UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2007

OR

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

For the transition period from                      to                     .

PROCENTURY CORPORATION

(Exact name of Registrant as specified in its charter)

Ohio		31-1718622
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)
465 Cleveland Avenue
Westerville, Ohio		43082
(Address of principal executive offices)		(Zip Code)

(614) 895-2000
(Registrant’s telephone number, including area code)

     Indicate by check mark whether registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such report(s)), and (2) has been subject to such filing requirements for the past 90 days.

YES þ NO o

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

Large accelerated filer o       Accelerated filer þ       Non-accelerated filer o

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

o Yes þ No

     As of May 8, 2007, the registrant had 13,363,867 outstanding Common Shares, without par value.

 

 

PROCENTURY CORPORATION

QUARTERLY REPORT ON FORM 10-Q
For the Quarterly Period Ended March 31, 2007

INDEX

		Page
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Condensed Statements of Operations (unaudited) — For the three months ended March 31, 2007 and 2006			3
Consolidated Condensed Balance Sheets – March 31, 2007 (unaudited) and December 31, 2006			4
Consolidated Condensed Statements of Shareholders’ Equity and Comprehensive Income (unaudited) — For the three months ended March 31, 2007 and 2006			5
Consolidated Condensed Statements of Cash Flows (unaudited) — For the three months ended March 31, 2007 and 2006			6
Notes to Consolidated Condensed Financial Statements (unaudited) — March 31, 2007			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			17
Item 3. Quantitative and Qualitative Disclosures About Market Risk			29
Item 4. Controls and Procedures			30
PART II: OTHER INFORMATION
Item 1. Legal Proceedings			31
Item 1A. Risk Factors			31
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			31
Item 3. Defaults Upon Senior Securities			31
Item 4. Submission of Matters to a Vote of Security Holders			31
Item 5. Other Information			31
Item 6. Exhibits			31
SIGNATURES			32
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

PROCENTURY CORPORATION AND SUBSIDIARIES

Consolidated Condensed Statements of Operations

(Unaudited)

(In thousands, except per share data)

		Three Months Ended March 31,
		2007				2006
Premiums earned		$	54,388				49,002
Net investment income			5,433				4,426
Net realized investment (losses) gains			(201	)			21
Other income			123				134
Total revenues			59,743				53,583
Losses and loss expenses			33,877				30,439
Amortization of deferred policy acquisition costs			13,699				12,066
Other operating expenses			3,851				4,057
Interest expense			686				543
Total expenses			52,113				47,105
Income before income tax expense			7,630				6,478
Income tax expense			2,251				1,878
Net income		$	5,379				4,600
Basic net income per share		$	0.41				0.35
Diluted net income per share		$	0.40				0.35
Weighted average of shares outstanding — basic			13,227,427				13,100,705
Weighted average of shares outstanding — diluted			13,421,607				13,200,571

See accompanying notes to the unaudited consolidated condensed financial statements.

PROCENTURY CORPORATION AND SUBSIDIARIES

Consolidated Condensed Balance Sheets

(In thousands, except share data)

		March 31,
		2007				December 31,
		(Unaudited)				2006
Assets
Investments
Fixed maturities:
Available-for-sale, at fair value (amortized cost 2007, $365,268; 2006, $362,066)		$	359,401				358,422
Held-to-maturity, at amortized cost (fair value 2007, $1,103; 2006, $1,101)			1,110				1,114
Equities (available-for-sale):
Equity securities, at fair value (cost 2007, $29,470; 2006, $28,112)			29,525				28,188
Bond mutual funds, at fair value (cost 2007, $14,513; 2006, $14,876)			14,485				14,755
Short-term investments, at amortized cost			34,898				25,623
Total investments			439,419				428,102
Cash and equivalents			9,764				7,960
Premiums in course of collection, net			36,017				37,428
Deferred policy acquisition costs			25,996				26,915
Prepaid reinsurance premiums			14,457				14,051
Reinsurance recoverable on paid losses, net			4,739				7,524
Reinsurance recoverable on unpaid losses, net			37,494				36,104
Deferred federal income tax asset			12,639				11,561
Other assets			10,853				9,403
Total assets		$	591,378				579,048
Liabilities and Shareholders’ Equity
Loss and loss expense reserves		$	260,181				250,672
Unearned premiums			123,698				127,620
Long term debt			25,000				25,000
Line of credit			4,650				4,000
Accrued expenses and other liabilities			12,301				9,778
Reinsurance balances payable			5,520				7,706
Collateral held			10,591				10,370
Income taxes payable			2,189				1,514
Total liabilities			444,130				436,660
Shareholders’ equity:
Common stock, without par value:
Common shares — Issued and outstanding 13,358,867 shares at March 31, 2007 and 13,248,323 shares issued and outstanding at December 31, 2006			—				—
Additional paid-in capital			102,370				100,954
Retained earnings			48,675				43,830
Accumulated other comprehensive loss, net of taxes			(3,797	)			(2,396	)
Total shareholders’ equity			147,248				142,388
Total liabilities and shareholders’ equity		$	591,378				579,048

See accompanying notes to the unaudited consolidated condensed financial statements.

PROCENTURY CORPORATION AND SUBSIDIARIES

Consolidated Condensed Statements of Shareholders’ Equity

and Comprehensive Income
(Unaudited)
(In thousands)

		Three Months Ended March 31,
		2007				2006
Shareholders’ Equity
Capital stock:
Beginning of period		$	—				—
Stock issued			—				—
End of period			—				—
Additional paid-in capital:
Beginning of period			100,954				100,202
Impact of adoption of SFAS 123R			—				(695	)
Shares issued under share compensation plans			414				302
Tax benefit on share compensation plans			305				32
Exercise of share options			697				—
End of period			102,370				99,841
Retained earnings:
Beginning of period			43,830				24,846
Net income			5,379				4,600
Dividend declared (2007, $0.04/share and 2006, $0.03/share)			(534	)			(396	)
End of period			48,675				29,050
Unearned share compensation:
Beginning of period			—				(695	)
Impact of adoption of SFAS 123R			—				695
End of period			—				—
Accumulated other comprehensive loss, net of taxes:
Beginning of period			(2,396	)			(3,150	)
Unrealized holding losses arising during the period, net of reclassification adjustment			(1,401	)			(1,770	)
End of period			(3,797	)			(4,920	)
Total shareholders’ equity		$	147,248				123,971
Comprehensive Income (Loss)
Net income		$	5,379				4,600
Other comprehensive loss:
Unrealized losses on securities:
Unrealized holding losses arising during the period:
Gross			(2,357	)			(2,703	)
Related federal income tax benefit			825				947
Net unrealized losses			(1,532	)			(1,756	)
Reclassification adjustment for (losses) gains included in net income
Gross			(201	)			21
Related federal income tax benefit (expense)			70				(7	)
Net reclassification adjustment			(131	)			14
Other comprehensive loss			(1,401	)			(1,770	)
Total comprehensive income		$	3,978				2,830

See accompanying notes to the unaudited consolidated condensed financial statements.

PROCENTURY CORPORATION AND SUBSIDIARIES

Consolidated Condensed Statements of Cash Flows

(Unaudited)
(In thousands)

		Three Months Ended March 31,
		2007				2006
Cash flows provided by operating activities:
Net income		$	5,379				4,600
Adjustments:
Net realized investment losses (gains)			201				(21	)
Deferred federal income tax benefit			(329	)			(583	)
Share-based compensation expense			414				302
Changes in assets and liabilities:
Premiums in course of collection, net			1,411				1,751
Deferred policy acquisition costs			919				(769	)
Prepaid reinsurance premiums			(406	)			298
Reinsurance recoverable on paid and unpaid losses, net			1,395				(3,012	)
Income taxes payable/receivable			675				2,180
Losses and loss expense reserves			9,509				12,133
Collateral held			221				(501	)
Unearned premiums			(3,922	)			1,132
Other, net			(3,843	)			1,308
Net cash provided by operating activities			11,624				18,818
Cash flows used in investing activities:
Purchases of equity securities			(6,385	)			(3,178	)
Purchases of fixed maturity securities available-for-sale			(45,415	)			(29,175	)
Proceeds from sales of equity securities			5,555				4,627
Proceeds from sales and maturities of fixed maturities available-for-sale			41,573				9,481
Change in short-term investments			(9,275	)			622
Change in securities receivable/payable			3,009				(270	)
Net cash used in investing activities			(10,938	)			(17,893	)
Cash flows provided by (used in) financing activities:
Dividend paid to shareholders			(534	)			(396	)
Tax benefit on share compensation plans			305				32
Draw on line of credit			650				—
Exercise of share options			697				—
Net cash provided by (used in) financing activities			1,118				(364	)
Increase in cash and equivalents			1,804				561
Cash and equivalents at beginning of period			7,960				5,628
Cash and equivalents at end of period		$	9,764				6,189
Supplemental disclosure of cash flow information:
Interest paid		$	909				548
Federal income taxes paid		$	1,600				250

See accompanying notes to the unaudited consolidated condensed financial statements.

PROCENTURY CORPORATION AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements

March 31, 2007

(Unaudited)

(1)		Basis of Presentation
		The accompanying interim unaudited consolidated condensed financial statements and notes include the accounts of ProCentury Corporation (the “Company” or “ProCentury”), and its wholly owned insurance subsidiaries, Century Surety Company (“Century”) and ProCentury Insurance Company (“PIC”). The interim unaudited consolidated condensed financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Article 10 of Regulation S-X. Accordingly, the interim unaudited consolidated condensed financial statements do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation of results for the interim periods have been included. These interim unaudited consolidated condensed financial statements and related notes should be read in conjunction with the consolidated financial statements and related notes in the Company’s audited consolidated financial statements, included in the Company’s annual report on Form 10-K for the year ended December 31, 2006. The Company’s results of operations for interim periods are not necessarily indicative of the results to be expected for the entire year.
		In preparing the interim unaudited consolidated condensed financial statements, management was required to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the financial reporting date and throughout the period being reported upon. Certain of the estimates result from judgments that can be subjective and complex and consequently actual results may differ from these estimates, which would be reflected in future periods.
		Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of loss and loss expense reserves, the recoverability of deferred policy acquisition costs, the determination of federal income taxes, the net realizable value of reinsurance recoverables and the determination of other-than-temporary declines in the fair value of investments. Although considerable variability is inherent in these estimates, management believes that the amounts provided are reasonable. These estimates are continually reviewed and adjusted as necessary. Such adjustments are reflected in current operations.
		All significant intercompany balances and transactions have been eliminated.
(2)		Income per Common Share
		Basic income per share (“EPS”) excludes dilution and is calculated by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the dilution that could occur if securities or other contracts to issue common shares (common share equivalents) were exercised. When inclusion of common share equivalents increases the EPS or reduces the loss per share, the effect on earnings is antidilutive. Under these circumstances, diluted net income or net loss per share is computed excluding the common share equivalents.
		Based on the above and pursuant to disclosure requirements contained in SFAS No. 128, Earnings Per Share, the following information represents a reconciliation of the numerator and denominator of the basic and diluted EPS computations contained in the Company’s interim unaudited consolidated condensed financial statements:

		Three Months Ended March 31, 2007
		(In thousands, except per share data)
		Income				Shares				Per Share
		(Numerator)				(Denominator)				Amount
Basic Net Income Per Share
Net income		$	5,379				13,227,427			$	0.41
Effect of Dilutive Securities
Restricted common shares and share options			—				194,180				(0.01	)
Diluted EPS
Net income		$	5,379				13,421,607			$	0.40

		Three Months Ended March 31, 2006
		(In thousands, except per share data)
		Income				Shares				Per Share
		(Numerator)				(Denominator)				Amount
Basic Net Income Per Share
Net income		$	4,600				13,100,705			$	0.35
Effect of Dilutive Securities
Restricted common shares and share options			—				99,866				—
Diluted EPS
Net income		$	4,600				13,200,571			$	0.35

(3)		Investments
		The Company invests primarily in investment-grade fixed maturities. The amortized cost, gross unrealized gains and losses and estimated fair value of fixed maturities classified as held-to-maturity were as follows:

		March 31, 2007
						(In thousands)
						Gross				Gross				Estimated
		Amortized				unrealized				unrealized				fair
		cost				gains				losses				value
U.S. Treasury securities		$	88				10				—				98
Agencies not backed by the full faith and credit of the U.S. Government			1,022				—				(17	)			1,005
Total		$	1,110				10				(17	)			1,103

		December 31, 2006
						(In thousands)
						Gross				Gross				Estimated
		Amortized				unrealized				unrealized				fair
		cost				gains				losses				value
U.S. Treasury securities		$	88				10				—				98
Agencies not backed by the full faith and credit of the U.S. Government			1,026				—				(23	)			1,003
Total		$	1,114				10				(23	)			1,101

The amortized cost, gross unrealized gains and losses, and estimated fair value of fixed-maturity and equity securities classified as available-for-sale were as follows:

		March 31, 2007
						(In thousands)
						Gross				Gross				Estimated
						Unrealized				Unrealized				Fair
		Amortized Cost				Gains				Losses				Value
Fixed maturities:
U.S. Treasury securities		$	3,621				1				(34	)			3,588
Agencies not backed by the full faith and credit of the U.S. Government			14,549				2				(151	)			14,400
Obligations of states and political subdivisions			134,903				195				(829	)			134,269
Corporate securities			36,195				137				(593	)			35,739
Mortgage-backed securities			72,694				5				(956	)			71,743
Collateralized mortgage obligations			58,126				220				(687	)			57,659
Asset-backed securities			45,180				262				(3,439	)			42,003
Total fixed maturities			365,268				822				(6,689	)			359,401
Equities:
Equity securities			29,470				384				(329	)			29,525
Bond mutual funds			14,513				105				(133	)			14,485
Total equities			43,983				489				(462	)			44,010
Total		$	409,251				1,311				(7,151	)			403,411

		December 31, 2006
						(In thousands)
						Gross				Gross				Estimated
						Unrealized				Unrealized				Fair
		Amortized Cost				Gains				Losses				Value
Fixed maturities:
U.S. Treasury securities		$	3,636				—				(49	)			3,587
Agencies not backed by the full faith and credit of the U.S. Government			13,793				—				(258	)			13,535
Obligations of states and political subdivisions			150,981				445				(795	)			150,631
Corporate securities			35,058				125				(730	)			34,453
Mortgage-backed securities			59,599				34				(1,108	)			58,525
Collateralized mortgage obligations			49,486				152				(622	)			49,016
Asset-backed securities			49,513				316				(1,154	)			48,675
Total fixed maturities			362,066				1,072				(4,716	)			358,422
Equities:
Equity securities			28,112				346				(270	)			28,188
Bond mutual funds			14,876				62				(183	)			14,755
Total equities			42,988				408				(453	)			42,943
Total		$	405,054				1,480				(5,169	)			401,365

Other-than-temporary impairment losses result in permanent reductions to the cost basis of the underlying investments and are recorded as realized losses in the interim unaudited consolidated condensed statements of operations. Other-than-temporary losses of $616,000 were realized during the three months ended March 31, 2007. These losses related to eleven asset-backed securities that were written down in accordance with EITF 99-20. No other-than-temporary impairments were realized during the three months ended March 31, 2006.

The estimated fair value, related gross unrealized loss, and the length of time that the securities have been impaired for held-to-maturity securities that are considered temporarily impaired at March 31, 2007 are as follows:

		March 31, 2007
		Less than 12 months								12 months or longer								Total
		Estimated				Gross				Estimated				Gross				Estimated				Gross
		fair				unrealized				fair				unrealized				fair				unrealized
		value				loss				value				loss				value				loss
		(In thousands)
Fixed Maturity Securities:
U.S. Treasury Securities		$	—				—				—				—				—				—
Agencies not backed by the full faith and credit of the U.S. Government			—				—				1,005				(17	)			1,005				(17	)
Total		$	—				—				1,005				(17	)			1,005				(17	)

The estimated fair value, related gross unrealized losses, and the length of time that the securities have been impaired for available-for-sale securities that are considered temporarily impaired at March 31, 2007 are as follows:

		March 31, 2007
		Less Than 12 Months								12 Months or Longer								Total
		Estimated				Gross								Gross				Estimated				Gross
		Fair				Unrealized				Estimated				Unrealized				Fair				Unrealized
		Value				Loss				Fair Value					Loss			Value				Loss
		(In thousands)
Fixed maturity securities:
U.S. Treasury securities		$	—				—				3,312				(34	)			3,312				(34	)
Obligations of U.S. government corporations and agencies			6,733				(30	)			6,671				(121	)			13,404				(151	)
Obligations of states and political subdivisions			51,089				(258	)			42,557				(571	)			93,646				(829	)
Corporate securities			1,525				(16	)			27,466				(577	)			28,991				(593	)
Mortgage-backed securities			39,059				(142	)			32,365				(814	)			71,424				(956	)
Collateralized mortgage obligations			12,007				(362	)			21,587				(325	)			33,594				(687	)
Asset-backed securities			14,712				(2,088	)			11,615				(1,351	)			26,327				(3,439	)
Total			125,125				(2,896	)			145,573				(3,793	)			270,698				(6,689	)
Equities:
Equity securities			7,164				(122	)			4,461				(207	)			11,625				(329	)
Bond mutual funds			—				—				5,159				(133	)			5,159				(133	)
Total			7,164				(122	)			9,620				(340	)			16,784				(462	)
Grand Total		$	132,289				(3,018	)			155,193				(4,133	)			287,482				(7,151	)

At March 31, 2007, the Company had 197 fixed income securities and 15 equity securities that have been in an unrealized loss position for one year or longer. Of the fixed income securities, 171 are investment grade, of which 158 of these securities are rated A1/A or better (including 116 securities which are rated AAA). The 26 remaining non-investment grade fixed income securities have an aggregate fair value equal to 91.0% of their book value as of March 31, 2007. Of the equity securities, four that have been in an unrealized loss position for one year or longer relate to investments in closed or open ended bond or preferred stock funds. Each of these investments continues to pay its regularly scheduled monthly dividend and there have been no material changes in credit quality for any of these funds over the past twelve months. Finally, the 11 remaining equity securities that have been in an unrealized loss position for one year or longer relate to preferred share investments in issuers each of which has shown an improved or stable financial performance during the past twelve months. In addition, these 11 equity securities have an aggregate fair market value equal to 95.5% of their book value as of March 31, 2007. All 197 of the fixed income securities are current on interest and principal and all 15 of the equity securities continue to pay dividends at a level consistent with the prior year. Management believes that it is probable that all contract terms of each security will be satisfied. The unrealized loss position is due to the changes in interest rate environment and the Company has the positive intent and ability to hold these securities until they mature or recover in value.

(4)

Loss and Loss Expense Reserves

Liability for losses and loss expenses represents the Company’s best estimate of the ultimate amounts needed to pay both reported and unreported claims. These estimates are based on quarterly internal actuarial studies and certified on an annual basis by an independent actuary. The Company continually reviews these estimates and, based on new developments and information, the Company includes adjustments of the probable ultimate liability in the operating results for the periods in which the adjustments are made.

Net loss and loss expenses incurred were $33.9 million for the quarter ended March 31, 2007, compared to $30.4 million for the quarter ended March 31, 2006. In the first quarter of 2007, the Company recorded $34.9 million of incurred losses and loss expenses attributable to the 2007 accident year, which was partially offset by favorable development of $991,000 attributable to events of prior years. In the first quarter of 2006, the Company recorded $29.7 million of incurred losses and loss expenses attributable to the 2006 accident year and $702,000 attributable to events of prior years.

The favorable development during the first quarter of 2007 from prior years consisted of approximately $1.2 million of favorable development on accident year 2005 contractor liability casualty business included in our property and casualty segment. The Company reduced carried reserves related to the 2005 casualty business based on the Company’s internal actuarial reserve recommendations. The 2005 casualty book has performed better than expected to date, and previously carried reserves exceeded the indications for each of the estimation methods applied in the Company’s internal actuarial analysis. At the beginning of 2005, the Company began writing certain contractors’ liability business on a claims made form, replacing the occurrence form which had previously been utilized through 2004. The Company wrote a significant volume of claims made contractor business in both 2005 and 2006. Casualty reserves for accident years 2005 and 2006 were particularly difficult to initially estimate due to the magnitude and very limited experience for claims made contractor business. The Company continues to monitor loss emergence on this book and adjusts assumptions and expectations as needed. The favorable reserve development on our casualty line was partially offset by approximately $200,000 of unfavorable reserve development primarily from the 2006 accident year in our property line. This increase was due to actual reported incurred losses that exceeded our expectations.

The increases for the first quarter of 2006 related to prior years were due to incurred amounts above our expectations in our casualty business included in our property and casualty segment. The increases were primarily due to reported incurred amounts above our expectations for the 2004 and 2003 accident year, an increase in our legal reserves related to expected arbitration with our reinsurers over a disputed claim and an increase in reserves for accident years 1996 and 1997 as a result of higher than anticipated loss, legal and settlement costs. The increase in casualty reserves was partially offset by favorable development in our 2004 and 2005 property line included in our property and casualty segment.

Management believes the loss and loss expense reserves make a reasonable provision for expected losses, however, ultimate settlement of these amounts could vary significantly from the amounts recorded.

(5)

Reinsurance

In the ordinary course of business, Century and PIC assume and cede reinsurance with other insurers and reinsurers. These arrangements provide greater diversification of business and limit the maximum net loss potential on large risks. There have been no changes in the Company’s reinsurance program since December 31, 2006. The amounts of ceded loss and loss expense reserves and ceded unearned premiums would represent a liability of the Company in the event that its reinsurers would be unable to meet existing obligations under reinsurance agreements.

The effects of assumed and ceded reinsurance on premiums written, premiums earned and loss and loss expenses incurred were as follows:

		For the Three Months
		Ended March 31,
		2007				2006
Premiums written:
Direct		$	57,428				57,275
Assumed			1,027				754
Ceded			(8,395	)			(7,597	)
Net premiums written		$	50,060				50,432
Premiums earned:
Direct			61,096				56,085
Assumed			1,281				812
Ceded			(7,989	)			(7,895	)
Net premiums earned		$	54,388				49,002
Losses and loss expenses incurred:
Direct		$	36,730				34,294
Assumed			123				104
Ceded			(2,976	)			(3,959	)
Net losses and loss expenses incurred		$	33,877				30,439

The Company’s allowance for uncollectible reinsurance at March 31, 2007 was $4.1 million, which has not changed since December 31, 2006. At March 31, 2006, the Company’s allowance for uncollectible reinsurance was $1.5 million.

Management believes that the reserves for uncollectible reinsurance constitute a reasonable provision for expected costs and recoveries related to the collection of the recoverables on these claims, however, actual legal costs and settlements of these claims could vary significantly from the current estimates recorded.

(6)

Deferred Policy Acquisition Costs

The following reflects the amounts of policy acquisition costs deferred and amortized:

		For the Three Months
		Ended March 31,
		2007				2006
Balance at beginning of year		$	26,915				20,649
Policy acquisition costs deferred			12,780				12,835
Amortization of deferred policy acquisition costs			(13,699	)			(12,066	)
Balance at end of quarter		$	25,996				21,418

For the three months ended March 31, 2007, the Company expensed $272,000 of unamortized deferred policy acquisition costs related to the auto physical damage program. This expense was a result of the fact that the program’s loss and loss expense ratio exceeded our expectations causing the program to fall below the profitability levels required for continued deferral of the additional policy acquisition costs. There were no such expenses during the three months ended March 31, 2006.

(7)

Federal Income Taxes

The income tax provision for the three months ended March 31, 2007 has been computed based on our estimated annual effective tax rate of 29.5% which differs from the federal income tax rate of 35% principally because of tax-exempt investment income. The income tax provision for the quarter ended March 31, 2006 was 29.0% primarily due to the effect of tax-exempt investment income.

(8)

Commitments and Contingencies

We are party to lawsuits, arbitrations and other proceedings that arise in the normal course of our business. Certain of the lawsuits, arbitrations and other proceedings involve claims under policies that we underwrite as an insurer, the liabilities for which we believe have been adequately included in our loss and loss adjustment expense reserves. Also, from time to time, we are party to lawsuits, arbitrations and other proceedings that relate to disputes over contractual relationships with third parties or that involve alleged errors and omissions on the part of our insurance subsidiaries. We provide accruals for these items to the extent we deem the losses probable and reasonably estimable.

The outcome of litigation is subject to numerous uncertainties. Although the ultimate outcome of pending matters cannot be determined at this time, based on present information, we believe the resolution of these matters will not have a material adverse effect on our financial position, results of operations or cash flows.

(9)

Employee Benefits

During 2004, the Company adopted and the shareholders approved a stock option plan that provided for tax-favored incentive share options (qualified options), non-qualified share options to employees and board members that do not qualify as tax-favored incentive share options (non-qualified options), time-based restricted shares that vest solely on service provided, restricted shares that vest based on achieved performance metrics and non-restricted shares that are issued in conjunction with the Company’s annual bonus plan. The Company accounts for this plan in accordance with FAS 123R. Any compensation cost recorded in accordance with FAS 123R is recorded in the same captions as the salary expense of the employee (i.e. the compensation cost for the Chief Investment Officer is recorded in net investment income). The Company will issue authorized but unissued shares or treasury shares to satisfy restricted share awards or the exercise of share options.

With respect to qualified options, an employee may be granted an option to purchase shares at the grant date fair market value, payable as determined by the Company’s board of directors. An optionee must exercise an option within 10 years from the grant date. Full vesting of options granted occurs at the end of four years.

With respect to non-qualified options, an employee or a board member may be granted an option to purchase shares at the grant date fair market value, payable as determined by the Company’s board of directors. An optionee must exercise an option within 10 years from the grant date. Full vesting of options granted occurs at the end of three years.

For both non-qualified and qualified options, the option exercise price equals the stock’s fair market value on the date of the grant. Compensation expense is measured on the grant date fair value using a Black Scholes model. The compensation cost is recognized over the respective service period, which typically matches the vesting period.

The time-based restricted shares are granted to key executives and vest in equal installments upon the lapse of a period of time, typically over four-and five-year periods and include both monthly and annual vesting periods. Compensation expense for time-based restricted shares is measured on the grant date fair value and then recognized over the respective service period, which typically matches the vesting period.

The performance-based restricted shares are granted to key executives and vest annually over a four-year period based on achieved specified performance metrics. Compensation expense for performance-based restricted share awards is recognized based on the fair value of the awards on the date of grant.

The non-restricted shares are granted to key executives pursuant to the stock option plan in conjunction with the Company’s annual bonus plan and are fully vested on the date of grant. These shares are granted to the executive when the annual bonus plan calculation exceeds the employee’s target bonus. Under the annual bonus plan the portion of the bonus that is less than or equal to the executive’s target bonus is paid in cash and any amount greater than the target bonus is paid in non-restricted shares. Compensation expense for non-restricted shares is recognized based on the grant date fair value.

The Company may grant awards for up to 1.2 million shares under the plan. Through March 31, 2007, the Company had granted 299,000 non-qualified options, 292,500 qualified options, 156,000 time-based restricted shares, 127,353 performance based restricted shares, and 8,661 non-restricted shares under the share plan.

During the quarter ended March 31, 2007, the Company awarded certain employees 85,000 share options which vest monthly over a four-year period. The weighted average fair value of options granted during the quarter ended March 31, 2007 was $6.44. A summary of the status of the option plan at March 31, 2007 and changes during the quarter is presented in the following table:

		March 31, 2007
						Weighted-
		Number of				Average
		Shares				Exercise Price
Outstanding at beginning of period			505,900			$	10.58
Changes during the period:
Granted			85,000				19.97
Exercised			(66,258	)			10.51
Forfeited			—				—
Expired			—				—
Outstanding at end of period			524,642			$	12.11
Exercisable at end of period			322,635			$	10.53

The fair market value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants issued in the first quarter of 2007:

		Three Months
		Ended March 31,
		2007
Risk-free interest rate			4.46	%
Expected dividends			0.71	%
Expected volatility			25.07	%
Weighted average expected term			6.25 Years

Information on the range of exercise prices for options outstanding at March 31, 2007, is as follows:

		Options Outstanding																		Options Excercisable
						Weighted
						Average				Weighted														Weighted
						Remaining				Average						Aggregate								Average				Aggregate
		Outstanding				Contractual				Exercise						Intrinsic				Exercisable				Exercise				Intrinsic
Price Range		Options				Term				Price						Value				Options				Price				Value
$10.20			12,000				8.2			$	10.20					$	156,000				7,326			$	10.20			$	95,238
$10.50			309,600				7.1			$	10.50					$	3,931,920				278,402			$	10.50			$	3,535,705
$10.64			106,042				8.8			$	10.64					$	1,331,888				38,583			$	10.64			$	484,602
$13.04			12,000				9.2			$	13.04					$	121,920				3,324			$	13.04			$	33,772
$19.97			85,000				9.9			$	19.97					$	274,550				—			$	19.97				—
																$	5,816,278											$	4,149,318

A summary of all employee time-based restricted share activity during the three months ended March 31, 2007 is as follows:

						Weighted
		Number of				Average
		Shares				Grant Price
Outstanding at beginning of period			45,156			$	10.19
Changes during the period:
Granted			—				—
Vested			(4,728	)			10.33
Cancelled			—				—
Outstanding at end of period			40,428			$	10.17

In March 2007, the Company granted 35,625 of performance based restricted shares to certain executives that vest annually over a four-year period subject to the achievement of certain performance metrics. The Company accounts for these awards as fixed awards that are recorded at fair value on the date of grant. A summary of all employee performance-based restricted share activity during the three months ended March 31, 2007 is as follows:

						Weighted
		Number of				Average
		Shares				Grant Price
Outstanding at beginning of period			64,728			$	12.76
Changes during the period:
Granted			35,625				19.97
Vested			(9,341	)			10.50
Cancelled			—				—
Outstanding at end of period			91,012			$	15.82

As of March 31, 2007, total compensation cost related to nonvested share options or restricted shares was $2.4 million, which is expected be recorded over 1.9 years. Total compensation cost for share based awards was $414,000 and $302,000 for the three months ended March 31, 2007 and 2006, respectively. The tax benefit included in the accompany statements of operations related to the compensation cost was $305,000 and $32,000 for the three months ended March 31, 2007 and 2006, respectively. As of March 31, 2007, the Company had $69,000 of compensation cost for share based awards capitalized with deferred policy acquisition costs.

(10) Segment Reporting Disclosures

The Company operates in the Property and Casualty Lines (including general liability, multi-peril, commercial property, garage liability and auto physical damage).

The Company’s Other (including exited lines) includes the surety business and the Company’s exited lines, such as workers’ compensation and commercial auto/trucking. A limited amount of surety business is written in order to maintain Century’s U.S. Treasury listing.

All investment activities are included in the Investing operating segment.

The Company considers many factors, including economic similarity, the nature of the underwriting unit’s insurance products, production sources, distribution strategies and regulatory environment in determining how to aggregate operating segments.

Segment profit or loss for each of the Company’s segments is measured by underwriting profit or loss. The property and casualty insurance industry commonly defines underwriting profit or loss as earned premium net of loss and loss expenses and underwriting, acquisition and insurance expenses. Underwriting profit or loss does not replace operating income or net income computed in accordance with GAAP as a measure of profitability. Segment profit for the Investing operating segment is measured by net investment income and net realized gains or losses. The Company does not allocate assets, including goodwill, to the

Property and Casualty and Other operating segments for management reporting purposes. The total investment portfolio and cash are allocated to the Investing operating segment.

Following is a summary of segment disclosures:

		For the Three Months
		Ended March 31,
		2007				2006
		(In thousands)
Segment revenue:
Property and Casualty		$	53,368				48,343
Investing			5,232				4,447
Other (including exited lines)			1,020				659
Segment revenue		$	59,620				53,449
Segment profit (loss):
Property and Casualty		$	2,904				2,288
Investing			5,232				4,447
Other (including exited lines)			190				377
Segment profit		$	8,326				7,112
Segment assets:
Investing		$	439,419				376,082
Assets not allocated			151,959				117,257
Total consolidated assets		$	591,378				493,339

The following summary reconciles significant segment items to the Company’s interim unaudited consolidated condensed financial statements:

		For the Three Months
		Ended March 31,
		2007				2006
		(In thousands)
Total revenues:
Segment revenues		$	59,620				53,449
Other			123				134
Total consolidated revenues		$	59,743				53,583
Income before income taxes:
Segment profit		$	8,326				7,112
Unallocated amounts:
Other income			123				134
Corporate expenses			(133	)			(225	)
Interest expense			(686	)			(543	)
Income before income taxes		$	7,630				6,478

The following is a summary of segment earned premium by group of products:

		Property				Casualty				Other				Consolidated
		(In thousands)
Three Months Ended March 31, 2007
Property and Casualty		$	18,970				34,398				—				53,368
Other (including exited lines)			—				—				1,020				1,020
Earned premiums		$	18,970				34,398				1,020				54,388
Three Months Ended March 31, 2006
Property and Casualty		$	14,433				33,910				—				48,343
Other (including exited lines)			—				—				659				659
Earned premiums		$	14,433				33,910				659				49,002

The Company does not manage property and casualty products at this level of detail.

(11) Dividends to Common Shareholders

On March 8, 2007, the Board of Directors declared a dividend of $0.04 per common share that was paid on April 18, 2007 to shareholders of record as of March 27, 2007. The dividends were accrued on the March 31, 2007 interim unaudited consolidated condensed balance sheet in the caption accrued expenses and other liabilities.

On March 12, 2006, the Board of Directors declared a dividend of $0.03 per common share that was paid on April 17, 2006 to shareholders of record as of March 27, 2006. The dividends were accrued on the March 31, 2006 interim unaudited consolidated condensed balance sheet in the caption accrued expenses and other liabilities.

(12) Line of Credit

The Company has a $10.0 million line of credit with a maturity date of September 30, 2009, and interest only payments due quarterly based on LIBOR plus 1.2% of the outstanding balance. All of the outstanding shares of Century are pledged as collateral. During the first quarter of 2007, the Company made draws totaling $650,000 on the line of credit for general corporate purposes. At March 31, 2007, there was $4.7 million outstanding under the line of credit. Interest expense for the three months ended March 31, 2007 was approximately $93,000. The Company did not have any amounts outstanding or any interest expense on the line of credit as of and for the three months ended March 31, 2006.

Item 2. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

     The following discussion of our financial condition and results of operations should be read in conjunction with our interim unaudited consolidated condensed financial statements and the notes to those statements included in this Form 10-Q. Some of the statements in this report, including those set forth in the discussion and analysis below, are “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are derived from information that we currently have and assumptions that we make and may be identified by words such as “believes,” “anticipates,” “expects,” “plans,” “should,” “estimates” and similar expressions. We cannot assure you that anticipated results will be achieved, since actual results may differ materially because of both known and unknown risks and uncertainties we face. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. Factors that could cause actual results to differ materially from our forward-looking statements are described under the heading “Risks Related to Our Business and Industry” in our Annual Report on Form 10-K for the year ended December 31, 2006, and elsewhere in this report, and include, but are not limited to, the following factors:

	•		our actual incurred losses may be greater than our loss and loss expense reserves, which could cause our future earnings, liquidity and financial rating to decline;
	•		a decline in our financial rating assigned by A.M. Best & Company may result in a reduction of new or renewal business;

	•		we are subject to extensive regulation and judicial decisions affecting insurance and tort law, which may adversely affect our ability to achieve our business objectives. In addition, if we fail to comply with these regulations, we may be subject to penalties, including fines and suspensions, which may adversely affect our financial condition and results of operations;
	•		our general agents may exceed their authority and bind us to policies outside our underwriting guidelines, and until we effect a cancellation of a policy, we may incur loss and loss expenses related to that policy;
	•		we may not be successful in developing our new specialty lines that could cause us to experience losses;
	•		if we lose key personnel or are unable to recruit qualified personnel, our ability to implement our business strategies could be delayed or hindered;
	•		our investment results and, therefore, our financial condition may be impacted by changes in the business, financial condition or operating results of the entities in which we invest, as well as changes in government monetary policies, general economic conditions and overall capital market conditions, all of which impact interest rates;
	•		we distribute our products through a select group of general agents, five of whom account for a significant part of our business, and such relationships could be discontinued or cease to be profitable;
	•		our reinsurers may not pay claims made by us on losses in a timely fashion or may not pay some or all of these claims, in each case causing our costs to increase and our revenues to decline;
	•		if we are not able to renew our existing reinsurance or obtain new reinsurance, either our net exposure would increase or we would have to reduce the level of our underwriting commitment;
	•		our business is cyclical in nature, which will affect our financial performance and may affect the price of our common shares;
	•		if we are unable to compete effectively with the large number of companies in the insurance industry for underwriting revenues, we may incur increased costs and our underwriting revenues and net income may decline;
	•		severe weather conditions and other catastrophes may result in an increase in the number and amount of claims experienced by our insureds;
	•		as a holding company, we are dependent on the results of operations of our insurance subsidiaries and the regulatory and contractual capacity of our subsidiaries to pay dividends to us. Some states limit the aggregate amount of dividends our subsidiaries may pay to us in any twelve-month period, thereby limiting our funds to pay expenses and dividends: and
	•		managing technology initiatives and meeting new data security requirements present significant challenges to us.

You are cautioned not to place undue reliance on forward-looking statements, which speak only as of their respective dates.

Overview

     ProCentury is a holding company that underwrites selected property and casualty and surety insurance through its subsidiaries collectively known as Century Insurance Group^®. As a “niche” company, we offer specialty insurance products designed to meet specific insurance needs of targeted insured groups. The excess and surplus lines market provides an alternative market for customers with hard-to-place risks and risks that insurance companies licensed by the state in which the insurance policy is sold, which are also referred to as “admitted insurers,” specifically refuse to write. As an underwriter within the excess and surplus lines market, we are selective in the lines of business and types of risks we choose to write. Typically, the development of these specialty insurance products is generated through proposals brought to us by an agent or broker seeking coverage for a specific group of clients.

     We evaluate our insurance operations by monitoring key measures of growth and profitability. The following provides further explanation of the key financial measures that we use to evaluate our results:

     Written and Unearned Premium. Written premium is recorded based on the insurance policies that have been reported to us and, beginning in the fourth quarter of 2006, the policies that have been written by agents but not yet reported to us. We must estimate the

amount of written premium not yet reported based on judgments relative to current and historical trends of the business being written. Such estimates are regularly reviewed and updated and any resulting adjustments are included in the current period’s results. An unearned premium reserve is established to reflect the unexpired portion of each policy at the financial reporting date. For additional information regarding our written and unearned premium refer to Note 5 to our interim unaudited consolidated condensed financial statements included in this Form 10-Q.

     Loss and Loss Expense Ratio. Loss and loss expense ratio is the ratio (expressed as a percentage) of losses and loss expenses incurred to premiums earned. Our net loss and loss expense ratio is meaningful in evaluating our financial results, which are net of ceded reinsurance, as reflected in our interim unaudited consolidated condensed financial statements.

     Expense Ratio. Expense ratio is the ratio (expressed as a percentage) of net operating expenses to premiums earned and measures a company’s operational efficiency in producing, underwriting and administering its insurance business. Interest expense is not included in the calculation of the expense ratio.

     Combined Ratio. Combined ratio is the sum of the loss and loss expense ratio and the expense ratio and measures a company’s overall underwriting profit. If the combined ratio is at or above 100, an insurance company cannot be profitable without investment income (and may not be profitable if investment income is insufficient). We use the combined ratio in evaluating our overall underwriting profitability and as a measure for comparing our profitability relative to the profitability of our competitors.

Critical Accounting Policies

     It is important to understand our accounting policies in order to understand our financial statements. Management considers certain of these policies to be critical to the presentation of our financial results, since they require management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the financial reporting date and throughout the period being reported upon. Certain of the estimates result from judgments that can be subjective and complex and consequently actual results may differ from these estimates, which would be reflected in future periods.

     Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of other-than-temporary declines in the fair value of investments, determination of loss and loss expense reserves, the net realizable value of reinsurance recoverables, the recoverability of deferred policy acquisition costs, and the determination of federal income taxes. Although considerable variability is inherent in these estimates, management believes that the amounts provided are reasonable. These estimates are continually reviewed and adjusted as necessary. Such adjustments are reflected in current operations.

     Loss and Loss Expense Reserves. Loss and loss expense reserves represent an estimate of the expected cost of the ultimate settlement and administration of losses based on facts and circumstances then known. We use actuarial methodologies to assist us in establishing these estimates, including judgments relative to estimates of future claims severity and frequency, length of time to develop to ultimate resolution, and consideration of new judicial decisions in tort and insurance law, emerging theories or liabilities and other factors beyond our control. Due to the inherent uncertainty associated with the cost of unsettled and unreported claims, the ultimate liability may be different from the original estimate. Such estimates are regularly reviewed and updated and any resulting adjustments are included in the current period’s results. Additional information regarding our loss and loss expense reserves can be found in “Results of Operations — Expenses — Losses and Loss Expenses,” and Note 4 to our interim unaudited consolidated condensed financial statements included in this Form 10-Q.

     Reinsurance Recoverables. Reinsurance recoverables on paid and unpaid losses, net, are established for the portion of our loss and loss expense reserves that are ceded to reinsurers. Reinsurance recoverables are determined based in part on the terms and conditions of reinsurance contracts which could be subject to interpretations that differ from our own based on judicial theories of liability. In addition, we bear credit risk with respect to our reinsurers that can be significant considering that certain of the reserves remain outstanding for an extended period of time. We are required to pay losses even if a reinsurer fails to meet its obligations under the applicable reinsurance agreement. See Note 5 to our interim unaudited consolidated condensed financial statements included in this Form 10-Q.

     Impairment of Investments. Impairment of investment securities results in a charge to operations when a market decline below cost is deemed to be other-than-temporary. Under our accounting policy for equity securities and fixed-maturity securities that can be contractually prepaid or otherwise settled in a way that may limit our ability to fully recover cost, an impairment is deemed to be

other-than-temporary unless we have both the ability and intent to hold the investment until the security’s forecasted recovery and evidence exists indicating that recovery will occur in a reasonable period of time.

     For other fixed-maturity and equity securities, an other-than-temporary impairment charge is taken when we do not have the ability and intent to hold the security until the forecasted recovery or if it is no longer probable that we will recover all amounts due under the contractual terms of the security. Many criteria are considered during this process including, but not limited to, the current fair value as compared to amortized cost or cost, as appropriate, of the security; the amount and length of time a security’s fair value has been below amortized cost or cost; specific credit issues and financial prospects related to the issuer; our intent to hold or dispose of the security; and current economic conditions. Other-than-temporary impairment losses result in a permanent reduction to the cost basis of the underlying investment.

     Additionally, for certain securitized financial assets with contractual cash flows (including asset-backed securities), FASB Emerging Task Force (EITF) 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets,” requires us to periodically update our best estimate of cash flows over the life of the security. If management determines that the fair value of a securitized financial asset is less than its carrying amount and there has been a decrease in the present value of the estimated cash flows since the last revised estimate, considering both timing and amount, then an other-than-temporary impairment is recognized.

     For additional detail regarding our investment portfolio at March 31, 2007 and December 31, 2006, including disclosures regarding other-than-temporary declines in investment value, see “Investment Portfolio” below and Note 3 to our interim unaudited consolidated condensed financial statements included in this Form 10-Q.

     Deferred Policy Acquisition Costs. We defer commissions, premium taxes and certain other costs that vary with and are primarily related to the acquisition of insurance contracts. These costs are capitalized and charged to expense in proportion to premium revenue recognized. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, anticipated losses and settlement expenses and certain other costs expected to be incurred as the premium is earned. Judgments as to ultimate recoverability of such deferred costs are highly dependent upon estimated future loss costs associated with the written premiums. See Note 6 to our interim unaudited consolidated condensed financial statements included in this Form 10-Q.

     Federal Income Taxes. We provide for federal income taxes based on amounts we believe we will ultimately owe. Inherent in the provision for federal income taxes are estimates regarding the deductibility of certain items and the realization of certain tax credits. In the event the ultimate deductibility of certain items or the realization of certain tax credits differs from estimates, we may be required to significantly change the provision for federal income taxes recorded in the consolidated financial statements. Any such change could significantly affect the amounts reported in the consolidated statements of income.

     We utilize the asset and liability method of accounting for income tax. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce the deferred tax assets to the amounts more likely than not to be realized. See Note 7 to our interim unaudited consolidated condensed financial statements included in this Form 10-Q.

Results of Operations

     The table below summarizes our operating results and key measures we use in monitoring and evaluating operations. The information is intended to summarize and supplement information contained in the interim unaudited consolidated condensed financial statements and to assist the reader in gaining a better understanding of results of operations.

		For the Three Months
		Ended March 31,
		2007				2006
		(In thousands)
Selected Financial Data:
Gross written premiums		$	58,455				58,029
Premiums earned			54,388				49,002
Net investment income			5,433				4,426
Net realized investment gains (losses)			(201	)			21
Total revenues			59,743				53,583
Total expenses			52,113				47,105
Net income			5,379				4,600
Key Financial Ratios:
Loss and loss expense ratio			62.3	%			62.1	%
Expense ratio			32.3	%			32.9	%
Combined ratio			94.6	%			95.0	%

Overview of Operating Results

     Net income was $5.4 million for the three months ended March 31, 2007 compared to net income of $4.6 million for the three months ended March 31, 2006.

     The increase in net income for the three months ended March 31, 2007 was primarily attributable to an increase in earned premium and net investment income, coupled with a lower combined ratio. The increase in net earned premium resulted from our growth in gross written premiums in 2006 and was supported by slightly higher gross written premiums for the first quarter of 2007 when compared to the first quarter of 2006. During the first quarter of 2007, we experienced increased competition across our product lines with indications of other carriers continuing to lower their rates and expand their risk profile. Despite this increase in competition, we maintained our underwriting discipline and our core book of business remained stable without a significant decline in rates. This increase in earned premium was supplemented by a 22.8% increase in net investment income for the three months ended March 31, 2007 compared to the same period in 2006. This is due to continued positive cash flows from operations and higher investment yields, which on a tax equivalent basis increased to 5.8% for the three months ended March 31, 2007 as compared to 5.7% for the same period in 2006.

     Total expenses increased to $52.1 million for the three months ended March 31, 2007 from $47.1 million for the same period in 2006. The increase can primarily be attributed to the growth in our underwriting business. The combined ratio for the three months ended March 31, 2007 was 94.6% with a loss and loss expense ratio of 62.3% and an expense ratio of 32.3%. This compares to a 95.0% combined ratio for the three months ended March 31, 2006 with a 62.1% loss and loss expense ratio and a 32.9% expense ratio. For the three months ended March 31, 2007, total loss and loss expenses related to the 2007 accident year was $34.9 million, which was partially offset by $991,000 of favorable reserve development on prior accident years. This compares to $29.7 million of current accident year loss and loss expenses and $702,000 million of unfavorable reserve development on prior accident years for the three months ended March 31, 2006. The increase in loss and loss expenses related to the current accident year is primarily due to the growth in business as well as increases in losses primarily from the auto physical damage program, weather related property losses and higher property claims severity. In response to the lower than expected performance of the auto physical damage program, beginning in the third quarter of 2006, we tightened the underwriting selection guidelines and increased premium rates in order to achieve an acceptable loss and loss expense ratio. We also decreased the commissions paid to the agent that produced the auto physical damage business from 21% to 17% of premiums. These changes were designed to increase the profitability of this program to meet our expectations. While the pricing and underwriting standards surrounding this program were improved late in 2006, we continue to experience higher than expected amount of losses as the business written prior to the rate and underwriting improvements runs-off.

     The expense ratio for the three months ended March 31, 2007 and 2006 was 32.3% and 32.9%, respectively. The decrease in the expense ratio for the quarter ended March 31, 2007 is directly attributable to legal defense recoveries received from our corporate insurance policy. These recoveries were partially offset by a higher than expected commission payouts related to our 2006 agent contingent commission plan. The recoveries, offset by the additional commission expense, decreased our expense ratio by one percentage point.

Revenues

     Premiums

     Premiums include insurance premiums underwritten by our insurance subsidiaries (which are referred to as direct premiums) and insurance premiums assumed from other insurers (which are referred to as assumed premiums). We refer to direct and assumed premiums together as gross premiums.

     Written premiums are the total amount of premiums billed to the policyholder less the amount of premiums returned, generally because of cancellations, during a given period. Written premiums become premiums earned as the policy ages. Barring premium changes, if an insurance company writes the same mix of business each year, written premiums and premiums earned will be equal, and the unearned premium reserve will remain constant. During periods of growth, the unearned premium reserve will increase, causing premiums earned to be less than written premiums. Conversely, during periods of decline, the unearned premium reserve will decrease, causing premiums earned to be greater than written premiums.

     Written premium is recorded based on the insurance policies that have been reported to us and, beginning in the fourth quarter of 2006, the policies that have been written by agents but not yet reported to us. We estimate the amount of written premium not yet

reported based on judgments relative to current and historical trends of the business being written. Such estimates will be regularly reviewed and updated and any resulting adjustments will be included in the current year’s results. An unearned premium reserve is established to reflect the unexpired portion of each policy at the financial reporting date.

     We have historically relied on quota share, excess of loss, and catastrophe reinsurance primarily to manage our regulatory capital requirements and to limit our exposure to loss. Generally, we have ceded a significant portion of our premiums to unaffiliated reinsurers in order to maintain net written premiums to statutory surplus ratio of less than 2-to-1.

     Our underwriting business is currently divided into two primary segments:

	•		property/casualty; and
	•		other (including exited lines).

     Our property/casualty segment primarily includes general liability, commercial property and multi-peril insurance for small and mid-sized businesses. The other (including exited lines) segment primarily includes our surety business, including landfill and specialty surety that is written in order to maintain Century’s U.S. Treasury listing.

     The following table presents our gross written premiums in our primary segments and provides a summary of gross, ceded and net written premiums and net premiums earned for the periods indicated.

		For the Three Months
		Ended March 31,
		2007				2006
		(In thousands)
Gross written premiums
Property/casualty		$	57,703				57,090
Other (including exited lines)			752				939
Total gross written premiums			58,455				58,029
Ceded written premiums			8,395				7,597
Net written premiums		$	50,060				50,432
Net premiums earned		$	54,388				49,002
Net written premiums to gross written premiums			85.6	%			86.9	%
Net premiums earned to net written premiums			108.6	%			97.2	%
Net writings ratio (1)			1.4				1.6

     Gross Written Premiums

     Gross written premiums increased slightly to $58.5 million for the three months ended March 31, 2007 from $58.0 million for the same period in 2006. During the first quarter of 2007, we experienced an increase in competition with indication that other carriers are striving to increase their market share by reducing prices and providing broader coverage forms. These softening market conditions were the most prevalent in our casualty market where we saw a decrease in premiums from our casualty book resulting from other carriers offering broader coverages at a lower price on certain classes of business. In addition, due to the unfavorable underwriting results from our auto physical damage book written in 2006, we significantly decreased the amount of business written in the program for the first three months of 2007 compared to the first three months of 2006.

     Despite the increase in competition and the lower amount of business written in the auto physical damage program, our overall business is stable with growth from our garage and ocean marine business. In addition, while we have experienced minimal rate deterioration in our property rates, our casualty rates remained stable.

     Net Written Premiums and Premiums Earned

     Net written premiums decreased by approximately $372,000 for the three months ended March 31, 2007, compared to the same period in 2006. This decrease is due to relatively flat gross written premiums and an increase in ceded premium. The additional ceded premium in the first quarter of 2007 compared to the same period in 2006 is due to an increase in the percent of property business to the total business, which has a higher ceding rate than our casualty line.

     Net written premiums represented 85.6% and 86.9% of gross written premiums for the three months ended March 31, 2007 and 2006, respectively. The lower relationship of net written premiums to gross written premiums for the first quarter of 2007 reflects an increase in ceded premiums in the current year, as noted above.

     The ratio of premiums earned to net written premiums increased by 11.4 percentage points for the three months ended March 31, 2007, compared to the same period in 2006. Premiums earned represent 108.6% of net written premiums for the three months ended March 31, 2007 compared to 97.2% in the first quarter in 2006. The relationship of premiums earned to net written premiums during the quarter ended March 31, 2007 was higher compared to the same periods in 2006, reflecting a decrease in the growth rate of premiums in the first quarter of 2007 compared to the same period in 2006.

     Net Investment Income

     Our investment portfolio generally consists of liquid, readily marketable and investment-grade fixed-maturity and equity securities. Net investment income is comprised of interest and dividends earned on these securities, net of related investment expenses.

     Net investment income was $5.4 million for the three months ended March 31, 2007, compared to $4.4 million for the same period in 2006. The increase was partially due to an increase in assets available for investment, including cash, and higher investment yields. Invested assets, including cash, increased by $66.9 million to $449.2 million as of March 31, 2007 from $382.3 million as of March 31, 2006. The pre-tax investment yield for the quarter ended March 31, 2007 was 5.2%, compared to 4.9% for the same period in 2006. Our taxable equivalent yield for the first quarter of 2007 was 5.8% compared to 5.7% for the same quarter in 2006.

     Net Realized Investment Losses

     Realized gains and losses on securities are principally affected by changes in interest rates, the timing of sales of investments and changes in credit quality of the securities we hold as investments.

     We realized net investment losses of $201,000 on the sale of securities for the quarter ended March 31, 2007 compared to $21,000 of net investment gains for the quarter ended March 31, 2006. Other-than-temporary losses of $616,000 were included in the net realized investment losses for the three months ended March 31, 2007. No other-than-temporary impairments were realized in the first quarter of 2006.

Expenses

     Losses and Loss Expenses

     Losses and loss expenses represent our largest expense item and include (1) payments made to settle claims, (2) estimates for future claim payments and changes in those estimates for current and prior periods, and (3) costs associated with settling claims. The items that influence the incurred losses and loss expenses for a given period include, but are not limited to, the following:

	•		the number of exposures covered in the current year;
	•		trends in claim frequency and claim severity;
	•		changes in the cost of adjusting claims;

	•		changes in the legal environment relating to coverage interpretation, theories of liability and jury determinations; and
	•		the re-estimation of prior years’ reserves in the current year.

     We establish or adjust (for prior accident quarters) our best estimate of the ultimate incurred losses and loss expenses to reflect loss development information and trends that have been updated for the most recent quarter’s activity through quarterly internal actuarial analysis. Our estimate of ultimate loss and loss expenses is evaluated and re-evaluated by accident year and by major coverage grouping each quarter and changes in estimates are reflected in the period the additional information becomes known. As of December 31 of each year, we have an independent actuarial analysis performed on the adequacy of our reserves.

     Our reinsurance program significantly influences our net retained losses. In exchange for premiums ceded to reinsurers under quota share and excess of loss reinsurance agreements, our reinsurers assume a portion of the losses and loss expenses incurred. We remain obligated for amounts ceded in the event that the reinsurers do not meet their obligations under the agreements (due to, for example, disputes with the reinsurer or the reinsurer’s insolvency).

     Net loss and loss expenses incurred were $33.9 million for the quarter ended March 31, 2007, compared to $30.4 million for the quarter ended March 31, 2006. In the first quarter of 2007, we recorded $34.9 million of incurred losses and loss expenses attributable to the 2007 accident year and $991,000 of favorable prior year development. In the first quarter of 2006, we recorded $29.7 million of incurred losses and loss expenses attributable to the 2006 accident year and $702,000 of adverse prior year development.

     The increase in net loss and loss expense reserves during the first three months of 2007 is primarily attributable to our continued growth and higher current accident year loss and loss and loss expense ratios primarily related to our property business. The higher loss and loss expense ratios related to our property business is a direct result of an increase in weather related claims together with increased claim severity. These higher losses together with an increase in losses related to the auto physical damage program, adversely affected the property line results but were partially offset by $991,000 of favorable prior year development. The favorable development during the first quarter of 2007 from prior years consisted of approximately $1.2 million of favorable development on accident year 2005 contractor liability casualty business, included in our property and casualty segment. We reduced held reserves related to the 2005 casualty business in accordance with internal actuarial reserve recommendations. The 2005 casualty book has performed better than expected to date, and previously held reserves exceeded the indications for each of the estimation methods applied in our internal actuarial analysis. At the beginning of 2005, we began writing certain contractors’ liability business on a claims made form, replacing the occurrence form which had previously been utilized through 2004. We wrote a significant volume of claims made contractor business in both 2005 and 2006. Casualty reserves for accident years 2005 and 2006 were particularly difficult to initially estimate due to the magnitude and very limited experience for claims made contractor business. We continue to monitor loss emergence on this book and adjust assumptions and expectations as needed. The favorable reserve development on our casualty line was partially offset by approximately $200,000 of unfavorable reserve development primarily from the 2006 accident year in our property line. This increase was due to actual reported incurred losses that exceeded our expectations.

     The increases for the first quarter of 2006 related to prior years were due to incurred amounts above our expectations in our casualty business included in our property and casualty segment. The increases were primarily due to reported incurred amounts above our expectations for the 2003 accident year, and increase in our legal reserves related to expected arbitration with our reinsurers over a disputed claim and an increase in reserves for accident years 1996 and 1997 as a result of higher than anticipated legal and settlement costs. The increase in casualty reserves was offset by favorable development in our 2004 and 2005 property line of the property and casualty segment.

     Our reserve for losses and loss expenses at March 31, 2007 was $260.2 million (before the effects of reinsurance) and $222.7 million (after the effects of reinsurance), as estimated through our actuarial analysis. During the first quarter of 2007, we concluded through our actuarial analysis that the December 31, 2006 reserve for losses and loss expenses of $214.6 million (after the effects of reinsurance) was redundant by $991,000, primarily due to favorable development in our casualty reserves. Our reserve for losses and loss expenses (net of the effects of reinsurance) at March 31, 2007 and December 31, 2006 by line is summarized as follows:

		March 31				December 31
		2007				2006
		(In thousands)
Property/casualty:
Casualty		$	193,694				188,370
Property			25,049				22,302
Other (including exited lines):
Commercial auto			133				147
Workers’ compensation			3,208				3,220
Surety			603				529
Net reserves for losses and loss expenses			222,687				214,568
Plus reinsurance recoverables on unpaid losses at end of period			37,494				36,104
Gross reserves for losses and loss expenses		$	260,181				250,672