings, LLC for approximately $7.5 million in cash and an earnout payment to the sellers of a minimum of $2.0 million and a maximum and $3.0 million based on AMT Warranty Corp.'s EBITDA over the three-year period from January 1, 2011 through December 31, 2013. Prior to the acquisition, we had a 27% equity interest (in the form of preferred units) in WT Acquisition Holdings, LLC and a $20 million senior secured note due January 31, 2012 issued to us by Warrantech. Interest on the note was payable monthly at a rate of 15% per annum and consisted of a cash component at 11% per annum and 4% per annum for the issuance of additional notes in principal amount equal to the interest not paid in cash on such date.  Immediately prior to the consummation of this transaction, WT Acquisition Holdings, LLC redeemed our preferred units that had represented our 27% equity interest in that entity. In addition, immediately following the transaction, AMT Warranty Corp. was recapitalized and we contributed our note receivable from Warrantech in the approximate amount of $24.1 million to AMT Warranty Corp. in exchange for Series A preferred stock, par value $0.01 per share (the "Series A Preferred Stock"), of AMT Warranty Corp. valued at $24.1 million. We also received additional shares of Series A Preferred Stock such that the total value of our 100% preferred share ownership in AMT Warranty Corp. is equivalent to $50.7 million. Lastly, AMT Warranty Corp. issued 20% of its issued and outstanding common stock to the Chairman of Warrantech, which had a fair value of $6.9 million as determined using both a market and an income approach. Given our preference position, absent our waiver, we will be paid distributions on our Series A Preferred Stock before any common shareholder would be entitled to a distribution on the common stock.  As a result, the ultimate acquisition price of Warrantech was $48.9 million and we recorded goodwill and intangible assets of approximately $69.7 million and $29.6 million, respectively. We incurred less than $0.1 million of costs related to the acquisition. The intangible assets consisted of trademarks, agency relationships and non-compete agreements, which had estimated lives of between 3 and 18 years. The results of operations from Warrantech, which are included in our Specialty Risk and Extended Warranty segment as a component of service and fee income, have been recorded since the acquisition date and were approximately $53 million and $17 million for the years ended December 31, 2011 and 2010, respectively.  

Risk Services

During June 2010, we completed the acquisition of eight direct and indirect subsidiaries of RS Acquisition Holdings Corp., including Risk Services, LLC and PBOA, Inc. (collectively, "Risk Services"). The entities acquired include various risk retention and captive management companies, brokering entities

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  and workers' compensation servicing entities. The acquired companies are held in a newly created entity, RS Acquisition Holdco, LLC. The Risk Services entities have offices in Florida, Vermont and the District of Columbia and are broadly licensed.  We have a majority ownership interest (80%) in Risk Acquisition Holdco, LLC, for which our total consideration was $11.7 million. Acquisition costs associated with the acquisition were approximately $0.2 million. As part of the purchase agreement, the non-controlling interest has the option under certain circumstances to require us to purchase the remaining ownership interest (20%) of Risk Services. In accordance with FASB ASC Topic 480, Distinguishing Liabilities from Equity, and FASB ASC Topic 815, Derivatives and Hedging, we have classified the remaining 20% ownership interest of Risk Services as mezzanine equity on the Consolidated Balance Sheet.  In accordance with FASB ASC 805, Business Combinations, our total consideration paid for Risk Services was $11.7 million, which included cash of $11.1 million and a value of $0.6 million that was assigned for the redeemable non-controlling interest. We assigned a value of approximately $5.0 million to intangible assets and $5.0 million to goodwill. The intangible assets consisted of trade names, customer relationships, renewal rights and non-compete agreements and have finite lives ranging from 4 years to 17 years. The results of operations from Risk Services, which are included in our Small Commercial Business segment as a component of service and fee income, have been recorded since the acquisition date and were approximately $7 million for each of the years ended December 31, 2011 and 2010.  Strategic Investments Investment in ACAC  During 2010, we completed our strategic investment in <org value="ACORN:3455047841" idsrc="xmltag.org">American Capital Acquisition Corporation ("ACAC"). We formed ACAC with The Michael Karfunkel 2005 Grantor Retained Annuity Trust (the "Trust") for the purpose of acquiring from GMAC Insurance Holdings, Inc. and Motor Insurance Corporation ("MIC", together with GMAC Insurance Holdings, Inc., "GMACI"), GMACI's U.S. consumer property and casualty insurance business (the "GMACI Business"), a writer of automobile coverages through independent agents in the United States. Its coverage includes standard/preferred auto, RVs, non-standard auto and commercial auto. The acquisition included ten statutory insurance companies (the "GMACI Insurers"). Michael Karfunkel, individually, and the Trust, which is controlled by Michael Karfunkel, own 100% of ACAC's common stock (subject to our conversion rights described below). Michael Karfunkel is the chairman of our board of directors and the father-in-law of Barry D. Zyskind, our chief executive officer. The ultimate beneficiaries of the Trust include Michael Karfunkel's children, one of whom is married to Mr. Zyskind. In addition, Michael Karfunkel is the Chairman of the Board of Directors of ACAC.  Pursuant to the Amended Stock Purchase Agreement, ACAC issued and sold to us for an initial purchase price of approximately $53.0 million, which was equal to 25% of the capital initially required by ACAC, 53,054 shares of Series A Preferred Stock, which provides an 8% cumulative dividend, is non-redeemable and is convertible, at our option, into 21.25% of the issued and outstanding common stock of ACAC (the "Preferred Stock"). We have pre-emptive rights with respect to any future issuances of securities by ACAC and our conversion rights are subject to customary anti-dilution protections. We have the right to appoint two members of ACAC's board of directors, which consists of six members. Subject to certain limitations, the board of directors of ACAC may not take any action in the absence of our appointees and ACAC may not take certain corporate actions without the unanimous prior approval of its board of directors (including our appointees).  We, the Trust and Michael Karfunkel, individually, each shall be required to make its or his proportionate share of deferred payments payable by ACAC to GMACI pursuant to the GMACI Securities Purchase Agreement, which are payable, annually on March 1 through March 1, 2013, to the extent that ACAC is unable to otherwise provide for such payments. Our proportionate share of such deferred payments will not exceed $15.0 million. In addition, in connection with our investment, ACAC will grant us a right of first refusal to purchase or to reinsure commercial auto insurance business acquired from GMACI.  In accordance with ASC 323-10-15, Investments-Equity Method and Joint Ventures, we account for our investment in ACAC under the equity method. We recorded $7.9 million and $25.3 million of income during the years ended December 31, 2011 and 2010, respectively related to our equity investment in ACAC.                                         68  --------------------------------------------------------------------------------

     TABLE OF CONTENTS  Personal Lines Quota Share  We, effective March 1, 2010, reinsure 10% of the net premiums of the GMACI Business, pursuant to a 50% quota share reinsurance agreement ("Personal Lines Quota Share") among Integon National Insurance Company, lead insurance company on behalf of the GMACI Insurers, as cedents, and the Company, ACP Re, Ltd., a Bermuda reinsurer that is a wholly-owned indirect subsidiary of the Trust, and Maiden Insurance Company, Ltd., as reinsurers. The Personal Lines Quota Share provides that the reinsurers, severally, in accordance with their participation percentages, receive 50% of the net premium of the GMACI Insurers and assume 50% of the related net losses. We have a 20% participation in the Personal Lines Quota Share, by which we receive 10% of the net premiums of the personal lines business and assume 10% of the related net losses. The Personal Lines Quota Share has an initial term of three years and will renew automatically for successive three-year terms unless terminated by written notice not less than nine months prior to the expiration of the current term. In addition, either party is entitled to terminate on 60 days' written notice or less upon the occurrence of certain early termination events, which include a default in payment, insolvency, change in control of the Company or the GMACI Insurers, run-off, or a reduction of 50% or more of the shareholders' equity. The GMACI Insurers also may terminate on nine months' written notice following the effective date of an initial public offering or private placement of stock by ACAC or a subsidiary. The Personal Lines Quota Share provides that the reinsurers pay a provisional ceding commission equal to 32.5% of ceded earned premium, net of premiums ceded by the personal lines companies for inuring reinsurance, subject to adjustment to a maximum of 34.5% if the loss ratio for the reinsured business is 60.5% or less and a minimum of 30.5% if the loss ratio is 64.5% or higher. The Personal Lines Quota Share is subject to a premium cap that limits the premium that could be ceded by the GMACI Insurers to TIC to $121 million during calendar year 2011 to the extent TIC was to determine, in good faith, that it could not assume additional premium. The premium cap increases by 10% per annum thereafter. As a result of this agreement, we assumed $102.6 million and $82.3 million of business from the GMACI Insurers during the years ended December 31, 2011 and 2010, respectively.  

Information Technology Services Agreement

  We provide ACAC and its affiliates information technology development services in connection with the development of a policy management system at a price of cost plus 20% pursuant to a Master Services Agreement with GMAC Insurance Management Corporation, a wholly-owned subsidiary of ACAC. In addition, as consideration for a license for ACAC and its affiliates to use that system, we receive a license fee in the amount of 1.25% of gross premiums of ACAC and its affiliates plus our costs for support services. We recorded approximately $4.0 million and $2.0 million of fee income for the years ended December 31, 2011 and 2010, respectively, related to this agreement.  

Asset Management Agreement

  We manage the assets of ACAC and its subsidiaries for an annual fee equal to 0.20% of the average aggregate value of the assets under management for the preceding quarter if the average aggregate value for the preceding quarter is $1 billion or less and 0.15% of the average aggregate value of the assets under management for the preceding quarter if the average aggregate value for that quarter is more than $1 billion. We currently manage approximately $0.7 billion of assets as of December 31, 2011. As a result of this agreement, we earned approximately $1.6 million and $1.5 million of investment management fees for the years ended December 31, 2011 and 2010, respectively.  As a result of the above service agreements with ACAC, we recorded fees totaling approximately $5.6 million and $3.5 million for the years ended December 31, 2011 and 2010, respectively. As of December 31, 2011, the outstanding balance receivable by ACAC related to these service fees and reimbursable costs was approximately $1.1 million.                                         69  --------------------------------------------------------------------------------

     TABLE OF CONTENTS  Life Settlement Contracts  A life settlement contract is a contract between the policy owner of a life insurance policy and a third-party investor who obtains the ownership and beneficiary rights of the underlying life insurance policy. During 2010, we formed Tiger Capital LLC ("Tiger") with a subsidiary of ACAC for the purposes of acquiring life settlement contracts. In 2011, we formed AMT Capital Alpha, LLC ("AMT Alpha") with a subsidiary of ACAC and AMT Capital Holdings, S.A. ("AMTCH") with ACP Re, LTD., an entity controlled by Michael Karfunkel, for the purposes of acquiring additional life settlement contracts. We have a fifty percent ownership interest in each of Tiger, AMT Alpha and AMTCH (collectively, the "LSC entities"). Tiger may also acquire premium finance loans made in connection with the borrowers' purchase of life insurance policies that are secured by the policy, which are in default at the time of purchase. The LSC entities acquire the underlying policies through the borrowers' voluntary surrender of the policy in satisfaction of the loan or foreclosure. A third party serves as the administrator of the Tiger life settlement contract portfolio, for which it receives an annual fee. Under the terms of an agreement for Tiger, the third party administrator is eligible to receive a percentage of profits after certain time and performance thresholds have been met. We provide for certain actuarial and finance functions related to the LSC entities. Additionally, in conjunction with our 21.25% ownership percentage of ACAC, we ultimately receive 60.6% of the profits and losses of Tiger and AMT Alpha. As such, in accordance with ASC 810-10, Consolidation, we have been deemed the primary beneficiary and, therefore, consolidate the LSC entities.  We account for investments in life settlements in accordance with ASC 325-30, Investments in Insurance Contracts, which states that an investor shall elect to account for its investments in life settlement contracts by using either the investment method or the fair value method. The election is made on an instrument-by- instrument basis and is irrevocable. We have elected to account for these policies using the fair value method. We determine fair value on a discounted cash flow basis of anticipated death benefits, incorporating current life expectancy assumptions, premium payments, the credit exposure to the insurance company that issued the life settlement contracts and the rate of return that a buyer would require on the contracts as no comparable market pricing is available.  Total capital contributions of approximately $43 million and $22 million were made to the LSC entities during the years ended December 31, 2011 and 2010, respectively, for which we contributed our fifty percent ownership share of approximately $21.5 million and $11 million in those same periods. The LSC entities used a majority of the contributed capital to acquire certain life insurance policies of approximately $26.4 million and $4.6 million for the years ended December 31, 2011 and 2010, respectively. Our investments in life settlements and cash value loans were approximately $136.8 million and $31.5 million as of December 31, 2011 and 2010, respectively and are included in Prepaid expenses and other assets on the Consolidated Balance Sheet. We recorded other income for the years ended December 31, 2011 and 2010 of approximately $46.9 million and $11.9 million, respectively, related to the life settlement contracts.  

Principal Revenue and Expense Items

  Gross Written Premium. Gross written premium represents estimated premiums from each insurance policy that we write, including as part of an assigned risk plan, during a reporting period based on the effective date of the individual policy. Certain policies that we underwrite are subject to premium audit at that policy's cancellation or expiration. The final actual gross premiums written may vary from the original estimate based on changes to the final rating parameters or classifications of the policy.  

Net Written Premium. Net written premium is gross written premium less that portion of premium that we cede to third party reinsurers under reinsurance agreements. The amount ceded under these reinsurance agreements is based on a contractual formula contained in the individual reinsurance agreement.

  Net Earned Premium. Net earned premium is the earned portion of our net written premiums. We earn insurance premiums on a pro rata basis over the term of the policy. At the end of each reporting period, premiums written that are not earned are classified as unearned premiums and are earned in subsequent periods over the remaining term of the policy. Our workers' compensation insurance and commercial package policies typically have a term of one year. Thus, for a one-year policy written on July 1, 2011 for an employer with a constant payroll during the term of the policy, we would earn half of the premiums in 2011 and the other half in 2012. We earn our specialty risk and extended warranty coverages over the estimated exposure                                         70  --------------------------------------------------------------------------------

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time period. The terms vary depending on the risk and have an average duration of approximately 23 months, but range in duration from one month to 120 months.

  Ceding Commission Revenues. Ceding commission is a commission we receive from ceding gross written premium to third-party reinsurers. In connection with the Maiden Quota Share, which is our primary source of ceding commission, we receive a ceding commission of 30% or 34.375%, based on the business ceded. Prior to April 1, 2011, we received a ceding commission of 31% or 34.375%, based on the business ceded. Additionally, for European medical liability business ceded to Maiden Insurance, Maiden Insurance pays us a 5% ceding commission, and we earn a profit commission of 50% of the amount by which the ceded loss ratio is lower than 65%. We allocate earned ceding commissions to our segments based on each segment's proportionate share of total acquisition costs and other underwriting expenses recognized during the period.  Net Investment Income and Realized Gains and (Losses). We invest our statutory surplus funds and the funds supporting our insurance liabilities primarily in cash and cash equivalents, fixed maturity and equity securities. Our net investment income includes interest and dividends earned on our invested assets. We report net realized gains and losses on our investments separately from our net investment income. Net realized gains occur when we sell our investment securities for more than their costs or amortized costs, as applicable. Net realized losses occur when we sell our investment securities for less than their costs or amortized costs, as applicable, or we write down the investment securities as a result of other-than-temporary impairment. We classify equity securities and our fixed maturity securities as available-for-sale. We report net unrealized gains (losses) on those securities classified as available-for-sale separately within accumulated other comprehensive income on our balance sheet.  

Service and Fee Income. We currently generate service and fee income from the following sources:

• Product warranty registration and service - Our Specialty Risk and Extended

Warranty business generates fee revenue for product warranty registration

and claims handling services provided to unaffiliated third parties.

• Servicing carrier - We act as a servicing carrier for workers' compensation

assigned risk plans in eight states. In addition, we also offer claims

adjusting and loss control services for fees to unaffiliated third parties.

• Management services - We provide services to insurance consumers,

traditional insurers and insurance producers by offering flexible and cost

effective alternatives to traditional insurance tools in the form of

various risk retention groups and captive management companies, as well as

management of workers' compensation and commercial property programs.

• Installment and reinstatement fees - We recognize fee income associated

with the issuance of workers' compensation policies for installment fees,

in jurisdictions where it is permitted and approved, and reinstatement

       fees, which are fees charged to reinstate a policy after it has been        cancelled for non-payment, in jurisdictions where it is permitted and        approved.  

• Broker services - We provide brokerage services to Maiden in connection

with our reinsurance agreement for which we receive a fee.

• Asset management services - We currently manage the investment portfolios

of Maiden and ACAC for which we receive a management fee.

• Information technology services - We provide information technology

services to ACAC and its affiliates for a fee.

   Loss and Loss Adjustment Expenses Incurred. Loss and loss adjustment expenses ("LAE") incurred represent our largest expense item and, for any given reporting period, include estimates of future claim payments, changes in those estimates from prior reporting periods and costs associated with investigating, defending and servicing claims. These expenses fluctuate based on the amount and types of risks we insure. We record loss and loss adjustment expenses related to estimates of future claim payments based on case-by-case valuations and statistical analyses. We seek to establish all reserves at the most likely ultimate exposure                                         71  --------------------------------------------------------------------------------

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  based on our historical claims experience. It is typical for our more serious bodily injury claims to take several years to settle, and we revise our estimates as we receive additional information about the condition of injured employees and claimants and the costs of their medical treatment. Our ability to estimate loss and loss adjustment expenses accurately at the time of pricing our insurance policies is a critical factor in our profitability.  

Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses consist of policy acquisition expenses, salaries and benefits and general and administrative expenses. These items are described below:

• Policy acquisition expenses comprise commissions directly attributable to

those agents, wholesalers or brokers that produce premiums written on our

behalf. In most instances, we pay commissions based on collected premium,

which reduces our credit risk exposure associated with producers in case a

policyholder does not pay a premium. We pay state and local taxes, licenses

and fees, assessments and contributions to various state guaranty funds

based on our premiums or losses in each state. Surcharges that we may be

required to charge and collect from insureds in certain jurisdictions are

recorded as accrued liabilities, rather than expense.

• Salaries and benefits expenses are those salaries and benefits expenses for

employees that are directly involved in the origination, issuance and

maintenance of policies, claims adjustment and accounting for insurance

transactions. We classify salaries and benefits associated with employees

that are involved in fee generating activities as other expenses.

• General and administrative expenses are comprised of other costs associated

with our insurance activities, such as federal excise tax, postage,

telephones and internet access charges, as well as legal and auditing fees

and board and bureau charges.

   Gain on Investment in Life Settlement Contracts. The gain on investment in life settlement contracts includes the gain on acquisition of life settlement contracts, the gain realized upon a mortality event and the change in fair value of the investments in life settlements as evaluated at the end of each reporting period. We determine fair value based upon the discounted cash flow of the anticipated death benefits, incorporating a number of factors, such as current life expectancy assumptions, expected premium payment obligations and increased cost assumptions, credit exposure to the insurance companies that issued the life insurance policies and the rate of return that a buyer would require on the policies. The gain realized upon mortality event is the difference between the death benefit received and the recorded fair value of that particular policy. We allocate gain on investment in life settlement contracts to our segments based on net written premium by segment.  Other Expense. Other expense includes those charges that are related to the amortization of tangible and intangible assets and non-insurance fee generating activities in which we engage, including salaries and benefits expenses and other charges directly attributable to non-insurance fee generating activities, such as those generated by Warrantech and Risk Services.  

Interest Expense. Interest expense represents amounts we incur on our outstanding indebtedness at the then-applicable interest rates.

Income Tax Expense. We incur federal income tax expense as well as income tax expense in certain foreign jurisdictions in which we operate.

Net Loss Ratio. The net loss ratio is a measure of the underwriting profitability of an insurance company's business. Expressed as a percentage, this is the ratio of net losses and LAE incurred to net premiums earned.

  Net Expense Ratio. The net expense ratio is a measure of an insurance company's operational efficiency in administering its business. Expressed as a percentage, this is the ratio of the sum of acquisition costs and other underwriting expenses less ceding commission revenue to net premiums earned. As we allocate certain acquisition costs and other underwriting expenses based on premium volume to our segments, net loss ratio on a segment basis may be impacted period over period by a shift in the mix of net written premium.                                         72  --------------------------------------------------------------------------------

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  Net Combined Ratio. The net combined ratio is a measure of an insurance company's overall underwriting profit. This is the sum of the net loss and net expense ratios. If the net combined ratio is at or above 100 percent, an insurance company cannot be profitable without investment income, and may not be profitable if investment income is insufficient.  

Net Premiums Earned less Expenses Included in Combined Ratio (Underwriting Income). Underwriting income is a measure of an insurance company's overall operating profitability before items such as investment income, interest expense and income taxes.

  Net Investment Income and Realized Gains and (Losses). We invest our statutory surplus funds and the funds supporting our insurance liabilities primarily in cash and cash equivalents, fixed maturity and equity securities. Our net investment income includes interest and dividends earned on our invested assets. We report net realized gains and losses on our investments separately from our net investment income. Net realized gains occur when we sell our investment securities for more than their costs or amortized costs, as applicable. Net realized losses occur when we sell our investment securities for less than their costs or amortized costs, as applicable, or we write down the investment securities as a result of other-than-temporary impairment. We classify equity securities and our fixed maturity securities as available-for-sale. We report net unrealized gains (losses) on those securities classified as available-for-sale separately within accumulated other comprehensive income on our balance sheet.  

Return on Equity. We calculate return on equity by dividing net income by the average of shareholders' equity.

Critical Accounting Policies

  It is important to understand our accounting policies in order to understand our financial statements. These policies require us to make estimates and assumptions. Our management has discussed the development, selection and disclosure of the estimates and assumptions we use with the Audit Committee of our Board of Directors. These estimates and assumptions affect the reported amounts of our assets, liabilities, revenues and expenses and the related disclosures. Some of the estimates result from judgments that can be subjective and complex, and, consequently, actual results in future periods might differ significantly from these estimates.  

We believe that the most critical accounting policies relate to the reporting of reserves for loss and loss adjustment expenses, including losses that have occurred but have not been reported prior to the reporting date, amounts recoverable from third party reinsurers, assessments, deferred policy acquisition costs, deferred income taxes, the impairment of investment securities, goodwill and other intangible assets and the valuation of stock based compensation.

The following is a description of our critical accounting policies.

  Premiums. We recognize insurance premiums, other than in our Specialty Risk and Extended Warranty segment, as earned on the straight-line basis over the contract period. Insurance premiums on Specialty Risk and Extended Warranty business are earned based on estimated program coverage periods. We base these estimates on the expected distribution of coverage periods by contract at inception, because a single contract may contain multiple coverage period options, and we revise these estimates based on the actual coverage periods selected by the insured. Unearned premiums represent the portion of premiums written that is applicable to the unexpired term of the contract or policy in force. We base premium adjustments on contracts and audit premiums on estimates made over the contract period. We also estimate an allowance for doubtful accounts based on a percentage of premium. We review our bad debt write-offs at least annually and adjust our premium percentage as required. Allowance for doubtful accounts were approximately $11.7 million and $10.4 million at December 31, 2011 and 2010, respectively.  Ceding Commission. Ceding commission is a commission we receive from ceding gross written premium to third party reinsurers. We earn commissions on reinsurance premiums ceded in a manner consistent with the recognition of the direct acquisition costs of the underlying insurance policies, generally on a pro-rata basis over the terms of the policies reinsured. In connection with the Maiden Quota Share, which is our primary source of ceding commission, the amount we receive is a blended rate based on a contractual formula contained in the individual reinsurance agreements, and the rate may not correlate specifically to the                                         73 

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  cost structure of our individual segments. As such, we allocate earned ceding commissions to our segments based on each segment's proportionate share of total acquisition costs and other underwriting expenses recognized during the period.  Life Settlement profit commission. Investments in life settlements are accounted for in accordance with ASC 325-30, Investments in Insurance Contracts, and we have elected to account for our investment in life settlements using the fair value method. We retain a third party service provider to perform certain administration functions to effectively manage these life settlement contracts and a portion of their fee is contingent on the overall profitability of the life settlement contracts. We accrue the related profit commission on life settlements at fair value, in relation to life settlements purchased prior to December 31, 2010. This profit commission is calculated based on the discounted anticipated cash flows and the provisions of the underlying contract. In addition, we accrue a best estimate in relation to profit commission due on certain life settlement contracts acquired subsequent to December 31, 2010 as no contractual relationship currently exists.  Reserves for Loss and Loss Adjustment Expenses. We record reserves for estimated losses under insurance policies that we write and for loss adjustment expenses related to the investigation and settlement of policy claims. Our reserves for loss and loss adjustment expenses represent the estimated cost of all reported and unreported loss and loss adjustment expenses incurred and unpaid at any given point in time based on known facts and circumstances. In establishing our reserves, we do not use loss discounting, which would involve recognizing the time value of money and offsetting estimates of future payments by future expected investment income. Our reserves for loss and loss adjustment expenses are estimated using case-by-case valuations and statistical analyses.  We utilize a combination of our incurred loss development factors and industry-wide incurred loss development factors. Our actuary generates a range within which it is reasonably likely that our ultimate loss and loss adjustment expenses for claims incurred in a particular time period, typically the calendar year, will fall. The low end of the range is established by assigning a weight of 100% to our ultimate losses obtained by application of our own loss development factors. The high end is established by assigning a weight of 50% each to our ultimate losses as developed through application of Company and industry wide loss development factors. The determination to assign particular weights to ultimate losses developed through application of our loss development factors and industry-wide loss development factors is made by our actuary and is a matter of actuarial judgment. In the selection of our reserves, we have given greater consideration over time to the results attributable to our own loss development factors.  We believe this method, by which we track the development of claims incurred in a particular time period, is the best method for projecting our ultimate liability. Loss development factors are dependent on a number of elements, including frequency and severity of claims, length of time to achieve ultimate settlement of claims, projected inflation of medical costs and wages (for workers' compensation), insurance policy coverage interpretations, judicial determinations and existing laws and regulations. The predictive ability of loss development factors is dependent on consistent underwriting, claims handling, and inflation, among other factors, and predictable legislatively and judicially imposed legal requirements. If all things remain equal, losses incurred in 2011 should develop similarly to losses incurred in 2010 and prior years. Thus, if the Net Loss Ratio for premiums written in year one is 55.0%, we expect that the Net Loss Ratio for premiums written in year two also would be 55.0%. However, due to the inherent uncertainty in the loss development factors, our actual liabilities may differ significantly from our original estimates.  Notwithstanding the inherent uncertainty, we have not experienced material variability in our loss development factors. We believe that it is reasonably likely that we could experience a 5% deviation in our loss and loss adjustment expense reserves due to changes in the elements that underlie loss development, such as claims frequency or severity. For example, as of December 31, 2011, the average cost per workers' compensation claim was $11,871, which was a 4.3% increase over the claims severity from 2001 - 2010 of $11,377. In 2011, claims frequency (number of claims per $1.0 million of payroll) decreased to .972 from .979, a decrease of 0.7%, for the period between 2001 and 2011.                                         74  --------------------------------------------------------------------------------

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  In the event of a 5% increase in claims frequency as measured by our insureds' payroll, which we believe is the most important assumption regarding our business, our loss reserves as of December 31, 2011 would be understated by $16.3 million and would result in an after tax reduction in shareholders' equity of $10.6 million. In the event of a 5% increase in claim severity, which is the average incurred loss per claim, our loss and loss adjustment expense reserves would be understated by $8.8 million and would result in an after tax reduction in shareholders' equity of $5.7 million.  On a quarterly basis, at a minimum, and in some cases more frequently, we review our reserves to determine whether they are consistent with our actual results. In the event of a discrepancy, we would seek to determine the causes (underwriting, claims, inflation, regulatory) and would adjust our reserves accordingly. For example, if the development of our total incurred losses were 5% greater than the loss development factors would have predicted, we would adjust our reserves for the periods in question. In 2009, our liabilities for unpaid losses and LAE attributable to prior years decreased by $4.8 million primarily as result of favorable development in the Small Commercial Business segment, partially offset by unfavorable development from our involuntary participation in NCCI pools. In 2010, our liabilities for unpaid losses and LAE attributable to prior years increased by $7.9 million primarily as result of unfavorable loss development, in our Specialty Program segment. In 2011, our liabilities for unpaid losses and LAE attributable to prior years increased by $12.5 million primarily as result of higher actuarial estimates based on actual losses in our Specialty Program segment. We do not anticipate that we will make any material reserve adjustments, but will continue to monitor the accuracy of our loss development factors and adequacy of our reserves. Additional information regarding our reserves for loss and loss adjustment expenses can be found in "Item 1A. Risk Factors" and "Item 1. Business - Loss Reserves."  Reinsurance. We account for reinsurance premiums, losses and LAE on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. We record premiums earned and losses incurred ceded to other companies as reductions of premium revenue and losses and LAE. We account for commissions allowed by reinsurers on business ceded as ceding commission revenue. Reinsurance recoverables relate to the portion of reserves and paid losses and LAE that are ceded to other companies. We remain contingently liable for all loss payments in the event of failure to collect from the reinsurer.  Deferred Policy Acquisition Costs. We defer commission expenses, premium taxes and assessments as well as certain sales, underwriting and safety costs that vary with and are primarily related to the acquisition of insurance policies. These acquisition costs are capitalized and charged to expense ratably as premiums are earned. We may realize deferred policy acquisition costs only if the ratio of loss and loss adjustment expense reserves (calculated on a discounted basis) to the premiums to be earned is less than 100%, as it historically has been. If, hypothetically, that ratio were to be above 100%, we could not continue to record deferred policy acquisition costs as an asset and may be required to establish a liability for a premium deficiency reserve.  Assessments Related to Insurance Premiums. We are subject to various assessments and premium surcharges related to our insurance activities, including assessments and premium surcharges for state guaranty funds and second injury funds. Assessments based on premiums are generally paid within one year after the calendar year in which the policies are written. Assessments based on losses are generally paid within one year of when claims are paid by us. State insurance regulatory agencies use state guaranty fund assessments to pay claims of policyholders of impaired, insolvent or failed insurance companies and the operating expenses of those agencies. States use second injury funds to reimburse insurers and employers for claims paid to injured employees for aggravation of prior conditions or injuries. In some states, these assessments and premium surcharges may be partially recovered through a reduction in future premium taxes.  Earned But Unbilled Premium. Earned but unbilled premium ("EBUB") estimates the amount of audit premium for those policies that have yet to be audited as of the date of the quarter or year end. Workers' compensation policies are subject to audit and the final premium may increase or decrease materially from the original premium due to revisions to actual payroll and/or employee classification. Based on guidance in FASB ASC 944 as well as Statement of Statutory Accounting Principles 53, we determine EBUB using                                         75  --------------------------------------------------------------------------------

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statistically supported aggregate calculations based on our historical premium audit results. We have not had a material adjustment as a result of actual premium audits materially differing from the estimates used in calculating EBUB.

  As of December 31, 2011, if the actual results of the future premiums audits were 1% lower than the historical results used in calculating EBUB, the result would be a decrease in EBUB and net earned premium of $2.9 million or $1.9 million after tax. If the actual results of the future premiums audits were 1% higher than the historical results used in calculating EBUB, the result would be an increase in EBUB, and net earned premium of $2.9 million or $1.9 million after tax.  In calculating EBUB, we consider our ability to collect the projected increased premium as well as those expenses associated with both the additional premium and return premium.  Cash and Cash Equivalents. Cash and cash equivalents are presented at cost, which approximates fair value. We consider all highly liquid investments with original maturities of three months or less to be cash equivalents. We maintain our cash balances at several financial institutions. The Federal Deposit Insurance Corporation secures accounts up to $250,000 at these institutions. Management monitors balances in excess of insured limits and believes they do not represent a significant credit risk to us.  Investments. We account for our investments in accordance with ASC 320, Debt and Equity Securities, which requires that fixed-maturity and equity securities that have readily determined fair values be segregated into categories based upon our intention for those securities. In accordance with ASC 320, we have classified our fixed-maturity securities and equity securities as available-for-sale. We may sell our available-for-sale securities in response to changes in interest rates, risk/reward characteristics, liquidity needs or other factors.  We report fixed-maturity securities and equity securities at their estimated fair values based on quoted market prices or a recognized pricing service, with unrealized gains and losses, net of tax effects, reported as a separate component of comprehensive income in stockholders' equity. We determine realized gains and losses on the specific identification of the investments sold.  Quarterly, our Investment Committee ("Committee") evaluates each security that has an unrealized loss as of the end of the subject reporting period for other-than-temporary-impairment ("OTTI"). The Company generally considers an investment to be impaired when it has been in a significant unrealized loss position (in excess of 35% of cost if the issuer has a market capitalization of under $1 billion and in excess of 25% of cost if the issuer has a market capitalization of $1 billion or more) for over 24 months. In addition, the Committee uses a set of quantitative and qualitative criteria to review our investment portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of our investments. The criteria the Committee primarily considers include:  

• the current fair value compared to amortized cost;

• the length of time the security's fair value has been below its amortized

cost;

• specific credit issues related to the issuer such as changes in credit

rating, reduction or elimination of dividends or non-payment of scheduled

interest payments;

• whether management intends to sell the security and, if not, whether it is

not more than likely than not that we will be required to sell the security

before recovery of its amortized cost basis;

• the financial condition and near-term prospects of the issuer of the

security, including any specific events that may affect its operations or

       earnings;      •   the occurrence of a discrete credit event resulting in the issuer        defaulting on material outstanding obligation or the issuer seeking        protection under bankruptcy laws; and  

• other items, including company management, media exposure, sponsors,

marketing and advertising agreements, debt restructurings, regulatory

changes, acquisitions and dispositions, pending litigation, distribution

       agreements and general industry trends.                                          76 

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  Impairment of investment securities results in a charge to operations when a market decline below cost is deemed to be other-than-temporary. We write down investments immediately that we consider to be impaired based on the above criteria collectively.  Based on guidance in FASB ASC 320-10-65, in the event of the decline in fair value of a debt security, a holder of that security that does not intend to sell the debt security and for whom it is not more than likely than not that such holder will be required to sell the debt security before recovery of its amortized cost basis, is required to separate the decline in fair value into (a) the amount representing the credit loss and (b) the amount related to other factors. The amount of total decline in fair value related to the credit loss shall be recognized in earnings as an OTTI with the amount related to other factors recognized in accumulated other comprehensive loss net loss, net of tax. OTTI credit losses result in a permanent reduction of the cost basis of the underlying investment. The determination of OTTI is a subjective process, and different judgments and assumptions could affect the timing of the loss realization. During 2011, 2010 and 2009, we recorded impairment write-downs of $4.4 million, $21.2 million and $24.8 million, respectively after determining that certain of our investments were OTTI.  Life Settlements - When we become the owner of a life insurance policy either by direct purchase or following a default on a premium finance loan, the life insurance premium for such policy is accounted for as an investment in life settlements. Investments in life settlements are accounted for in accordance with ASC 325-30, Investments in Insurance Contracts, which states that an investor shall elect to account for its investments in life settlement contracts using either the investment method or the fair value method. The election is made on an instrument-by-instrument basis and is irrevocable. We have elected to account for these investments using the fair value method.  Goodwill and Intangible Assets - We account for goodwill and intangible assets in accordance with ASC 820, Business Combinations and ASC 350, Intangibles - Goodwill and Other. We record a purchase price paid that is in excess of net assets ("goodwill") arising from a business combination as an asset, and it is not amortized. We amortize intangible assets with a finite life over the estimated useful life of the asset. We do not amortize intangible assets with an indefinite useful life. We test goodwill and intangible assets for impairment on an annual basis or more frequently if events or changes in circumstances indicate that the carrying amount may not be recoverable. If the goodwill or intangible asset is impaired, it is written down to its realizable value with a corresponding expense reflected in the consolidated statement of operations.  Income Taxes - We join our domestic subsidiaries in the filing of a consolidated federal income tax return and are party to federal income tax allocation agreements. Under the tax allocation agreements, we pay to or receive from our subsidiaries the amount, if any, by which the group's federal income tax liability was affected by virtue of inclusion of the subsidiary in the consolidated federal return.  Deferred income taxes reflect the impact of "temporary differences" between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. The deferred tax asset primarily consists of book versus tax differences for premiums earned, loss and loss adjustment expense reserve discounting, policy acquisition costs, earned but unbilled premiums, and unrealized holding gains and losses on marketable equity securities. We record changes in deferred income tax assets and liabilities that are associated with components of other comprehensive income, primarily unrealized investment gains and losses and foreign currency translation gains and losses, directly to other comprehensive income. Otherwise, we include changes in deferred income tax assets and liabilities as a component of income tax expense.  In assessing the recoverability of deferred tax assets, management considers whether it is more likely than not that we will generate future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, tax planning strategies and projected future taxable income in making this assessment. If necessary, we establish a valuation allowance to reduce the deferred tax assets to the amounts that are more likely than not to be realized.                                         77  --------------------------------------------------------------------------------
     TABLE OF CONTENTS  Results of Operations Consolidated Results of Operations  [[Image Removed]]            [[Image Removed]]     [[Image Removed]]     [[Image Removed]]                                                       December 31,                                     2011                  2010                  2009                                                  (Amounts in Thousands) Gross written premium        $      2,150,472      $      1,560,822      $      1,198,946 Net written premium          $      1,276,597      $        827,226      $        643,426 Change in unearned premium           (239,736 )             (81,567 )             (69,544 ) Net earned premium                  1,036,861               745,659               573,882 Ceding commission - primarily                153,953               138,261               113,931 related party Service and fee income (related parties $16,700;             108,660                62,067                30,690 $12,322; $8,622) Net investment income                  55,515                50,517                55,287 Net realized gain (loss)                2,768                 5,953               (33,579 ) on investments Total revenue                       1,357,757             1,002,457               740,211 Loss and loss adjustment              678,333               471,481               327,771 expense Acquisition costs and other underwriting                    398,404               302,809               244,279 expenses Other                                  86,611                56,403                22,232 Total expenses                      1,163,348               830,693               594,282 Income before other income (expense), income taxes and equity in earnings                194,409               171,764               145,929 (loss) of unconsolidated subsidiaries Other income (expense): Foreign currency (loss)                (2,418 )                 684                 2,459 gain Interest expense                      (16,079 )             (12,902 )             (16,884 ) Acquisition gain on                     5,850                     -                     - purchase Net gain on investment in              46,892                11,855                     - life settlement contracts Total other income                     34,245                  (363 )             (14,425 ) (expense) Income before income taxes and equity in earnings                228,654               171,401               131,504 (loss) of unconsolidated subsidiaries Provision for income taxes             42,372                47,053                27,459 Income before equity in earnings (loss) of unconsolidated                        186,282               124,348               104,045 subsidiaries and minority interest Equity in earnings (loss) of unconsolidated                       7,871                24,044                  (822 ) subsidiaries  - related parties Net income                            194,153               148,392               103,223 Non-controlling interest              (23,719 )              (5,927 )                   - Net income attributable to AmTrust Financial            $        170,434      $        142,465      $        103,223 Services, Inc. Net realized gain (loss) on investments: Total other-than-temporary   $         (4,411 )    $        (21,196 )    $        (24,778 ) impairment losses Portion of loss recognized in other comprehensive                      -                     -                     - income Net impairment losses                  (4,411 )             (21,196 )             (24,778 ) recognized in earnings Other net realized gain                 7,179                27,149                (8,801 ) (loss) on investments Net realized investment      $          2,768      $          5,953      $        (33,579 ) gain (loss)                                          78 
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Consolidated Results of Operations 2011 Compared to 2010
  Gross Written Premium. Gross written premium increased $589.5 million, or 37.8%, to $2,150.4 million from $1,560.9 million for the years ended December 31, 2011 and 2010, respectively. The increase of $589.5 million was attributable to growth across all segments. Gross written premium increased in our Small Commercial Business segment by $143.8 million, resulting primarily from increases in policy counts, new product offerings and the Majestic acquisition. The increase in Specialty Risk and Extended Warranty business of $308.0 million resulted primarily from growth in new programs in the U.S. and Europe, as well as our European medical liability business. The increase in our Specialty Program segment of $117.4 million resulted largely from new program additions. We also benefited from participating in the Personal Lines Quota share with the GMACI Insurers for all of 2011 compared to ten months in 2010, which resulted in an additional $20.3 million of assumed gross written premium.  Net Written Premium. Net written premium increased $449.4 million, or 54.3%, to $1,276.6 million from $827.2 million for the years ended December 31, 2011 and 2010, respectively. The increase by segment was: Small Commercial Business - $112.6 million; Specialty Risk and Extended Warranty - $253.5 million; Specialty Program - $63.0 million; and Personal Lines - $20.3 million. Net written premium increased for the year ended December 31, 2011 compared to the same period in 2010 due to the increase in gross written premium in 2011 compared to 2010, as well as the reduction in the percentage of our European medical liability business ceded to reinsurers from 80% to 40%, which became effective April 1, 2011.  Net Earned Premium. Net earned premium increased $291.3 million, or 39.1%, to $1,037.0 million from $745.7 million for the years ended December 31, 2011 and 2010, respectively. The increase by segment was: Small Commercial Business - $67.9 million; Specialty Risk and Extended Warranty - $143.2 million; Specialty Program - $31.1 million; and Personal Lines - $49.1 million.  Ceding Commission. Ceding commission represents commission earned primarily through the Maiden Quota Share, whereby AmTrust receives a 30% or 34.375% ceding commission, depending on the business ceded, on ceded written premiums to Maiden. The ceding commission earned during the year ended December 31, 2011 and 2010 was $154.0 million and $138.3 million, respectively. Ceding commission increased period over period as a result of increased premium writings. Additionally, effective April 1, 2011, we entered into a 40% quota share reinsurance agreement with Maiden covering our European medical liability business by which we receive a five percent ceding commission. Prior to April 1, 2011, this business was ceded to another reinsurer.  Service and Fee Income. Service and fee income increased $46.5 million, or 74.9%, to $108.6 million from $62.1 million for the years ended December 31, 2011 and 2010, respectively. The increase was attributable primarily to incremental fees of approximately $36 million generated by Warrantech, which was acquired during the third quarter of 2010 as well as an increase of approximately $4 million in fees derived by services we provide to ACAC and Maiden.  Net Investment Income. Net investment income increased $5.0 million, or 10.0%, to $55.5 million from $50.5 million for the years ended December 31, 2011 and 2010, respectively. In the year ended December 31, 2010, investment income benefited from the inclusion of $2.6 million of interest income related to a note receivable due from Warrantech before it was acquired during the third quarter of 2010. Absent this item, investment income increased $7.6 million as a result of a higher amount of invested assets period over period, which included the cash and investments acquired in the Majestic transaction.  Net Realized Gains (Losses) on Investments. Net realized gains on investments were $2.8 million, compared to net realized gains of $5.9 million for the year ended December 31, 2011 and 2010, respectively. The decrease in realized gains of investments related to lower trading activity of equity securities in 2011 as we have deemphasized equity investments in our overall investment portfolio. The net realized gains were inclusive of non-cash impairment writedowns of $4.4 million and $21.2 million in 2011 and 2010, respectively.                                         79  --------------------------------------------------------------------------------
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  Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses increased $206.8 million, or 43.8%, to $678.3 million for the year ended December 31, 2011 from $471.5 million for the year ended December 31, 2010. Our loss ratio for the years ended December 31, 2011 and 2010 was 65.4% and 63.2%, respectively. The increase in the loss ratio in 2011 resulted from higher current year accident selected ultimate losses as compared to selected ultimate losses from the prior year.  Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $95.6 million, or 31.6%, to $398.4 million for the year ended December 31, 2011 from $302.8 million for the year ended December 31, 2010. Our expense ratio increased to 23.6% in 2011 from 22.1% in 2010 and resulted from a reduction in the percentage of Maiden ceding commission earned in 2011 which was 27.5% compared to 31.3% in 2010.  Other. Other expenses increased $30.2 million, or 53.5%, to $86.6 million for the year ended December 31, 2011 from $56.4 million for the year ended December 31, 2010. The increase was the result, primarily, of the inclusion of Warrantech's results for all of 2011 compared to five months in 2010.  Income Before Other Income (Expense), Income Taxes and Equity in Earnings of Unconsolidated Subsidiaries. Income before other income (expense), income taxes and equity in earnings of unconsolidated subsidiaries increased $22.6 million, or 13.1%, to $194.4 million from $171.8 million for the years ended December 31, 2011 and 2010, respectively. The increase from 2010 to 2011 resulted primarily from higher net earned premium and increased service and fee income offset, partially, by higher loss and loss adjustment expenses and other insurance general and administrative expense.  Interest Expense. Interest expense for the years ended December 31, 2011 and 2010 was $16.1 million and $12.9 million, respectively. The increase in interest expense was primarily attributable to higher average outstanding debt balances in 2011 compared to 2010. The increase in average debt balances for 2011 relate to our revolving credit facility we entered into during January 2011, which replaced our now terminated $40 million term loan, a secured loan agreement we entered into in February 2011 and the reduction of the principal amount of our $30 million promissory note.  
Acquisition Gain on Purchase. We recorded a gain of $5.9 million in 2011 related to the acquisition of Majestic's workers' compensation renewal rights acquisition and loss portfolio transfer in 2011.
  Net Gain on Investment in Life Settlement Contracts. Gain on investment in life settlement contracts increased $35.0 million, or 294%, to $46.9 million from $11.9 million for the years ended December 31, 2011 and 2010, respectively, and primarily resulted from the gain realized upon a mortality event in 2011 and the acquisition of a higher number of life settlement contracts that were purchased by or surrendered to us in satisfaction of premium finance loans during the year ended December 31, 2011 as compared to the year ended December 31, 2010.  Provision for Income Tax. Income tax expense for the year ended December 31, 2011 was $42.4 million, which resulted in an effective tax rate of 18.5%. Income tax expense for the year ended December 31, 2010 was $47.1 million, which resulted in an effective tax rate of 27.5%. The decrease in our effective rate resulted primarily from increases in tax exempt interest and foreign source income not subject to tax for the year ended December 31, 2011 compared to the year ended December 31, 2010.  Equity in Earnings of Unconsolidated Subsidiaries - Related Parties. Equity in earnings of unconsolidated subsidiaries - related parties decreased by $16.2 million for the year ended December 31, 2011 to $7.8 million. The majority of the decrease related to the initial acquisition gain on ACAC of $10.4 million we recognized during the year ended December 31, 2010 that was adjusted downward during the year ended December 31, 2011 by $3.6 million. Absent this adjustment for purchase price accounting, earnings related to ACAC decreased to $11.4 million in 2011 from $14.9 million in 2010 and resulted primarily from higher loss ratios on the GMACI Business.  
Consolidated Results of Operations 2010 Compared to 2009
  Gross Written Premium. Gross written premium increased $362.0 million, or 30.2%, to $1,560.9 million from $1,198.9 million for the years ended December 31, 2010 and 2009, respectively. The increase of $362.0 million was primarily attributable to growth in our Specialty Risk and Extended Warranty segment of                                         80  --------------------------------------------------------------------------------
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$287.2 million. The increase in Specialty Risk and Extended Warranty business resulted primarily from new coverage plans in the U.S. and Europe, as well as additional premiums from growth in our European business related to general liability, employers' liability and professional and medical liability business generated by new underwriting teams who joined us in 2009 and 2010. Additionally, gross written premium increased by $82.3 million in 2010 as a result of business assumed from the GMACI Insurers pursuant to the Personal Lines Quota share.  Net Written Premium. Net written premium increased $183.8 million, or 28.6%, to $827.2 million from $643.4 million for the years ended December 31, 2010 and 2009, respectively. The increase (decrease), by segment, was: Small Commercial Business - $(12.4) million; Specialty Risk and Extended Warranty - $116.5 million; Specialty Program - $(2.6) million; and Personal Lines - $82.3 million.  Net Earned Premium. Net earned premium increased $171.8 million, or 29.9%, to $745.7 million from $573.9 million for the years ended December 31, 2010 and 2009, respectively. The increase (decrease) by segment was: Small Commercial Business - $13.4 million; Specialty Risk and Extended Warranty -  $113.4 million; Specialty Program - $(4.4) million; and Personal Lines - $49.4 million.  Ceding Commission. The ceding commission earned during the years ended December 31, 2010 and 2009 was $138.3 million and $113.9 million, respectively. Ceding commission increased period over period as a result of increased premium writings, which were partially offset by an increase in the percentage of business ceded at 31% instead of 34.375% in 2010 compared to 2009.  Service and Fee Income. Service and fee income increased $31.4 million, or 102.3%, to $62.1 million from $30.7 million for the years ended December 31, 2010 and 2009, respectively. The increase was attributable primarily to fees of approximately $24.7 million generated from Warrantech and Risk Services, which were acquired in 2010, as well as $2.9 million of incremental fees from ACAC in 2010.  Net Investment Income. Net investment income decreased $4.8 million, or 8.6%, to $50.5 million from $55.3 million for the years ended December 31, 2010 and 2009, respectively. The change period over period related primarily to a decrease in the yields on our fixed maturities to 3.6% in 2010 from 4.0% in the same period in 2009.  Net Realized Gains (Losses) on Investments. Net realized gains on investments for the year ended December 31, 2010 were $5.9 million, compared to the net realized loss of $33.6 million for the same period in 2009. The increase period over period related to the continued recovery of our equity portfolio and the timing of certain sales within our equity and fixed income portfolio. The net realized gain and loss included non-cash write-downs of $21.2 million and $24.8 million during 2010 and 2009, respectively, for securities that we determined to be other-than-temporarily-impaired.  Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses increased $143.7 million, or 43.8%, to $471.5 million for the year ended December 31, 2010 from $327.8 million for the year ended December 31, 2009. Our loss ratio for the years ended December 31, 2010 and 2009 was 63.2% and 57.1%, respectively. The increase in the loss ratio in 2010 resulted from higher actuarial estimates based on current year actual losses and was not the result of any increase in the frequency or severity of losses. Additionally, the loss ratio in 2009 benefited from the effect of a one-time $11.8 million benefit to the Specialty Risk and Extended Warranty segment related to the 2009 acquisition of AHL.  Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $58.5 million, or 24.0%, to $302.8 million for the year ended December 31, 2010 from $244.3 million for the year ended December 31, 2009. The expense ratio decreased slightly to 22.1% from 22.7% for the years ended December 31, 2010 and 2009, respectively. The decrease in the expense ratio in 2010 resulted primarily from a decline in other underwriting expenses, which resulted from a change in product mix from the Small Commercial Business segment to the Specialty Risk and Extended Warranty segment.  Income Before Other Income (Expense), Income Taxes and Equity in Earnings of Unconsolidated Subsidiaries. Income before other income (expense), income taxes and equity in earnings of unconsolidated subsidiaries increased $25.8 million, or 18.0%, to $171.8 million from $146.0 million for the years ended                                         81  --------------------------------------------------------------------------------
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December 31, 2010 and 2009, respectively. The increase from 2009 to 2010 resulted primarily from improvement in realized gains on our investment portfolio offset partially by a higher loss ratio in 2010.
  Interest Expense. Interest expense for the years ended December 31, 2010 and 2009 was $12.9 million and $16.9 million, respectively. The decrease was attributable to lower outstanding debt balances on our $40 million term loan and $30 million promissory note as well as lower expenses on an interest rate swap agreement.  
Gain on Investment in Life Settlement Contracts. Gain on investment in life settlement contracts was $11.9 million in 2010 and resulted from the gain recognized in 2010 from the initial portfolio purchase of life settlement contracts by Tiger Capital, LLC, a company we formed in the third quarter of 2010 with ACAC.
  Provision for Income Tax. Income tax expense for the year ended December 31, 2010 was $47.1 million, which resulted in an effective tax rate of 27.5%. Income tax expense for the year ended December 31, 2009 was $27.5 million, which resulted in an effective tax rate of 20.9%. The increase in our effective rate for the year ended December 31, 2010 resulted primarily from a one-time benefit in 2009 related to the acquisition of AHL in the first quarter of 2009.  Equity in Earnings of Unconsolidated Subsidiaries - Related Party. Equity in earnings of unconsolidated subsidiaries - related parties increased by $24.9 million for the year ended December 31, 2010 to $24.0 million. The increase related to our proportionate share of income from our equity investment in ACAC of $14.9 million for the year ended December 31, 2010 of $14.9 million and a gain on acquisition of ACAC of $10.4 million. Additionally, prior to acquiring the remaining 73% ownership of Warrantech during the third quarter of 2010, our proportionate share of equity loss in Warrantech was included in this line item. We previously classified the equity earnings (loss) from Warrantech as a component of investment income in prior years. This amount has been reclassified in all periods presented.  
Small Commercial Business Segment - Results of Operations
 [[Image Removed]]        [[Image Removed]]      [[Image Removed]]      [[Image Removed]]                                                     December 31,                                  2011                   2010                   2009                                                (Amounts in Thousands) Gross written premium    $       609,822        $       465,951        $       469,627 Net written premium      $       355,721        $       243,146        $       255,496 Change in unearned               (35,455 )                9,296                (16,525 ) premium Net earned premium               320,266                252,442                238,971 Ceding commission revenue - primarily               62,093                 66,282                 59,415 related party Loss and loss                    201,921                154,442                137,525 adjustment expense Acquisition costs and other underwriting               148,041                128,142                119,734 expenses                                  349,962                282,584                257,259 Underwriting income      $        32,397        $        36,140        $        41,127 Key Measures: Net loss ratio                      63.0 %                 61.2 %                 57.5 % Net expense ratio                   26.8 %                 24.5 %                 25.2 % Net combined ratio                  89.9 %                 85.7 %                 82.8 % Reconciliation of net expense ratio: Acquisition costs and other underwriting       $       148,041        $       128,142        $       119,734 expenses Less: Ceding commission                        62,093                 66,282                 59,415 revenue - primarily related party                          $        85,948        $        61,860        $        60,319 Net earned premium       $       320,266        $       252,442        $       238,971 Net expense ratio                   26.8 %                 24.5 %                 25.2 %                                          82 
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Small Commercial Business Segment Results of Operations 2011 Compared to 2010
  Gross Written Premium. Gross written premium increased $143.8 million, or 30.9%, to $609.8 million for the year ended December 31, 2011 from $466.0 million for the year ended December 31, 2010. The increase resulted primarily from new business associated with additional product offerings, workers' compensation rate increases in New York and Florida, higher overall policy counts and an increase in California workers' compensation production of approximately $43 million, as well as $26 million from the assumption of unearned premium in connection with the Majestic acquisition.  Net Written Premium. Net written premium increased $112.6 million, or 46.3%, to $355.7 million from $243.1 million for the years ended December 31, 2011 and 2010, respectively. The increase in net premium resulted from an increase in gross written premium for the year ended December 31, 2011 compared to the year ended December 31, 2010, as well as the assumption of $26 million of unearned premium from Majestic.  Net Earned Premium. Net earned premium increased $67.9 million, or 26.9%, to $320.3 million for the year ended December 31, 2011 from $252.4 million for the year ended December 31, 2010. As premiums written earn ratably over a twelve month period, the increase in net premium earned resulted from higher net premium written for the twelve months ended December 31, 2011 compared to the twelve months ended December 31, 2010, as well as the assumption of $26 million of unearned premium from Majestic in the second quarter of 2011, for which we earned approximately $24.4 million during 2011.  Ceding Commission. The ceding commission earned during the years ended December 31, 2011 and 2010 was $62.1 million and $66.3 million, respectively. The decrease related to a decline in the allocation to this segment of its proportionate share of our overall policy acquisition expense in 2011, which achieved proportionally less growth than our other segments in 2011, and from a reduction in the Maiden ceding commission percentage resulting from our amended quota share agreement, which became effective April 1, 2011.  Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses increased $47.5 million, or 30.7%, to  for the year ended December 31, 2011 from $154.4 million for the year ended December 31, 2010. Our loss ratio for the segment for the year ended December 31, 2011 increased to 63.0% from 61.2% for the year ended December 31, 2010. The increase in the loss ratio in the year ended December 31, 2011 resulted primarily from higher current accident year selected ultimate losses as compared to selected ultimate losses in prior accident years.  Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $19.9 million, or 15.5%, to $148.0 million for the year ended December 31, 2011 from $128.1 million for the year ended December 31, 2010. The expense ratio increased to 26.8% for the year ended December 31, 2011 compared to 24.5% for the year ended December 21, 2010. The increase in the expense ratio resulted primarily from a lower allocation of Maiden ceding commission to the segment during the year ended December 31, 2011 compared to the same period in 2010 and an increase in premium for this segment, resulting in a higher allocation of expenses to this segment.  Net Earned Premium Less Expenses Included in Combined Ratio (Underwriting Income). Net earned premium less expenses included in combined ratio decreased to $32.4 million for the year ended December 31, 2011 compared to $36.1 million for the year ended December 31, 2010. This decrease resulted primarily from higher loss and loss adjustment expenses during the year ended December 31, 2011 as compared to the year ended December 31, 2010, as well as lower ceding commission earned in 2011 compared to 2010.                                         83  --------------------------------------------------------------------------------
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Small Commercial Business Segment Results of Operations 2010 Compared to 2009
  Gross Written Premium. Gross written premium decreased $3.6 million, or 0.8%, to $466.0 million for the year ended December 31, 2010 from $469.6 million for the year ended December 31, 2009. The decrease resulted from a six percent mandated rate reduction in the state of Florida's workers' compensation rates, a decrease in assigned risk business and our continued effort of reunderwriting of our commercial package business.  Net Written Premium. Net written premium decreased $12.4 million, or 4.9%, to $243.1 million from $255.5 million for the years ended December 31, 2010 and 2009, respectively. The decrease in net premium resulted from a decrease in gross written premium for the twelve months ended December 31, 2010 compared to gross written premium for the twelve months ended December 31, 2009 and the cession of certain gross written premium to a new reinsurer in 2010 at a higher rate than the rate in effect in 2009.  Net Earned Premium. Net earned premium increased $13.4 million, or 5.6%, to $252.4 million for the year ended December 31, 2010 from $239.0 million for the year ended December 31, 2009. As premiums written earn ratably over the policy term, net earned premium continued to increase in 2010 although gross written premium remained primarily flat in 2010 compared to 2009. This increase was due to a decline in unearned premium that resulted from an additional $19.4 million of premium writings in the three months ended December 31, 2009 compared to the three months ended December 31, 2010.  Ceding Commission. The ceding commission earned during the years ended December 31, 2010 and 2009 was $66.3 million and $59.4 million, respectively. The increase related to the allocation to this segment of its proportionate share of our overall policy acquisition expense.  Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses increased $16.9 million, or 12.3%, to $154.4 million for the year ended December 31, 2010 from $137.5 million for the year ended December 31, 2009. Our loss ratio for the segment for the year ended December 31, 2010 increased to 61.2% from 57.5% for the year ended December 31, 2009. The increase in the loss and loss adjustment expense ratio in the twelve months ended December 31, 2010 resulted primarily from higher actuarial estimates based on actual losses.  Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $8.4 million, or 7.0%, to $128.1 million for the year ended December 31, 2010 from $119.7 million for the year ended December 31, 2009. The expense ratio decreased to 24.5% for the year ended December 31, 2010 compared to 25.2% for the year ended December 21, 2009. The decrease in expense ratio resulted primarily from a decrease in the segment's proportionate share of allocated salary expense and other underwriting expenses during the year ended 2010.  Net Earned Premium Less Expenses Included in Combined Ratio (Underwriting Income). Net earned premium less expenses included in combined ratio decreased $5.0 million, or 12.1%, to $36.1 million for the year ended December 31, 2010 from $41.1 million for the year ended December 31, 2009. The decrease resulted primarily from an increase in the segment's loss ratio in 2010 compared to 2009.                                         84  --------------------------------------------------------------------------------
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Specialty Risk and Extended Warranty Segment - Results of Operations
 [[Image Removed]]         [[Image Removed]]     [[Image Removed]]      [[Image Removed]]                                                     December 31,                                  2011                   2010                   2009                                                (Amounts in Thousands) Gross written premium     $      1,056,511      $       748,525        $       461,338 Net written premium       $        615,563      $       362,100        $       245,604 Change in unearned                (168,798 )            (58,517 )              (55,378 ) premium Net earned premium                 446,765              303,583                190,226 Ceding commission revenue - primarily                 57,648               48,015                 25,909 related party Loss and loss                      297,501              191,149                 98,797 adjustment expense Acquisition costs and other underwriting                 137,442               98,547                 55,551 expenses                                    434,943              289,696                154,348 Underwriting income       $         69,470      $        61,902        $        61,787 Key measures: Net loss ratio                        66.6 %               63.0 %                 51.9 % Net expense ratio                     17.9 %               16.6 %                 15.6 % Net combined ratio                    84.5 %               79.6 %                 67.5 % Reconciliation of net expense ratio: Acquisition costs and other underwriting        $        137,442      $        98,547        $        55,551 expenses Less: Ceding commission revenue - primarily                 57,648               48,015                 25,909 related party                           $         79,794      $        50,532        $        29,642 Net earned premium        $        446,765      $       303,583        $       190,226 Net expense ratio                     17.9 %               16.6 %                 15.6 %  
Specialty Risk and Extended Warranty Segment Results of Operations 2011 Compared to 2010
  Gross Written Premium. Gross written premium increased $308 million, or 41.1%, to $1,057 million for the year ended December 31, 2011 from $749 million for the year ended December 31, 2010. A majority of the increase related to growth in new and existing programs in our European business from warranty coverage of approximately $73 million, medical liability of approximately $61 million, general liability of approximately $19 million and professional liability of approximately $16 million. Additionally, the segment benefited from the underwriting of new programs in the U.S., and the assumption of unearned premium of $19 million from a new customer.  Net Written Premium. Net written premium increased $253.5 million, or 70.0%, to $615.6 million from $362.1 million for the years ended December 31, 2011 and 2010, respectively. The increase in net written premium resulted from an increase of gross written premium for the year ended December 31, 2011 compared to gross written premium for the year ended December 31, 2010, as well as the reduction in the percentage of our European medical liability business ceded to reinsurers from 80% to 40% commencing in the second quarter of 2011.  Net Earned Premium. Net earned premium increased $143.2 million, or 47.2%, to $446.8 million for the year ended December 31, 2011 from $303.6 million for the year ended December 31, 2010. As net premiums written are earned ratably over the term of a policy, which on average is 23 months, the increase resulted from growth in net written premium between 2010 and 2011. In addition, net earned premium increased as a result of our new reinsurance program for our European medical liability business.                                         85 
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  Ceding Commission. The ceding commission earned during the years ended December 31, 2011 and 2010 was $57.6 million and $48.0 million, respectively. The increase related to the allocation to this segment of its proportionate share of our overall policy acquisition expense, which achieved proportionally more growth than certain other segments in 2011. Additionally, beginning on April 1, 2011, we entered into a 40% quota share reinsurance agreement with Maiden covering our European medical liability business by which we receive five percent ceding commission. Prior to April 1, 2011, this business was ceded to another reinsurer.  Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expense increased $106.4 million, or 55.7%, to $297.5 million for the year ended December 31, 2011 from $191.1 million for the year ended December 31, 2010. Our loss ratio for the segment for the year ended December 31, 2011 increased to 66.6% from 63.0% for the year ended December 31, 2010. The increase in the loss ratio in 2011 resulted primarily from higher current accident year selected ultimate losses as compared to selected ultimate losses in prior accident years, as well as a shift of business mix within the segment.  Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $38.9 million, or 39.5%, to $137.4 million for the year ended December 31, 2011 from $98.5 million for the year ended December 31, 2010. The expense ratio increased to 17.9% for the year ended December 31, 2011 compared to 16.6% for the year ended December 31, 2010. The increase in the expense ratio resulted primarily from the allocation of a smaller percentage of Maiden ceding commission to the segment during year ended December 31, 2011 compared to the same period in 2010 and an increase in premium for this segment, resulting in a higher allocation of expenses to this segment.  Net Earned Premium Less Expenses Included in Combined Ratio (Underwriting Income). Net earned premium less expenses included in combined ratio increased to $69.5 million for the year ended December 31, 2011 compared to $61.9 million for the year ended December 31, 2010. The increase was attributable primarily to higher earned premium that was partially offset by higher loss and loss adjustment expense.  
Specialty Risk and Extended Warranty Segment Results of Operations 2010 Compared to 2009
  Gross Written Premium. Gross written premium increased $287.2 million, or 62.3%, to $748.5 million for the year ended December 31, 2010 from $461.3 million for the year ended December 31, 2009. The increase related primarily to the underwriting of new coverage plans in the U.S. and Europe, as well as additional premiums from growth in our European business related to general liability, employers' liability and professional and medical liability business generated by new underwriting teams who joined us in 2009 and 2010. The segment was also affected from the strengthening of the U.S. dollar in 2010, which negatively impacted the European business by approximately $14.6 million.  Net Written Premium. Net written premium increased $116.5 million, or 47.4%, to $362.1 million from $245.6 million for the years ended December 31, 2010 and 2009, respectively. The increase in net written premium resulted from an increase of gross written premium for the year ended December 31, 2010 compared to gross written premium for the year ended December 31, 2009.  Net Earned Premium. Net earned premium increased $113.4 million, or 59.6%, to $303.6 million for the year ended December 31, 2010 from $190.2 million for the year ended December 31, 2009. As net premiums written are earned ratably over the term of a policy, which range from one to three years, the increase resulted from growth in net written premium between 2008 and 2010.  Ceding Commission. The ceding commission earned during the years ended December 31, 2010 and 2009 was $48.0 million and $25.9 million, respectively. The increase related to the allocation to this segment of its proportionate share of our overall policy acquisition expense.  Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expense increased $92.3 million, or 93.4%, to $191.1 million for the year ended December 31, 2010 from $98.8 million for the year ended December 31, 2009. Our loss ratio for the segment for the year ended December 31, 2010 increased to 63.0% from 51.9% for the year ended December 31, 2009. The increase in the loss ratio resulted primarily from a one-time benefit of $11.8 million in 2009, which was recognized over the first half of 2009, related to the acquisition of AHL in 2009. Absent the one-time benefit, the loss ratio would have been 58.1%                                         86  --------------------------------------------------------------------------------
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  for the twelve months ended December 31, 2009. The additional increase in the loss and loss adjustment expense ratio in the twelve months ended December 31, 2010 resulted primarily from higher actuarial estimates based on actual losses.  Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $42.9 million, or 77.2%, to $98.5 million for the year ended December 31, 2010 from $55.6 million for the year ended December 31, 2009. The expense ratio increased to 16.6% for the year ended December 31, 2010 from 15.6% for the year ended December 31, 2009. The increase in the expense ratio resulted, primarily, from higher allocated policy acquisition expense for the year ended December 31, 2010 compared to the year ended December 31, 2009.  Net Earned Premium Less Expenses Included in Combined Ratio (Underwriting Income). Net earned premium less expenses included in combined ratio increased $0.1 million, or 0.2%, to $61.9 million for the year ended December 31, 2010 from $61.8 million for the years ended December 31, 2009. The slight increase was attributable primarily to higher premiums earned in 2010 offset by an increase in allocated policy acquisition costs and salary expense.  
Specialty Program Segment - Results of Operations
 [[Image Removed]]        [[Image Removed]]      [[Image Removed]]      [[Image Removed]]                                                     December 31,                                  2011                   2010                   2009                                                (Amounts in Thousands) Gross written premium    $       381,541        $       264,051        $       267,981 Net written premium      $       202,715        $       139,685        $       142,326 Change in unearned               (31,340 )                  568                  2,359 premium Net earned premium               171,375                140,253                144,685 Ceding commission revenue - primarily               34,212                 23,964                 28,607 related party Loss and loss                    114,685                 94,261                 91,449 adjustment expense Acquisition costs and other underwriting                81,568                 60,071                 68,994 expenses                                  196,253                154,332                160,443 Underwriting income      $         9,334        $         9,885        $        12,849 Key measures: Net loss ratio                      66.9 %                 67.2 %                 63.2 % Net expense ratio                   27.6 %                 25.7 %                 27.9 % Net combined ratio                  94.6 %                 93.0 %                 91.1 % Reconciliation of net expense ratio: Acquisition costs and other underwriting       $        81,568        $        60,071        $        68,994 expenses Less: Ceding commission                        34,212                 23,964                 28,607 revenue - primarily related party                          $        47,356        $        36,107        $        40,387 Net earned premium       $       171,375        $       140,253        $       144,685 Net expense ratio                   27.6 %                 25.7 %                 27.9 %  
Specialty Program Segment Results of Operations 2011 Compared to 2010
  Gross Written Premium. Gross written premium increased $117.4 million, or 44.5%, to $381.5 million for the year ended December 31, 2011 from $264.1 million for the year ended December 31, 2010. The increase in gross written premium related primarily to an increase in new and existing programs of approximately $192 million, including commercial auto and general liability programs, excess and surplus lines programs and public entity programs. The increases were offset by declines in other programs as a result of our maintenance of our pricing and administrative discipline, which resulted in the termination of certain programs representing approximately $73 million, of which three programs represented approximately 81% of this decrease. Additionally, we experienced a decrease of approximately $1.6 million in business we wrote on                                         87  --------------------------------------------------------------------------------
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behalf of HSBC Insurance Company of Delaware pursuant to a 100% fronting arrangement we entered into in connection with our acquisition of WIC, which is now in run-off.
  Net Written Premium. Net written premium increased $63.0 million, or 45.1%, to $202.7 million for the year ended December 31, 2011 from $139.7 million for the year ended December 31, 2010. The increase in net written premium resulted from an increase of gross written premium for the year ended December 31, 2011 compared to gross written premium for the year ended December 31, 2010.  Net Earned Premium. Net earned premium increased $31.1 million, or 22.2%, to $171.4 million for the year ended December 31, 2011 from $140.3 million for the year ended December 31, 2010. The segment experienced a majority of the net written premium increase in the second half of 2011. As a result, the increase in net earned premium was not in proportion to the increase in gross written premiums. As premiums earn ratably primarily over a twelve month period, the increase in net premium earned resulted from higher net premium written for the year ended December 31, 2011 compared to the year ended December 31, 2010.  Ceding Commission. The ceding commission earned during the years ended December 31, 2011 and 2010 was $34.2 million and $24.0 million, respectively. The increase related primarily to an increase in earned premium and a shift in the mix of the programs written during the periods. The policy acquisition costs for certain programs that we wrote in 2011 are greater relative to earned premiums from programs that were in place in 2010. Therefore, we allocated more ceding commission to the segment. In addition, this segment achieved proportionally more growth as compared to certain other segments.  Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses increased $20.4 million, or 21.7%, to $114.7 million for the year ended December 31, 2011 compared to $94.3 million for the year ended December 31, 2010. The loss ratio for the segment was consistent year over year and was 66.9% compared to 67.2% for the years ended December 31, 2011 and 2010, respectively. Current accident year selected ultimate losses were similar to selected ultimate losses from the prior accident years, resulting in a flat loss ratio for the year ended December 31, 2011 as compared to the year ended December 31, 2010.  Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $21.5 million, or 35.8%, to $81.6 million for the year ended December 31, 2011 from $60.1 million for the year ended December 31, 2010. The expense ratio increased to 27.6% for the year ended December 31, 2011 from 25.7% for the year ended December 31, 2010. The increase in the expense ratio was attributable to the allocation to this segment of a higher proportion of our unallocated expenses as a result of the increase in premium compared to the year ended December 31, 2010, but was partially offset by a decline in acquisition costs resulting from the assumption of certain business from an arrangement we fronted in 2010.  
Net Earned Premium Less Expenses Included in Combined Ratio (Underwriting Income). Net earned premium less expenses included in combined ratio were $9.3 million and $9.9 million for the years ended December 31, 2011 and 2010, respectively. The majority of the decrease of $0.6 million resulted from an increase in the expense ratio.
Specialty Program Segment Results of Operations 2010 Compared to 2009
  Gross Written Premium. Gross written premium decreased $3.9 million, or 1.5%, to $264.1 million for the year ended December 31, 2010 from $268.0 million for the year ended December 31, 2009. The decrease in Specialty Program gross written premium related primarily to maintenance of our pricing and administrative discipline, which resulted in the termination of two programs. Additionally we experienced a decline from business we wrote on behalf of HSBC Insurance Company of Delaware pursuant to a 100% fronting arrangement that was entered into as an accommodation to the seller in connection with our acquisition of WIC and is now in run-off. The decrease was partially offset from new business generated by the addition of underwriting teams and their specialty programs.                                         88  --------------------------------------------------------------------------------
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  Net Written Premium. Net written premium decreased $2.6 million, or 1.8%, to $139.7 million for the year ended December 31, 2010 from $142.3 million for the year ended December 31, 2009. The decrease in net written premium resulted from a decrease of gross written premium for the year ended December 31, 2010 compared to gross written premium for the year ended December 31, 2009.  Net Earned Premium. Net earned premium decreased $4.4 million, or 3.0%, to $140.3 million for the year ended December 31, 2010 from $144.7 million for the year ended December 31, 2009. As premiums written earn ratably primarily over a twelve month period, the decrease was a result of lower net written premium for the twelve months ended December 31, 2010 compared to the twelve months ended December 31, 2009.  Ceding Commission. The ceding commission earned during the years ended December 31, 2010 and 2009 was $24.0 million and $28.6 million, respectively. The decrease related to the allocation to the segment of its proportionate share of our overall policy acquisition expense.  Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses increased $2.8 million, or 3.1%, to $94.3 million for the year ended December 31, 2010 compared to $91.5 million for the year ended December 31, 2009. The loss ratio for the segment increased for the year ended December 31, 2010 to 67.2% from 63.2% for the years ended December 31, 2009. The increase in the loss and loss adjustment expense ratio in 2010 resulted primarily from higher actuarial estimates based on actual losses.  Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses decreased $8.9 million, or 12.9%, to $60.1 million for the year ended December 31, 2010 from $69.0 million for the year ended December 31, 2009. The expense ratio decreased to 25.7% for the year ended December 31, 2010 from 27.9% for the year ended December 31, 2009. The decrease in the expense ratio related primarily to a decrease in allocated policy acquisition expenses.  Net Earned Premium Less Expenses Included in Combined Ratio (Underwriting Income). Net earned premium less expenses included in combined ratio were $9.9 million and $12.8 million for the years ended December 31, 2010 and 2009, respectively. The decrease of $2.9 million resulted primarily from an increase to the loss ratio period over period.  
Personal Lines Reinsurance Segment - Results of Operations
 [[Image Removed]]                           [[Image Removed]]      [[Image Removed]]                                                            December 31,                                                     2011                   2010                                                       (Amounts in Thousands) Gross written premium                       $       102,598        $        82,295 Net written premium                                 102,598                 82,295 Change in unearned premium                           (4,143 )              (32,914 ) Net earned premium                                   98,455                 49,381 Ceding commission revenue - primarily                     -                 
     -
 related party Loss and loss adjustment expense                     64,226                 
31,629
 Acquisition costs and other underwriting             31,353                 16,049 expenses                                                      95,579                 47,678 Underwriting income                         $         2,876        $         1,703 Key measures: Net loss ratio                                         65.2 %                 64.1 % Net expense ratio                                      31.8 %                 32.5 % Net combined ratio                                     97.1 %                 96.6 %                                          89 
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  We began assuming commercial auto business from the GMACI Insurers effective March 1, 2010 pursuant to the Personal Lines Quota Share. We assumed $102.6 million and $82.3 million of premium from the GMACI Insurers for the years ended December 31, 2011 and 2010, respectively. The increase in 2011 related primarily to assuming business for twelve months in 2011 compared to ten months in 2010. Net earned premium increased in 2011 compared to 2010 due to the earning cycle of assumed premium written in 2010 and earned in 2011. Loss and loss adjustment expense increased 103.1% in 2011 compared to 2010 and increased proportionally with net earned premium. The increase in the net loss ratio in 2011 from 2010 resulted primarily from higher actuarial estimates based on actual losses. The decrease in the net expense ratio in 2011 compared to 2010 resulted from the sliding scale commission structure, by which the ceding commission payable to GMACI decreases as the loss ratio increases.  
Investment Portfolio
  The first priority of our investment strategy is preservation of capital, with a secondary focus on maximizing an appropriate risk adjusted return. We expect to maintain sufficient liquidity from funds generated from operations to meet our anticipated insurance obligations and operating and capital expenditure needs, including debt service and additional payments in connection with our past producer network and renewal rights acquisitions. The excess funds will be invested in accordance with both the overall corporate investment guidelines as well as an individual subsidiary's investment guidelines. Our investment guidelines are designed to maximize investment returns through a prudent distribution of cash and cash equivalents, fixed maturities and equity positions. Cash and cash equivalents include cash on deposit, commercial paper, pooled short-term money market funds and certificates of deposit with an original maturity of 90 days or less. Our fixed maturity securities include obligations of the U.S. Treasury or U.S. government agencies, obligations of U.S. and Canadian corporations, mortgages guaranteed by the Federal National Mortgage Association, the Government National Mortgage Association, the Federal Home Loan Mortgage Corporation, Federal Farm Credit entities, and asset-backed securities and commercial mortgage obligations. Our equity securities include common stocks of U.S. and Canadian corporations.  Our investment portfolio, including cash and cash equivalents, increased $519.9 million, or 35.6%, to $1,980.2 million at December 31, 2011 from $1,460.3 million as of December 31, 2010 (excluding $14.6 million and $21.5 million of other investments, respectively). Our investment portfolio is classified as available-for-sale, as defined by ASC 320, Investments - Debt and Equity Securities. This increase is attributable to cash flow from operations, the cash proceeds we received upon issuance of our convertible senior notes in December 2011 and the investments received from the Majestic loss portfolio transfer. Our fixed maturity securities, gross, as of December 31, 2011, had a fair value of $1,394.2 million and an amortized cost of $1,382.9 million. Our equity securities are reported at fair value and were $35.6 million with a cost of $34.0 million as of December 31, 2011. Securities sold but not yet purchased represent our obligations to deliver the specified security at the contracted price and thereby create a liability to purchase the security in the market at prevailing rates. We account for sales of securities under repurchase agreements as collateralized borrowing transactions and we record these sales at their contracted amounts.                                         90  --------------------------------------------------------------------------------
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Our investment portfolio exclusive of our life settlement contracts and other investments is summarized in the table below by type of investment:
[[Image Removed]]   [[Image Removed]]     [[Image Removed]]       [[Image Removed]]     [[Image Removed]]
December 31, 2011
December 31, 2010
                         Carrying             Percentage of            Carrying             Percentage of                            Value                Portfolio                Value                Portfolio                                                      (Amounts in Thousands) Cash, cash equivalents and     $         421,837                21.3 %       $         201,949                13.8 % restricted cash Time and short-term                    128,565                 6.5                    32,137                 2.2 deposits U.S. treasury                  53,274                 2.7                    82,447                 5.6 securities U.S. government                 6,790                 0.3                     7,162                 0.5 agencies Municipals                    275,017                13.9                    66,676                 4.6 Commercial mortgage back                     150                   -                     2,076                 0.1 securities Residential mortgage back securities: Agency backed                 364,000                18.4                   546,098                37.4 Non-agency backed               7,664                 0.4                     8,591                 0.6 Asset backed                        -                   -                     2,687                 0.2 securities Corporate bonds               687,348                34.7                   493,076                33.8 Preferred stocks                4,314                 0.2                     7,037                 0.5 Common stocks                  31,286                 1.6                    10,375                 0.7                     $       1,980,245               100.0 %       $       1,460,311               100.0 %  
The table below summarizes the credit quality of our fixed maturity securities as of December 31, 2011 and 2010, as rated by Standard and Poor's.
 [[Image Removed]]                         [[Image Removed]]       [[Image Removed]]                                                   2011                    2010 U.S. Treasury                                         3.2 %                   2.5 % AAA                                                  12.5                    55.3 AA                                                   39.7                     4.6 A                                                    23.0                    20.8 BBB, BBB+, BBB-                                      20.1                    13.2 BB, BB+, BB-                                          0.8                     2.7 B, B+, B-                                             0.4                     0.1 Other (includes securities rated CC,                  0.3                     0.8 CCC, CCC- and D) Total                                               100.0 %                 100.0 %   The decrease in the percentage of our fixed maturity securities we owned having a credit quality of AAA in 2010 to 2011 was due to the downgrading of the U.S. credit rating to AA+ in 2011 by Standard & Poor's.  
The table below summarizes the average duration by type of fixed maturity as well as detailing the average yield as of December 31, 2011 and 2010:
[[Image Removed]]   [[Image Removed]]      [[Image Removed]]       [[Image Removed]]      [[Image Removed]]
December 31, 2011
December 31, 2010
                           Average                 Average                Average                Average                            Yield%                Duration                 Yield%                Duration                                                  in Years                                       in Years U.S. treasury                   2.31                    3.3                    2.77                    6.9 securities U.S. government                 4.12                    2.9                    4.82                    2.9 agencies Foreign                         3.98                    5.6                    4.30                    2.1 government Corporate bonds                 4.38                    3.7                    4.01                    3.1 Municipals                      4.18                    5.4                    5.32                   10.5 Mortgage and                    3.68                    2.6                    3.78                    3.3 asset backed  
As of December 31, 2011, the weighted average duration of our fixed income securities was 3.7 years and had a yield of 4.1%.
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  Other investments represented approximately 1.0% and 1.5% of our total investment portfolio as of December 31, 2011 and 2010, respectively. At December 31, 2011, other investments consisted primarily of limited partnerships or hedge funds totaling $13.2 million and an annuity of $1.4 million. At December 31, 2010, other investments consisted primarily of limited partnerships or hedge funds totaling $15.1 million, an annuity of $1.4 million and miscellaneous investments totaling $5.0 million.  Quarterly, our Investment Committee ("Committee") evaluates each security that has an unrealized loss as of the end of the subject reporting period for OTTI. We generally consider an investment to be impaired when it has been in a significant unrealized loss position (in excess of 35% of cost if the issuer has a market capitalization of under $1 billion and in excess of 25% of cost if the issuer has a market capitalization of $1 billion or more) for over 24 months. In addition, the Committee uses a set of quantitative and qualitative criteria to review our investment portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of our investments. The criteria the Committee primarily considers include:  
 • the current fair value compared to amortized cost;
   •   the length of time the security's fair value has been below its amortized
       cost;
   •   specific credit issues related to the issuer such as changes in credit
       rating, reduction or elimination of dividends or non-payment of scheduled
       interest payments;
   •   whether management intends to sell the security and, if not, whether it is
       not more than likely than not that the Company will be required to sell the
       security before recovery of its amortized cost basis;
   •   the financial condition and near-term prospects of the issuer of the
       security, including any specific events that may affect its operations or
       earnings;      •   the occurrence of a discrete credit event resulting in the issuer        defaulting on material outstanding obligations or the issuer seeking        protection under bankruptcy laws; and  
   •   other items, including company management, media exposure, sponsors,
       marketing and advertising agreements, debt restructurings, regulatory
       changes, acquisitions and dispositions, pending litigation, distribution
       agreements and general industry trends.
   Impairment of investment securities results in a charge to operations when a market decline below cost is deemed to be other-than-temporary. We write down investments immediately that we consider to be impaired based on the above criteria collectively.  The impairment charges of our fixed-maturities and equity securities for the years ended December 31, 2011, 2010 and 2009 are presented in the table below:  [[Image Removed]]           [[Image Removed]]     [[Image Removed]]     [[Image Removed]]                                    2011                  2010                  2009                                                 (Amounts in Thousands) Equity securities           $             937     $          10,656     $          20,639 Fixed maturity securities               3,474                10,540                 4,139                             $           4,411     $          21,196     $          24,778  
In addition to the other-than-temporary impairment of $4.4 million recorded during the year ended December 31, 2011, we had $41.3 million of gross unrealized losses, of which $3.7 million related to marketable equity securities and $37.6 million related to fixed maturity securities as of December 31, 2011.
  Corporate bonds represent 49% of the fair value of our fixed maturities and 97% of the total unrealized losses of our fixed maturities. We own 232 corporate bonds in the industrial, bank and financial and other sectors, which have a fair value of approximately 9%, 37% and 3%, respectively, and 8%, 85% and 4% of total unrealized losses, respectively, of our fixed maturities. We believe that the unrealized losses in these securities are the result, primarily, of general economic conditions and not the condition of the issuers, which we believe are solvent and have the ability to meet their obligations. Therefore, we expect that the market                                         92 
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  price for these securities should recover within a reasonable time. Additionally, we do not intend to sell the investments and it is not more likely than not that we will be required to sell the investments before recovery of their amortized cost basis.  Our investment in marketable equity securities consist of investments in preferred and common stock across a wide range of sectors. We evaluated the near-term prospects for recovery of fair value in relation to the severity and duration of the impairment and have determined in each case that the probability of recovery is reasonable and we have the ability and intent to hold these investments until a recovery of fair value. Within our portfolio of equity securities, 11 common stocks comprised $3.6 million, or 97%, of the unrealized loss. We own 3 securities in the financial sector that represent 12% of the fair market value and 42% of our unrealized losses. We own 3 securities in the industrial sector that represent approximately 5% of the fair market value and approximately 35% our unrealized losses. We own 3 securities in the consumer products sector that have approximately 3% of the fair value and approximately 12% of the unrealized losses. We also own 2 securities in the healthcare sector that represent approximately 1% of the fair market value and 8% of our unrealized losses. The duration of these impairments ranges from 1 to 24 months. The remaining securities in a loss position are not considered individually significant and accounted for 3% of our unrealized losses. We believe these securities will recover and that we have the ability and intent to hold them to recovery.  The table below summarizes the gross unrealized losses of our fixed maturity and equity securities by length of time the security has continuously been in an unrealized loss position as of December 31, 2011:  [[Image Removed]]   [[Image Removed]]     [[Image Removed]]      [[Image Removed]]       [[Image Removed]]     [[Image Removed]]      [[Image Removed]]      [[Image Removed]]     [[Image Removed]] [[Image Removed]]   [[Image Removed]]     [[Image Removed]]      [[Image Removed]]       [[Image Removed]]     [[Image Removed]]      [[Image Removed]]      [[Image Removed]]     [[Image Removed]]                                                                                                                  12 Months or More                                             Total                                            Less than 12 Months                            Fair                Unrealized               No. of                  Fair                Unrealized               No. of                 Fair                Unrealized                           Market                 Losses                Positions               Market                 Losses               Positions               Market                 Losses                            Value                                         Held                   Value                                         Held                  Value                                                                                                   (Amounts in Thousands) Common and          $           4,211     $          (648 )                     7        $           4,573     $        (3,021 )                    17       $           8,784     $        (3,669 ) preferred stock U.S. treasury                   7,523                (257 )                     4                      773                   -                       1                   8,296                (257 ) securities Municipal bonds                43,452                (452 )                    10                    4,098                 (61 )                     1                  47,550                (513 ) Corporate bonds: Finance                       221,950             (13,250 )                    81                  104,461             (18,668 )                    17                 326,411             (31,918 ) Industrial                     35,105              (2,125 )                    11                    2,500                (865 )                     1                  37,605              (2,990 ) Utilities                      21,483              (1,261 )                     9                    5,766                (457 )                     1                  27,249              (1,718 ) Commercial mortgage backed                   150                   -                       2                        -                   -                       -                     150                   - securities Residential mortgage backed securities: Agency backed                  31,986                 (58 )                     9                        -                   -                       -                  31,986                 (58 ) Non-agency backed               7,641                (216 )                     1                       22                  (6 )                     1                   7,663                (222 ) Total temporarily   $         373,501     $       (18,267 )                
  134        $         122,193     $       (23,078 )                    39       $         495,694     $       (41,345 ) impaired    There are 173 securities at December 31, 2011 that account for the gross unrealized loss, none of which we deem to be OTTI. Significant factors influencing our determination that unrealized losses were temporary included the magnitude of the unrealized losses in relation to each security's cost, the nature of the investment and management's intent not to sell these securities and it being not more likely than not that we will be required to sell these investments before anticipated recovery of fair value to our cost basis.  
For further information on our investments and related performance, see Note 3. "Investments" in the audited consolidated financial statements included elsewhere in this report.
Liquidity and Capital Resources
  We are organized as a holding company with eleven insurance company subsidiaries ("Insurance Subsidiaries"), as well as various other non-insurance subsidiaries. Our primary liquidity needs include debt                                         93  --------------------------------------------------------------------------------
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payments, interest on debt, taxes and shareholder dividends. Our income is generated primarily from our Insurance Subsidiaries and investment income.
  We may generate liquidity through a combination of debt or equity securities issuances, as well as financing through borrowing and sales of securities. In 2011, we issued ten-year, $175.0 million convertible senior notes (the $25.0 million overallotment was issued in January 2012) and entered into a three-year, $150 million credit facility that was initially used to pay off the remaining principal balance of a then outstanding $40 million term loan.  Our principal sources of operating funds are premiums, investment income and proceeds from sales and maturities of investments. Our primary uses of operating funds include payments of claims and operating expenses. Currently, we pay claims using cash flow from operations and invest our excess cash primarily in fixed maturity and equity securities. We expect that projected cash flow from operations will provide us sufficient liquidity to fund our anticipated growth, by providing capital to increase the surplus of our Insurance Subsidiaries, as well as for payment of claims and operating expenses, payment of interest and principal on debt facilities and other holding company expenses for at least the next twelve months. However, if our growth attributable to potential acquisitions, internally generated growth or a combination of these, exceeds our projections, we may have to raise additional capital sooner to support our growth. If we cannot obtain adequate capital on favorable terms or at all, we may be unable to support future growth or operating requirements and, as a result, our business, financial condition and results of operations could be adversely affected.  The laws of the jurisdictions in which our Insurance Subsidiaries are organized regulate and restrict, under certain circumstances, their ability to pay dividends to us. As of December 31, 2011 and 2010, respectively, the Insurance Subsidiaries would have been permitted to pay dividends in the aggregate of approximately $306.1 million and $253.0 million, respectively. Our Insurance Subsidiaries paid dividends to us of $5.8 million in 2011. There were $5.0 million and $4.5 million of dividends paid in 2010 and 2009, respectively. In addition, the terms of our debt arrangements limit our ability to pay dividends on our common stock, and future borrowings may include prohibitions and restrictions on dividends. Additional information regarding our dividends is presented in "Item 1. Business - Regulation", in "Item 1A. Risk Factors" and in "Item 5. Market for Registrant's Common Equity, Related Shareholder Matters and Issuer Purchase of <org>Equity Securities - Dividend Policy" appearing elsewhere in this Form 10-K.  We forecast claim payments based on our historical trends. We seek to manage the funding of claim payments by actively managing available cash and forecasting cash flows on a short-term and long-term basis. Cash payments for claims were $313.1 million, $409.6 million and $569.9 million in 2009, 2010 and 2011, respectively. Historically, we have funded claim payments from cash flow from operations (principally premiums) net of amounts ceded to our third party reinsurers. We presently expect to maintain sufficient cash flow from operations to meet our anticipated claim obligations and operating and capital expenditure needs. Our cash and investment portfolio has increased from $1,460.3 million (excluding $21.5 million of other investments) at December 31, 2010 to $1,980.2 million (excluding $14.6 million of other investments) at December 31, 2011. We do not anticipate selling securities in our investment portfolio to pay claims or to fund operating expenses. Should circumstances arise that would require us to do so, we may incur losses on such sales, which would adversely affect our results of operations and financial condition and could reduce investment income in future periods.  We also purchase life settlement contracts which require us to make premium payments on individual life insurance policies to maintain the policies. We seek to manage the funding of premium payments required. Historically, we have funded these premium payments from operations. We presently expect to maintain sufficient cash flow from operations to meet future premium payments.  
Comparison of Years Ended December 31, 2011 and 2010
  Net cash provided by operating activities was approximately $295 million for the year ended December 31, 2011, compared to $26 million for the same period in 2010. The increase in cash provided from operations resulted primarily from an increase in gross written premium written in 2011 compared to 2010. Additionally, we had increased cash collections in 2011 related to the earning of the tail end of premium written in 2010 for Specialty Risk and Extended Warranty segment policies that generally have a longer                                         94  --------------------------------------------------------------------------------
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policy life and therefore a longer cash collection cycle. The increase was partially offset by earnings from our equity investment in ACAC and gains from our investment in life settlement contracts, which were non-cash.
  Net cash used in investing activities was $97 million for the year ended December 31, 2011. Net cash used in investing activities was $210 million for the year ended December 31, 2010. In 2011, net cash used in investing activities primarily included approximately $44 million for the net purchase of fixed and equity securities, approximately $53 million for the acquisition of and premium payments for life settlement contracts, approximately $39 million for capital expenditures and approximately $30 million for the Cardinal Comp acquisition, and was partially offset by the net receipt of cash in the approximate amount of $44 million obtained in the acquisition of Luxembourg captives and approximately $29 million obtained as part of the loss portfolio transfer from Majestic. In 2010, major components of net cash provided by investing activities included an equity investment in ACAC of $53 million, acquisitions of Warrantech and Risk Services of $20 million, net purchases of investments for $105 million and capital expenditures of $15 million.  Net cash provided by financing activities was $19 million for the year ended December 31, 2011 compared to net cash used in 2010 of $150 million. In 2011, cash provided by financing activities primarily included the receipt of $175 million from the issuance of our convertible senior notes and the contribution of approximately $25 million from non-controlling interests to our subsidiaries partially offset by the repayment on repurchase agreements in the amount of approximately $156 million, dividend payments of approximately $20 million and principal payment of debt obligations of approximately $15 million. In 2010, cash provided by financing activities included $175 million received from entering into repurchase agreements and capital contributions to a subsidiary of $11 million, partially offset by principal payments on debt of $21 million and dividend payments of $17 million.  
Other Material Changes in Financial Position
 [[Image Removed]]                              [[Image Removed]]     [[Image Removed]]                                                              December 31,                                                       2011                  2010                                                         (Amounts in Thousands) Selected Assets: Cash and cash equivalents                      $         406,847     $         192,925 Premiums receivable, net                                 932,992               727,561 Prepaid expenses and other assets                        292,849            
   155,799
 Reinsurance recoverable                                1,098,569            
   775,432
 Selected Liabilities: Loss and loss expense reserves                 $       1,879,175     $      
 1,263,537
 Unearned premium                                       1,366,170            
 1,024,965
 Securities sold under arrangements to                    191,718               347,617 repurchase, at contract value Debt                                                     279,600               144,781   In 2011, cash and cash equivalents increased $213.9 million and resulted primarily from generating cash from operations and the issuance of our convertible senior notes. Premium receivables increased $205.4 million as a result of the increase in premium writing in 2011, related primarily to organic growth in Europe in the Specialty Risk and Extended Warranty segment. Prepaid expenses and other assets increased $137.1 million and resulted primarily from our investment in life settlement contracts. Reinsurance recoverable increased $323.1 million as a result of ceding more premium in 2011 compared to 2010.  Loss and loss expense reserves increased $615.6 million and unearned premium increased $341.2 million in 2011 due primarily to higher premium writings in 2011. Securities sold under agreements to repurchase, at contract value, decreased by $155.9 million in 2011 as we decreased our borrowing position on these investments in 2011. Debt increased $134.8 million as a result of the issuance of our convertible senior notes in 2011.                                         95  --------------------------------------------------------------------------------
     TABLE OF CONTENTS  Reinsurance 
The following table summarizes the top eleven reinsurers that account for approximately 92% of our reinsurance recoverables on paid and unpaid losses and loss adjustment expenses as of December 31, 2011:
 [[Image Removed]]                            [[Image Removed]]       [[Image Removed]]                                                                            Amount Reinsurer                                            A.M.             Recoverable as of                                                   Best Rating           December 31,                                                                             2011                                                        (Amounts in Thousands) Maiden Insurance Company Ltd.                         A-             $      
   597,525
National Indemnity Company                            A++                   
    71,687
National Workers' Compensation Reinsurance            NR                    
    68,440
 Pool (NWCRP)(1) American Home Assurance Company                        A                    
    66,370
Trinity Universal Insurance Company(2)                A-                    
    54,601
 Hannover Ruckversicherungs AG(3)                       A                        48,971 Alterra Bermuda Limited(3)                             A                        35,730 Twin Bridges Ltd.(3)                                  NR                        31,478 Lloyd's Underwriter Syn No. 2003 SIC                   A                    
    13,359
 Swiss Reinsurance America Corporation                 A+                        12,329 AXIS Specialty(3)                                      A                        12,097   [[Image Removed]] 
  (1) As per the NWCRP Articles of Agreement, reinsurance is provided through a
      100% quota share reinsurance agreement entered into among the servicing
      carrier (TIC) and the participating companies (all carriers writing in the
      state) pursuant to the Articles of Agreement.     (2) Amount recoverable from Trinity Universal is the result of the UBI
      acquisition. Prior to our acquisition, MCIC, SNIC, AICK and ALIC ceded all
      of their net retention to Trinity Universal.
  (3) At the time of the Majestic loss portfolio transfer, these entities were
      reinsurers of Majestic. We currently hold collateral of approximately $73
      million in a trust account related to cessions for Twin Bridges and Alterra,
      as well as approximately $37 million of funds held.
Third Party Excess of Loss Reinsurance
  We purchase excess of loss reinsurance from third party insurers for our workers' compensation, commercial property and casualty business attributable to both the Small Commercial Business segment and the Specialty Program segment. Under excess of loss reinsurance, covered losses above a specified amount up to the limit of the reinsurance coverage are paid by the reinsurer. In return for this coverage, we pay our reinsurers a percentage of our insurance premiums subject to certain minimum reinsurance premium requirements. Our excess of loss reinsurance program includes contracts that are scheduled to renew at various times during the year.  
Workers' Compensation Excess of Loss
  We have coverage for our workers' compensation line of business under excess of loss reinsurance agreements. In addition to insuring employers for their statutory workers' compensation liabilities, our workers' compensation policies provide insurance for the employers' tort liability (if any) for bodily injury or disease sustained by employees in the course of their employment. Certain layers of our workers' compensation reinsurance provide coverage for such employers' liability insurance at lower limits than the applicable limits for workers' compensation insurance. As the scale of our workers' compensation business has increased, we have also increased the amount of risk we retain. The agreements cover, per occurrence, losses in excess of $0.5 million through December 31, 2004, $0.6 million effective January 1, 2005, $1.0 million effective July 1, 2006 through July 1, 2009, $1.0 million plus 55% of $9.0 million in excess of $1.0 million effective July 1, 2009 through January 1, 2010, and $10 million effective January 1, 2010 up to a maximum $130 million ($50 million prior to December 1, 2003) in losses. For losses occurring on or after January 1, 2010, we purchased a "third and fourth event cover" that covers losses between $5.0 million and $10.0 million per occurrence, after an aggregate deductible equal to the first $10.0 million per annum on such losses. For losses occurring on or after January 1, 2011, we replaced this "third and fourth event cover" with a "second and third event cover" that applies after an aggregate deductible equal to the first $5.0 million                                         96  --------------------------------------------------------------------------------
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  per annum on such losses. Effective August 19, 2011, we purchased a new layer of coverage providing $100 million in excess of $130 million per occurrence, providing us with total protection of $220 million for losses in excess of $10.0 million. The agreements have annual limits of coverage of twice the occurrence limit.  Our reinsurance for workers' compensation losses caused by acts of terrorism is more limited than our reinsurance for other types of workers' compensation losses and, effective August 19, 2011, provides coverage, per contract year, of $220.0 million in the aggregate, in excess of an aggregate retention of $10.0 million, but excludes acts of nuclear, biological or chemical terrorism (which are covered by the Terrorism Risk Insurance Act, as amended ("TRIA")). The reinsurance for worker's compensation losses caused by acts of terrorism is provided net of any recovery we receive from the federal government pursuant to TRIA. A limited amount of workers' compensation and excess workers' compensation exposures are written as reinsurance and were not, prior to January 1, 2012, protected by the excess reinsurance program listed above. The limit exposed to a single workers' compensation occurrence loss for such exposures varies depending on the size of the loss occurrence. For smaller losses, the additional exposure can be as high as $6.625 million, while for larger losses (greater than $30.0 million for the group), the additional exposure is $0.525 million or less unless the group loss exceeds $230 million.  
Specialty Risk Excess of Loss
  We have excess of loss reinsurance coverage for international general liability and professional business underwritten by our English and Irish insurers. The agreements cover losses in excess of £1.0 million per occurrence up to a maximum of £10.0 million per occurrence, subject to annual aggregate limits that vary by layer. Through December 31, 2010, we had excess of loss reinsurance under the same terms for our European medical liability business. In 2010, we purchased an 80% quota share reinsurance agreement from National Indemnity Company for our European medical liability business. This contract was effective for claims made through March 31, 2011. Effective April 1, 2011, we replaced this quota share reinsurance agreement with a 40% cession to Maiden Insurance, as more fully described below under "Reinsurance Agreements with Maiden Holdings, Ltd." In addition, we purchase various pro-rata and excess reinsurance relating to specific foreign insurance programs and/or specialty lines of business.  
Casualty Reinsurance
  We have coverage for our U.S. casualty lines of business under an excess of loss reinsurance agreement. The agreement covers losses in excess of $2.0 million per occurrence (in certain cases the retention can rise to $2.5 million) up to a maximum $30.0 million, subject to annual limits that vary by layer. We purchase quota share reinsurance for a portion of our umbrella business, whereby we cede 70% of the first $5.0 million of loss per policy and 100% of the next $5.0 million loss per policy. In addition, we also purchase various pro-rata and excess reinsurance relating to specific insurance programs and/or specialty lines of business, including casualty, public entity, and professional errors and omissions insurance.  
Property Per Risk Excess Coverage
  We have coverage for our U.S. property lines of business under an excess of loss reinsurance agreement. The agreement covers losses in excess of $2.0 million per location up to a maximum $20 million, subject to per occurrence and annual limits that vary by layer.  
Property Catastrophe Reinsurance
  For our U.S. business, we have a property catastrophe excess of loss agreement that covers losses in excess of $5.0 million per occurrence up to a maximum $65.0 million, subject to annual limits that vary by layer. We also have coverage for our U.K. property lines of business under an excess of loss reinsurance agreement. The agreement covers losses in excess of £0.5 million per risk up to a maximum £2.0 million. In addition, we have a property catastrophe excess of loss agreement that covers losses in excess of £5.0 million per occurrence up to a maximum £45.0 million, subject to annual limits that vary by layer.                                         97 
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  TRIA requires that commercial property and casualty insurance companies offer coverage for U.S. risks (with certain exceptions, such as with respect to commercial auto insurance) for certain acts of terrorism and has established a federal assistance program through the end of 2014 to help such insurers cover claims for terrorism-related losses. TRIA covers certified acts of terrorism, and the U.S. Secretary of the Treasury must declare the act to be a "certified act of terrorism" for it to be covered under this federal program. In addition, no certified act of terrorism will be covered by the TRIA program unless the aggregate insurance industry losses from the act exceed $100 million for each year. Under the TRIA program, the federal government covers 85% of the losses from covered certified acts of terrorism on commercial risks in the United States only, in excess of a deductible amount. This deductible is calculated as a percentage of an affiliated insurance group's prior year premiums on commercial lines policies (with certain exceptions, such as commercial auto insurance policies) covering risks in the United States. This deductible amount is 20% of such premiums.  TRIA will expire at the end of 2014 and no assurance can be given that it will be renewed or that any such renewal will not be on materially less favorable terms.  
Specialty Risk and Extended Warranty Reinsurance
  We purchase quota share and/or excess of loss and/or facultative reinsurance for specific programs, specialty lines of business, or individual policies to limit our loss exposure and/or allow our program managers to share the risks and rewards of the business they produce.  
Reinsurance Agreements with Maiden Holdings, Ltd.
  During the third quarter of 2007, we entered into a master agreement with Maiden, as amended, by which our Bermuda subsidiary, AII, and Maiden Insurance entered into a quota share reinsurance agreement (the "Maiden Quota Share"), as amended. Under this agreement, AII retrocedes to Maiden Insurance an amount equal to 40% of the premium written by our U.S., Irish and U.K. insurance companies (the "AmTrust Ceding Insurers"), net of the cost of unaffiliated inuring reinsurance (and in the case of our U.K. insurance subsidiary, AEL, net of commissions) and 40% of losses, excluding certain specialty risk programs that we commenced writing after the effective date and risks, other than workers' compensation risks and certain business written by our Irish subsidiary, AIU, for which the AmTrust Ceding Insurers' net retention exceeds $5.0 million, which Maiden has not expressly agreed to assume ("Covered Business"). Effective January 1, 2010, Maiden agreed to assume its proportionate share of our workers' compensation exposure in excess of $5.0 million, and will share the benefit of our excess of loss reinsurance protection.  The Maiden Quota Share, which had an initial term of three years, was renewed through June 30, 2014 and will automatically renew for successive three-year terms unless either AII or Maiden Insurance notifies the other of its election not to renew not less than nine months prior to the end of any such three-year term. In addition, either party is entitled to terminate on thirty days' notice or less upon the occurrence of certain early termination events, which include a default in payment, insolvency, change in control of AII or Maiden Insurance, run-off, or a reduction of 50% or more of the shareholders' equity of Maiden Insurance or the combined shareholders' equity of AII and the AmTrust Ceding Insurers.  Effective April 1, 2011, the Maiden Quota Share, as amended, further provides that AII receives a ceding commission of 30% of ceded written premiums with respect to all Covered Business, except retail commercial package business, for which the ceding commission is 34.375%. Commencing January 1, 2012, the ceding commission, excluding the retail package business ceding commission (which remains at 34.375%), was adjusted to (a) 30% of ceded premium, if the Specialty Risk and Extended Warranty subject premium, excluding ceded premium related to our medical liability business discussed below, is greater than or equal to 42% of the total subject premium, (b) 30.5% of ceded premium, if the Specialty Risk and Extended Warranty subject premium is less than 42% but greater than or equal to 38%, or (c) 31% of ceded premium, if the Specialty Risk and Extended Warranty subject premium is less than 38% of the total subject premium. Prior to April 1, 2011, AII received a ceding commission of 31% of ceded premiums with respect to all Covered Business, except retail commercial package business, for which the ceding commission was 34.375%.  We recorded approximately $154 million, $138 million and $113 million of ceding commission during 2011, 2010 and 2009, respectively, as a result of the Maiden Quota Share. The agreement also will include, subject to regulatory requirements, the premiums and losses of any Covered Business of any majority-owned insurance subsidiary that we may acquire in the future.                                         98  --------------------------------------------------------------------------------
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  Effective September 1, 2010, we, through our subsidiary, SNIC, entered into a reinsurance agreement with Maiden Reinsurance Company and an unrelated third party. Under the agreement, which had an initial term of one year and has been extended to August 31, 2012, SNIC cedes 80% of the gross liabilities produced under the Southern General Agency program to Maiden Reinsurance Company and 20% of the gross liabilities produced to the unrelated third party. SNIC receives a five percent commission on ceded written premiums. We ceded written premium of $0.9 million for the year ended December 31, 2011 related to this agreement, for which we earned ceding commission of $0.2 million for the year ended December 31, 2011.  Effective April 1, 2011, we, through our subsidiaries AEL and AIU, entered into a reinsurance agreement with Maiden Insurance by which we cede 40% of our European medical liability business, including business in force at April 1, 2011. The quota share has an initial term of one year and can be terminated at April 1, 2012 or any April 1 thereafter by either party on four months' notice. Maiden Insurance pays us a 5% ceding commission, and we will earn a profit commission of 50% of the amount by which the ceded loss ratio is lower than 65%.  
Other Reinsurance
  As part of our acquisition of AIIC, we acquired reinsurance recoverables as of the date of closing. The most significant reinsurance recoverable is from American Home Assurance Co. ("American Home"). AIIC's reinsurance relationship with American Home incepted January 1, 1998 on a loss occurring basis. From January 1, 1998 through March 31, 1999, the American Home reinsurance covered losses in excess of $0.25 million per occurrence up to statutory coverage limits. Effective April 1, 1999, American Home provided coverage in the amount of $0.15 million in excess of $0.1 million. This additional coverage terminated on December 31, 2001 on a run-off basis. Therefore, for losses occurring in 2002 that attached to a 2001 policy, the retention was $0.1 million per occurrence. Effective January 1, 2002, American Home increased its attachment to $0.25 million per occurrence. The excess of loss treaty that had an attachment of $0.25 million was terminated on a run-off basis on December 31, 2002. Therefore, losses occurring in 2003 that attached to a 2002 policy were ceded to American Home at an attachment point of $0.25 million per occurrence.  We reevaluate our reinsurance programs annually or more frequently, as needed, and consider a number of factors, including cost of reinsurance, quality of reinsurers, our liquidity requirements, operating leverage and coverage terms. Even if we maintain our existing retention levels, if the cost of reinsurance increases, our cash flow from operations would decrease as we would cede a greater portion of our premiums written to our reinsurers. Conversely, our cash flow from operations would increase if the cost of reinsurance declined relative to our retention.  Revolving Credit Agreement  On January 28, 2011, we entered into a three-year, $150 million credit agreement (the "Credit Agreement"), among JPMorgan Chase Bank, N.A., as Administrative Agent, The Bank of Nova Scotia, as Syndication Agent, SunTrust Bank, as Documentation Agent, and the various lending institutions party thereto. The credit facility is a revolving credit facility with a letter of credit sublimit of $50 million and an expansion feature not to exceed $50 million. Proceeds of borrowings under the Credit Agreement may be used for working capital, acquisitions and general corporate purposes. In connection with entering into the Credit Agreement, we terminated the then existing Term Loan and Uncommitted Line of Credit Letter Agreement with JPMorgan Chase Bank, N.A. We did not record a gain or loss on the extinguishment of its previous term loan.  ABR borrowings (which are borrowings bearing interest at a rate determined by reference to the Alternate Base Rate) under the Credit Agreement will bear interest at (x) the greatest of (a) the Administrative Agent's prime rate, (b) the federal funds effective rate plus 0.5 percent or (c) the adjusted LIBO rate for a one month interest period on such day plus 1 percent, plus (y) a margin that is adjusted on the basis of our consolidated leverage ratio. Eurodollar borrowings under the credit agreement will bear interest at the adjusted LIBO rate for the interest period in effect plus a margin that is adjusted on the basis of our consolidated leverage ratio.                                         99  --------------------------------------------------------------------------------
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  The Credit Agreement contains certain restrictive covenants customary for facilities of this type (subject to negotiated exceptions and baskets), including restrictions on indebtedness, liens, acquisitions and investments, restricted payments and dispositions. There are also financial covenants that require us to maintain a minimum consolidated net worth, a maximum consolidated leverage ratio, a minimum fixed charge coverage ratio, a minimum risk-based capital and a minimum statutory surplus. We were in compliance with all covenants as of December 31, 2011.  As of December 31, 2011, we had no outstanding borrowings under this Credit Agreement. We had outstanding letters of credit in place under this Credit Agreement at December 31, 2011 for $49.8 million, which reduced the availability on the line of credit to $0.2 million and the availability under the facility to $100.2 million as of December 31, 2011.  We recorded approximately $1.0 million of deferred financing costs related to the Credit Agreement. Fees payable by us under the Credit Agreement include a letter of credit participation fee (which is the margin applicable to Eurodollar borrowings and was 2.25% at December 31, 2011), a letter of credit fronting fee with respect to each letter of credit (.125%) and a commitment fee on the available commitments of the lenders (a range of .35% to .45% based on our consolidated leverage ratio and was 0.40% at December 31, 2011).  The interest rate on the credit facility as of December 31, 2011 was 2.50%. We recorded interest expense of approximately $2.7 million for the year ended December 31, 2011, under the Credit Agreement. We recorded interest expense of approximately $0.07 million and $0.8 million for the years ended December 31, 2011 and 2010, respectively, related to the terminated term loan.  
Convertible Senior Notes
  In December 2011, we issued $175 million aggregate principal amount of our 5.5% convertible senior notes due 2021 (the "Notes") to certain initial purchasers in a private placement. In January 2012, the initial purchasers of the Notes exercised their overallotment option for the purchase of $25.0 million of Notes, bringing the aggregate amount of Notes issued to $200 million. The Notes bear interest at a rate equal to 5.50% per year, payable semiannually in arrears on June 15th and December 15th of each year, beginning on June 15, 2012.  The Notes will mature on December 15, 2021 (the "Maturity Date"), unless earlier purchased by us or converted into shares of our common stock, par value $0.01 per share (the "Common Stock"). Prior to September 15, 2021, the Notes will be convertible only upon satisfaction of certain conditions, and thereafter, at any time prior to the close of business on the second scheduled trading day immediately preceding the Maturity Date. The conversion rate will initially equal 31.4218 shares of Common Stock per $1,000 principal amount of Notes, which corresponds to an initial conversion price of approximately $31.83 per share of Common Stock, representing a conversion premium of 25.0% over $25.46 per share, which was the last reported sale price of the Common Stock on the NASDAQ on December 15, 2011. The conversion rate will be subject to adjustment upon the occurrence of certain events as set forth in the indenture governing the notes. Upon conversion of the Notes, we will, at our election, pay or deliver, as the case may be, cash, shares of Common Stock, or a combination of cash and shares of Common Stock.  Upon the occurrence of a fundamental change (as defined in the indenture governing the notes), holders of the Notes will have the right to require us to repurchase their Notes for cash, in whole or in part, at 100% of the principal amount of the Notes to be repurchased, plus any accrued and unpaid interest, if any, to, but excluding, the fundamental change purchase date.  We separately allocate the proceeds for the issuance of the Notes to a liability component and an equity component, which is the embedded conversion option. The equity component was reported as an adjustment to paid-in-capital, net of tax, and is reflected as an original issue discount ("OID"). The OID of $36.5 million and deferred origination costs relating to the liability component of $4.2 million will be amortized into interest expense over the term of the loan of the Notes. After considering the contractual interest payments and amortization of the original discount, the Notes effective interest rate is 8.57%. Transaction costs of $1.1 million associated the equity component were netted with the equity component in paid-in-capital. Interest expense, including amortization of deferred origination costs, recognized on the Notes was $0.5 million for the year ended December 31, 2011.                                        100 
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     TABLE OF CONTENTS  Secured Loan Agreement  During February 2011, we entered into a seven-year secured loan agreement with Bank of America Leasing & Capital, LLC in the aggregate amount of $10.8 million to finance the purchase of an aircraft. The loan bears interest at a fixed rate of 4.45%, requires monthly installment payments of approximately $0.1 million, commencing on March 25, 2011 and ending on February 25, 2018, and a balloon payment of $3.2 million at the maturity date. We recorded approximately $0.07 million of deferred financing costs related this agreement. We recorded interest expense of approximately $0.4 million for the year ended December 31, 2011 related to this agreement. The loan is secured by an aircraft that one of our subsidiaries acquired in February 2011.  The agreement contains certain covenants that are similar to our revolving credit facility. Additionally, subsequent to February 25, 2012, but prior to payment in full, if the outstanding balance of this loan exceeds 90% of the fair value of the aircraft, we are required to pay the lender the entire amount necessary to reduce the outstanding principal balance to be equal or less than 90% of the fair value of the aircraft. The agreement allows us, under certain conditions, to repay the entire outstanding principal balance of this loan without penalty.  
Promissory Note
  In connection with the stock and asset purchase agreement with a subsidiary of Unitrin, Inc. (now called Kemper Corporation), on June 1, 2008, we issued a promissory note to Unitrin, Inc. in the amount of $30 million. The note is non-interest bearing and requires four annual principal payments of $7.5 million. We paid the first three annual principal payments between 2009 and 2011, and the remaining principal payment is due on June 1, 2012. Upon entering into the promissory note, we calculated imputed interest of approximately $3.2 million based on interest rates available to us, which was 4.5%. Accordingly, the note's carrying balance was adjusted to approximately $26.8 million at the acquisition. The note is required to be paid in full, immediately, under certain circumstances including a default of payment or change of control of the Company. We included approximately $0.5 million and $0.8 million of amortized discount on the note in our results of operations for the years ended December 31, 2011 and 2010, respectively. The note's carrying value at December 31, 2011 was $7.4 million.  
Securities Sold Under Agreements to Repurchase, at Contract Value
  We enter into repurchase agreements. The agreements are accounted for as collateralized borrowing transactions and are recorded at contract amounts. We receive cash or securities that we invest or hold in short term or fixed income securities. As of December 31, 2011, there were $191.7 million principal amount outstanding at interest rates between 0.4% and 0.45%. Interest expense associated with these repurchase agreements for 2011 was $1.0 million of which $0 million was accrued as of December 31, 2011. We have approximately $210.9 million of collateral pledged in support of these agreements.  
Note Payable - Collateral for Proportionate Share of Reinsurance Obligation
  In conjunction with the Maiden Quota Share (see "- Reinsurance"), AII entered into a loan agreement with Maiden Insurance during the fourth quarter of 2007, whereby, Maiden Insurance loaned to AII the amount equal to its quota share of the obligations of the AmTrust Ceding Insurers that AII was then obligated to secure. We deposited all proceeds from the advances into a sub-account of each trust account that has been established for each AmTrust Ceding Insurer. To the extent of the loan, Maiden Insurance is discharged from providing security for its proportionate share of the obligations as contemplated by the Maiden Quota Share. If an AmTrust Ceding Insurer withdraws loan proceeds from the trust account for the purpose of reimbursing such AmTrust Ceding Insurer for an ultimate net loss, the outstanding principal balance of the loan shall be reduced by the amount of such withdrawal. The loan agreement was amended in February 2008 to provide for interest at a rate of LIBOR plus 90 basis points and is payable on a quarterly basis. Each advance under the loan is secured by a promissory note. Advances totaled $168.0 million as of December 31, 2011.                                        101  --------------------------------------------------------------------------------
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Comerica Letter of Credit Facility
  One of our subsidiaries, entered into a secured letter of credit facility with Comerica Bank, N.A. during 2011. The credit limit is for $75 million and was utilized for $49.8 million as of December 31, 2011. We are required to pay a letter of credit participation fee for each letter of credit in the amount of 0.40%.  Short-term borrowings  During the last three years, we did not engage in short-term borrowings to fund our operations. As discussed above, our Insurance Subsidiaries create liquidity by collecting and investing insurance premiums in advance of paying claims. Details about our investment portfolio can be found under "- Investment Portfolio" appearing elsewhere in this Form 10-K.  
Contractual Obligations and Commitments
The following table sets forth certain of our contractual obligations as of December 31, 2011:
  [[Image Removed]]   [[Image Removed]]     [[Image Removed]]     [[Image Removed]]     [[Image Removed]]     [[Image Removed]]                                                                Payment Due by Period                            Total               Less than            1 - 3 Years           3 - 5 Years            More than                                                 1 Year                                                            5 Years                                                               (Amounts in Thousands) Loss and loss adjustment          $       1,879,175     $         944,535     $         503,800     $         208,980     $         221,860 expenses(1) Loss-based insurance                      13,696                 6,884                 3,672                 1,523                 1,617 
assessments(2)
 Operating lease                62,352                 8,403                15,435                13,418                25,096 
obligations
 Purchase                       16,309                12,087                 3,143                 1,079                     - 
obligations(3)
Employment
 agreement                      22,495                 9,474                 6,610                 4,204                 2,207 obligations Life insurance policy premiums related to life settlement                    662,033                22,444                53,208                65,436               520,945 contracts and premium finance loans(4) Debt and                      700,901                27,570               206,423                31,814               435,094 interest(5) Total               $       3,356,961     $       1,031,397     $         792,291     $         326,454     $       1,206,819   [[Image Removed]]  
  (1) The loss and loss adjustment expense payments due by period in the table
      above are based upon the loss and loss adjustment expense estimates as of
December 31, 2011 and actuarial estimates of expected payout patterns and       are not contractual liabilities as to a time certain. Our contractual       liability is to provide benefits under the policy. As a result, our
      calculation of loss and loss adjustment expense payments due by period is
      subject to the same uncertainties associated with determining the level of
      loss and loss adjustment expenses generally and to the additional
      uncertainties arising from the difficulty of predicting when claims
      (including claims that have not yet been reported to us) will be paid. For a
      discussion of our loss and loss adjustment expense estimate process, see
      "Item 1. Business - Loss Reserves." Actual payments of loss and loss
      adjustment expenses by period will vary, perhaps materially, from the table
      above to the extent that current estimates of loss and loss adjustment
      expenses vary from actual ultimate claims amounts and as a result of       variations between expected and actual payout patterns. See "Item 1A. Risk       Factors - Risks Related to Our Business - Our loss reserves are based on
      estimates and may be inadequate to cover our actual losses" for a discussion
      of the uncertainties associated with estimating loss and loss adjustment
      expenses.
  (2) We are subject to various annual assessments imposed by certain of the
      states in which we write insurance policies. These assessments are generally
      based upon the amount of premiums written or losses paid during the
      applicable year. Assessments based on premiums are generally paid within one
      year after the calendar year in which the policies are written, while
      assessments based on losses are generally paid within one year after the
      loss is paid. When we establish a reserve for loss and loss adjustment
      expenses for a reported claim, we accrue our obligation to pay any
      applicable assessments. If settlement of the claim is to be paid out over
      more than one year, our obligation to pay any related loss-based assessments
      extends for the same period of time. Because our reserves for loss and loss
      adjustment expenses are based on estimates, our accruals for loss-based
      insurance assessments are also based on estimates. Actual payments of loss
      and loss adjustment expenses may differ, perhaps materially, from our
      reserves. Accordingly, our actual loss-based insurance assessments may vary,
      perhaps materially, from our accruals.                                         102 
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  (3) We are required by certain purchase agreements to pay the seller in the
      future based on the passage of time, volume of premium writings or a
      profitability metric. Also, we may be required by the terms of certain
      purchase agreements to pay the seller an annual minimum override payment
      based on a contractually defined formula. The amount payable to the seller
      under these agreements could be materially higher if the premiums produced
      generate a higher payment than the calculated minimum payment. We are
      required by certain agreements to pay fees based on profitability of certain
      subsidiary companies.
  (4) We currently own 237 life settlement contracts and 36 premium finance loans
      with a carrying value of $136.8 million. In order for us to derive the
      economic benefit of the face value of the policies, we are required to make
      these premium payments.     (5) The interest related to the debt by period is as follows: $19.2       million - less than 1 year, $36.4 million  - 1 - 3 years, $29.5
      million - 3 - 5 years and $135.4 million - more than 5 years. In addition,
      included within debt and interest is $168.0 million related to the Maiden
      collateral loan and $4.8 million of associated interest.
Inflation
  We establish property and casualty insurance premiums before we know the amount of losses and loss adjustment expenses or the extent to which inflation may affect such amounts. We attempt to anticipate the potential impact of inflation in establishing our reserves, especially as it relates to medical and hospital rates where historical inflation rates have exceeded the general level of inflation. Inflation in excess of the levels we have assumed could cause loss and loss adjustment expenses to be higher than we anticipated, which would require us to increase reserves and reduce earnings. Fluctuations in rates of inflation also influence interest rates, which in turn impact the market value of our investment portfolio and yields on new investments. Operating expenses, including salaries and benefits, generally are impacted by inflation. 


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