sbx_10q-093012.htm

Part I.	Financial Information	Page

Item 1.	Financial Statements (unaudited)	2

	Condensed Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011	2

	Condensed Consolidated Statements of Operations and Comprehensive Income for the Three Months and Nine Months Ended September 30, 2012 and 2011	3

	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2012 and 2011	4

	Notes to Unaudited Condensed Consolidated Financial Statements	5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	28

Item 4.	Controls and Procedures	28

Part II.	Other Information

Item 1.	Legal Proceedings	28

Item 1A.	Risk Factors	29

Item 6.	Exhibits	31

Signatures		32

	September 30, 2012		December 31, 2011
			(As adjusted)
	(in thousands, except share and per share amounts)
ASSETS

Fixed income securities available for sale, at fair value (amortized cost $674,880 in 2012 and $665,891 in 2011)	$	709,585	$	700,346
Cash and cash equivalents		51,286		28,503
Premiums receivable, net		16,338		18,332
Deferred premiums, net		139,101		142,486
Reinsurance recoverables		112,435		94,173
Federal income tax recoverable		5,432		12,823
Deferred income taxes, net		22,043		21,681
Deferred policy acquisition costs, net		13,466		14,844
Goodwill		2,794		2,794
Other assets		32,068		38,314
Total assets	$	1,104,548	$	1,074,296

LIABILITIES AND STOCKHOLDERS’ EQUITY

Liabilities:
Unpaid loss and loss adjustment expense	$	537,500	$	518,044
Unearned premiums		125,980		130,300
Reinsurance funds withheld and balances payable		9,077		7,079
Premiums payable		6,587		6,351
Accrued expenses and other liabilities		54,194		51,553
Surplus notes		12,000		12,000
Total liabilities	$	745,338	$	725,327



Stockholders’ equity:
Series A preferred stock, $0.01 par value; 750,000 shares authorized; no shares issued and outstanding		−		−
Undesignated preferred stock, $0.01 par value; 10,000,000 shares authorized; no shares issued and outstanding		–		–
Common stock, $0.01 par value; 75,000,000 shares authorized; issued and outstanding – 22,459,963 shares at September 30, 2012 and 22,327,749 shares at December 31, 2011		225		223
Paid-in capital		216,318		213,746
Accumulated other comprehensive income		23,430		23,269
Retained earnings		119,237		111,731
Total stockholders’ equity		359,210		348,969
Total liabilities and stockholders’ equity	$	1,104,548	$	1,074,296

	Three Months Ended September 30,						Nine Months Ended September 30,
	2012			2011			2012			2011
				(as adjusted)						(as adjusted)
	(in thousands, except share and per share information)
Revenue:
Premiums earned	$	63,291		$	63,994		$	179,008		$	182,812
Claims service income		437			340			963			976
Net investment income		4,375			5,161			13,824			15,833
Net realized gains		37			256			10,099			663
Other income		1,121			1,044			3,005			3,338
Total revenue		69,261			70,795			206,899			203,622
Losses and expenses:
Loss and loss adjustment expenses		46,532			48,636			133,211			164,559
Underwriting, acquisition and insurance expenses		17,673			18,355			51,317			56,459
Interest expense		137			131			409			390
Other expenses		3,340			2,012			7,765			6,059
Total losses and expenses		67,682			69,134			192,702			227,467
Income (loss) before taxes		1,579			1,661			14,197			(23,845	)

Income tax expense (benefit)		183			93			3,325			(9,613	)
Net income (loss)	$	1,396		$	1,568		$	10,872		$	(14,232	)

Other comprehensive income:
Net unrealized gains on investment securitiesavailable for sale		6,288			13,254			10,349			22,840
Less: Reclassification adjustment for net realized gains recorded into net income gains recorded into net income		(37	)		(256	)		(10,099	)		(663	)
Income tax expense related to items of other comprehensive income comprehensive income		(2,207	)		(4,621	)		(89	)		(7,898	)
Other comprehensive income		4,044			8,377			161			14,279
Comprehensive income	$	5,440		$	9,945		$	11,033		$	47

Basic earnings (loss) per share	$	0.07		$	0.07		$	0.51		$	(0.67	)
Diluted earnings (loss) per share	$	0.06		$	0.07		$	0.50		$	(0.67	)

Dividends declared per share	$	0.05		$	0.05		$	0.15		$	0.15

Weighted average basic shares outstanding		21,414,423			21,179,035			21,325,918			21,102,373
Weighted average diluted shares outstanding		22,027,281			21,734,789			21,886,547			21,102,373

	Nine Months Ended September 30,
	2012			2011
				(As adjusted)
	(in thousands)

Cash flows from operating activities:
Net income (loss)	$	10,872		$	(14,232	)
Adjustments to reconcile net income (loss) to cash provided by operating activities:
Amortization of deferred policy acquisition costs		24,601			27,217
Policy acquisition costs deferred		(23,223	)		(24,872	)
Depreciation and amortization		7,837			6,427
Compensation cost on restricted shares of common stock		2,766			3,278
Compensation cost on stock options		389			514
Net realized gain on investments		(10,099	)		(663	)
Deferred income tax benefit		(452	)		(4,267	)
Changes in certain assets and liabilities:
Unpaid loss and loss adjustment expense		19,456			61,977
Federal income tax recoverable		7,391			(889	)
Reinsurance recoverables, net of reinsurance withheld		(13,327	)		(31,557	)
Unearned premiums, net of deferred premiums and premiums receivable		1,059			(2,499	)
Accrued investment income		512			791
Other assets and other liabilities		1,179			(4,003	)
Net cash provided by operating activities		28,961			17,222

Cash flows from investing activities:
Purchases of investments		(251,662	)		(112,796	)
Sales of investments		191,100			74,758
Maturities and redemption of investments		59,289			41,581
Purchases of property and equipment		(978	)		(1,296	)
Net cash (used in) provided by investing activities		(2,251	)		2,247

Cash flows from financing activities:
Proceeds from exercise of stock options		225			-
Stockholder dividends paid		(3,344	)		(3,336	)
Grant of restricted shares of common stock		2			5
Surrender of stock in connection with restricted stock vesting		(810	)		(897	)
Net cash used in financing activities		(3,927	)		(4,228	)

Net increase in cash and cash equivalents		22,783			15,241
Cash and cash equivalents at beginning of period		28,503			15,958
Cash and cash equivalents at end of period	$	51,286		$	31,199

Supplemental disclosures:
Interest paid on surplus notes	$	408		$	390
Federal income taxes paid		3,500			-
Federal income taxes recovered		7,018			4,470
Accrual for unsettled purchases of investments		1,988			6,309
Receivable from sale of investments		-			3,415

The accompanying unaudited condensed consolidated financial statements include the accounts of SeaBright Holdings, Inc. (“SeaBright”) and its wholly owned subsidiaries, SeaBright Insurance Company (“SBIC”), PointSure Insurance Services, Inc. (“PointSure”), and Paladin Managed Care Services, Inc. (“PMCS”) (collectively, the “Company,” “we” or “us”). All significant intercompany transactions among these affiliated entities have been eliminated in consolidation.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. The condensed consolidated balance sheet at December 31, 2011 has been derived from the audited financial statements at that date but does not include all of the information and notes required by GAAP for complete financial statements. The 2011 financial statements have been revised to reflect the impact of retrospective adoption on January 1, 2012 of Accounting Standards Update (“ASU”) 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. See Note 2.e. for additional disclosure regarding these adjustments. These unaudited condensed consolidated financial statements and notes should be read in conjunction with the audited financial statements and accompanying notes as of and for the year ended December 31, 2011 included in the Company’s Annual Report on Form 10-K, which was filed with the U.S. Securities and Exchange Commission (the “SEC”) on March 5, 2012.

The preparation of the consolidated financial statements in conformity with GAAP requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. The Company has used significant estimates in determining unpaid loss and loss adjustment expenses, including losses that have occurred but were not reported to us by the financial reporting date; the amount and recoverability of reinsurance recoverable balances; goodwill and other intangibles; retrospective premiums; earned but unbilled premiums; deferred policy acquisition costs; income taxes; and the valuation and other-than-temporary impairments of investment securities.

On August 7, 2012, the Company’s Board of Directors declared a quarterly dividend of $0.05 per common share. The dividend was paid on October 15, 2012 to stockholders of record on October 1, 2012. Any future determination to pay cash dividends on the Company’s common stock will be at the discretion of its Board of Directors and will be dependent on the Company’s earnings; financial condition; operating results; capital requirements; any contractual, regulatory or other restrictions on the payment of dividends by the Company’s subsidiaries; and other factors that the Company’s Board of Directors deems relevant. Pursuant to the terms of the Merger Agreement described in Note 3. Merger Agreement below, the Company has agreed not to declare, set aside, make or pay any dividend without the prior consent of Enstar. See Note 3 for additional disclosure regarding the Merger Agreement.

In July 2012, the Financial Accounting Standards Board (the “FASB”) issued ASU 2012-02, Intangibles—Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment, to simplify the guidance for testing the decline in the realizable value (impairment) of indefinite-lived intangible assets other than goodwill. Under this update, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of an intangible asset is less than its carrying amount. If such a determination is not reached, then performance of further impairment testing is not necessary. The new guidance is effective for annual and interim goodwill tests performed for fiscal years beginning after September 15, 2012. However, early adoption is permitted. The adoption of ASU 2012-02 is not expected to have a material effect on the Company’s consolidated financial condition or results of operations.

In October 2010, the FASB issued ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. This ASU allows insurance entities to defer only direct incremental costs associated with successful insurance contract acquisitions or renewals. All other costs related to the acquisition of new or renewal insurance contracts are required to be expensed as incurred. The Company adopted this guidance retrospectively effective January 1, 2012 and has adjusted its previously issued financial information.

	As Previously Reported		Effect of Change			As Currently Reported
	(in thousands)
December 31, 2011:
Deferred policy acquisition costs, net	$	21,834	$	(6,990	)	$	14,844
Deferred income taxes, net		19,233		2,448			21,681
Retained earnings		116,273		(4,542	)		111,731
Total stockholders’ equity		353,511		(4,542	)		348,969

December 31, 2010:
Retained earnings	135,265	(4,487	)	130,778
Total stockholders’ equity	351,017	(4,487	)	346,530

	As Previously Reported		Effect of Change			As Currently Reported
	(in thousands)
Three Months Ended September 30, 2011:
Underwriting, acquisition and insurance expenses	$	18,261	$	94		$	18,355
Income tax expense		126		(33	)		93
Net income		1,629		(61	)		1,568
Basic earnings per share		0.08		(0.01	)		0.07
Diluted earnings per share		0.07		0.00			0.07

Nine Months Ended September 30, 2011:
Underwriting, acquisition and insurance expenses	$	56,003		$	456		$	56,459
Income tax expense (benefit)		(9,454	)		(159	)		(9,613	)
Net income (loss)		(13,935	)		(297	)		(14,232	)
Basic earnings (loss) per share		(0.66	)		(0.01	)		(0.67	)
Diluted earnings (loss) per share		(0.66	)		(0.01	)		(0.67	)

On August 27, 2012, the Company entered into an agreement and plan of merger (“Merger Agreement”) with Enstar Group Limited, a Bermuda exempted company (“Enstar”), and AML Acquisition, Corp., a Delaware corporation and wholly owned subsidiary of Enstar (“Merger Sub”), pursuant to which Merger Sub will merge with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly owned subsidiary of Enstar. At the effective time of the Merger, each share of Company common stock issued and outstanding immediately prior to the effective time (other than shares held in the Company’s treasury, shares held by Enstar, Merger Sub or any of their or the Company’s respective subsidiaries and shares held by stockholders of the Company who properly exercise appraisal rights under Delaware law) will be automatically cancelled and converted into the right to receive $11.11 in cash without interest.

The Merger is currently expected to close in the fourth quarter of 2012 or the first quarter of 2013. Consummation of the Merger is subject to customary closing conditions, including (i) approvals by the Company’s stockholders at a special meeting scheduled to be held on November 19, 2012, (ii) receipt of antitrust and insurance regulatory approvals and (iii) the absence of any law, order or injunction prohibiting the Merger. In addition, each party’s obligation to consummate the Merger is subject to (i) the accuracy of the other party’s representations and warranties (subject to customary materiality qualifiers) and (ii) the other party’s compliance with its covenants and agreements contained in the Merger Agreement (subject to customary materiality qualifiers). The Merger is not subject to any financing condition.

The Merger Agreement contains customary representations and warranties of the Company, Enstar and Merger Sub. The Merger Agreement also contains customary covenants and agreements, including with respect to the operation of the business of the Company and its subsidiaries between signing and closing, governmental filings and approvals, public disclosures and similar matters. In addition, the Company has agreed not to (i) solicit proposals relating to alternative business combination transactions and (ii) subject to certain exceptions, enter into discussions, or enter into any agreement concerning, or provide confidential information in connection with, any proposals for alternative business combination transactions.

The Merger Agreement provides for certain termination rights of each of Enstar and the Company, including the Company’s right to terminate the Merger Agreement under certain circumstances to enter into a definitive agreement providing for a “Superior Proposal.” In addition, the Merger Agreement provides that, in connection with the termination of the Merger Agreement under specified circumstances, including by Enstar if the Company’s Board of Directors makes an “Adverse Recommendation Change” or by the Company if the Company enters into a definitive agreement providing for a “Superior Proposal,” the Company may be required to pay Enstar a termination fee of $7.5 million.

During the three months ended September 30, 2012, the Company recorded approximately $1.5 million pre-tax (approximately $1.3 million after-tax) of costs in connection with the proposed Merger, and during the nine months ended September 30, 2012, the Company recorded approximately $1.8 million pre-tax (approximately $1.4 million after-tax) of costs in connection with the proposed Merger. These costs are included primarily in other expenses in the consolidated statements of operations and comprehensive income. See Note 8. Contingencies for a description of the pending litigation related to the Merger. See Part II, Item 1A. Risk Factors for additional risks and uncertainties related to the Merger.

	Cost or Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
	(in thousands)
September 30, 2012:
U.S. Treasury securities	$	29,261	$	1,613	$	(1	)	$	30,873
Government sponsored agency securities		32,920		1,004		-			33,924
Corporate securities		182,368		8,958		(94	)		191,232
Taxable municipal securities		24,467		1,936		-			26,403
Tax-exempt municipal securities		270,139		17,579		-			287,718
Mortgage pass-through securities		83,212		2,990		-			86,202
Collateralized mortgage obligations		8,166		56		(25	)		8,197
Asset-backed securities		44,347		699		(10	)		45,036
Total investment securities available for sale	$	674,880	$	34,835	$	(130	)	$	709,585

December 31, 2011:
U.S. Treasury securities	$	24,989	$	1,579	$	–		$	26,568
Government sponsored agency securities		15,567		1,330		–			16,897
Corporate securities		144,503		8,109		(578	)		152,034
Taxable municipal securities		22,622		1,573		–			24,195
Tax-exempt municipal securities		308,953		17,903		(1	)		326,855
Mortgage pass-through securities		77,532		3,399		–			80,931
Collateralized mortgage obligations		14,546		168		(54	)		14,660
Asset-backed securities		57,179		1,052		(25	)		58,206
Total investment securities available for sale	$	665,891	$	35,113	$	(658	)	$	700,346

The Company regularly reviews its investment portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of its investments. A number of 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 length of time the security’s fair value has been below amortized cost or cost; the likelihood that the Company will be required to sell the security before recovery of its cost basis; objective information supporting recovery in a reasonable period of time; specific credit issues related to the issuer; and current economic conditions. The Company has the ability and intent to hold impaired investments to maturity or for a period of time sufficient for recovery of their carrying amount. For the three month and nine month periods ended September 30, 2012 and 2011, the Company recognized no other-than-temporary impairment losses related to investments in debt securities.

	Less Than 12 Months					12 Months or More					Total
Investment Category	Aggregate Fair Value		Aggregate Unrealized Loss			Aggregate Fair Value		Aggregate Unrealized Loss			Aggregate Fair Value		Aggregate Unrealized Loss
						(in thousands)
U.S. Treasury securities	$	1,341	$	(1	)	$	-	$	-		$	1,341	$	(1	)
Corporate securities		14,363		(94	)		-		-			14,363		(94	)
Collateralized mortgage obligations		3,209		(10	)		262		(15	)		3,471		(25	)
Asset-backed securities		1,660		(2	)		1,245		(8	)		2,905		(10	)
Total	$	20,573	$	(107	)	$	1,507	$	(23	)	$	22,080	$	(130	)

	Insured Bonds				Uninsured Bonds		Total Municipal Portfolio (1) Based On
Rating	Insured Ratings		Underlying Ratings		Ratings		Overall Ratings (2)		Underlying Ratings
	(in thousands)
AAA	$	4,787	$	4,787	$	25,663	$	30,449	$	30,449
AA+		8,097		5,798		59,531		67,629		65,330
AA		10,316		11,001		68,503		78,819		79,504
AA-		26,732		23,325		42,962		69,694		66,287
A+		9,055		15,082		6,584		15,639		21,666
A		2,230		2,231		23,513		25,743		25,744
A-		2,017		1,010		6,032		8,049		7,042
BBB		-		-		3,010		3,010		3,010
Pre-refunded (3)		11,079		11,079		4,010		15,089		15,089
Total	$	74,313	$	74,313	$	239,808	$	314,121	$	314,121

On October 1, 2012, the Company extended the reinsurance agreements with nonaffiliated reinsurers that it entered into on October 1, 2011, wherein it retains the first $0.5 million of each loss occurrence. The next $0.5 million of losses per occurrence (excess of the first $0.5 million of losses per occurrence retained by the Company) are 50% reinsured. Losses in excess of $1.0 million per loss occurrence are fully reinsured through the program limit of $75.0 million per loss occurrence, subject to various deductibles, limitations and exclusions as more fully described in the treaties. The extended reinsurance program is effective through March 31, 2013, except that two reinsurers have extended their participation only through the earlier of the closing date of the Merger and December 31, 2012. The combined participation of these two reinsurers in the reinsurance layers is set forth below:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2012			2011			2012			2011
	(in thousands)
Beginning balance:
Unpaid loss and loss adjustment expense	$	527,086		$	490,929		$	518,044		$	440,919
Reinsurance recoverable		(106,824	)		(80,093	)		(93,710	)		(56,350	)
Net balance, beginning of period		420,262			410,836			424,334			384,569
Incurred related to:
Current period		46,945			46,354			134,622			133,921
Prior periods		(413	)		2,282			(1,411	)		30,638
Total incurred		46,532			48,636			133,211			164,559
Paid related to:
Current period		(10,515	)		(13,579	)		(20,733	)		(26,962	)
Prior periods		(30,475	)		(31,271	)		(111,008	)		(107,544	)
Total paid		(40,990	)		(44,850	)		(131,741	)		(134,506	)
Net balance, end of period		425,804			414,622			425,804			414,622
Reinsurance recoverable		111,696			88,274			111,696			88,274
Unpaid loss and loss adjustment expense	$	537,500		$	502,896		$	537,500		$	502,896

As a result of changes in estimates of insured events in prior periods, unpaid loss and loss adjustment expenses decreased by a net amount of approximately $0.4 million in the three months ended September 30, 2012 and approximately $1.4 million in the nine months then ended. The favorable development in the third quarter of 2012 included an increase in direct loss reserves of approximately $0.4 million, which was offset by approximately $0.8 million of net favorable development of other amounts such as unallocated loss adjustment expense (“ULAE”), loss based assessments and losses assumed from National Council on Compensation Insurance (“NCCI”) residual market pools.

a. SBIC is subject to guaranty fund and other assessments by the states in which it writes business. Guaranty fund assessments are accrued at the time premiums are written. Other assessments are accrued either at the time of assessment or in the case of premium-based assessments, at the time the premiums are written, or in the case of loss-based assessments, at the time the losses are incurred. As of September 30, 2012, SBIC had a liability for guaranty fund and other assessments of $7.4 million and a guaranty fund receivable of $6.1 million, which are reported as accrued expenses and other liabilities and other assets, respectively, in the accompanying condensed consolidated balance sheets. These amounts represent management’s best estimate based on information received from the states in which it writes business and may change due to many factors, including the Company’s share of the ultimate cost of current and future insolvencies. The majority of assessments are paid out in the year following the year in which the premium is written or the losses are paid. Guaranty fund receivables and other surcharge items are generally realized by a charge to new and renewing policyholders in the year following the year in which the related assessments were paid.

c. On April 17, 2012, the Company was notified by the Internal Revenue Service that it had commenced a routine examination of the consolidated federal income tax return of SeaBright Holdings, Inc. and Subsidiaries for the years ended December 31, 2010 and 2008. Management believes the outcome of this examination will not have a material adverse effect on the Company’s consolidated financial positions or results of operations. The Company is in the process of gathering and providing information in response to this examination.

d. On July 3, 2012, the Illinois Department of Insurance (the “DOI”) announced that it had entered an Agreed Order of Rehabilitation against Lumbermens Mutual Casualty Company (“LMC”) and an affiliated company, American Manufacturers Mutual Insurance Company. The companies had previously commenced a voluntary run-off plan in 2003 and had been operating under a run-off plan filed with and approved by the DOI since 2004. Under Illinois law, the DOI’s Director was appointed statutory rehabilitator of both companies involved. This restructuring, or run-off, involves taking over the affairs of a company but no longer taking on new obligations or issuing new or renewing policies. The Director is vested with title to the company’s property, assets, rights of action or lawsuits, books, records and premises. The Company is unable to predict what impact this Order of Rehabilitation might have on its business dealings with LMC, which include primarily an adverse development cover and related collateralized reinsurance trust, a claims administration services agreement and an administrative services agreement.

e. On September 13, 2012, a purported stockholder in the Company, Mitchell Daks, filed a lawsuit in the Superior Court of the State of Washington in and for the County of King against the Company, the members of the Company’s Board of Directors, and Merger Sub. On October 5, 2012, the plaintiff filed an amended complaint, along with a motion to expedite discovery and for a briefing and hearing schedule on the plaintiff’s anticipated motion for a temporary injunction. The amended complaint, which purports to be brought as a class action on behalf of all of the Company’s stockholders (except the defendants and their affiliates), alleges, among other things, that (1) the members of the board of directors breached their fiduciary duties to stockholders by failing to take steps to maximize the value of the Company, failing to properly value the Company, and ignoring or failing to protect against conflicts of interest, (2) the members of the board of directors also breached their fiduciary duties to stockholders by making materially inadequate disclosures and material disclosure omissions with regard to the merger, and (3) the Company and Merger Sub aided and abetted these alleged breaches of fiduciary duties by the Company’s directors. The amended complaint seeks to enjoin consummation of the merger, or, in the event the merger is completed, seeks to rescind the merger or recover money damages on behalf of the Company’s stockholders caused by alleged breaches of fiduciary duties. On October 11, 2012, the Company and John G. Pasqualetto, two of the defendants, filed an opposition to plaintiff’s motion for expedited discovery and for a briefing and hearing schedule on the plaintiff’s anticipated motion for a temporary injunction. On October 12, 2012, the plaintiff filed a reply. The motion remains pending.

On September 20, 2012, a purported stockholder in the Company, Craig Lochner, filed a lawsuit in the Court of Chancery for the State of Delaware against the Company, the members of the Company’s Board of Directors, Enstar and Merger Sub. The complaint, which purports to be brought as a class action on behalf of all of the Company’s stockholders (except the defendants and their affiliates, immediate families, legal representatives, heirs, successors or assigns and any entity in which defendants have or had a controlling interest), alleges, among other things, that (1) the members of the board of directors violated their fiduciary duties because they failed to take steps to maximize the value of the Company to its public stockholders and took steps to avoid competitive bidding and they failed to properly value the Company, and (2) the Company, Enstar and Merger Sub aided and abetted these alleged breaches of fiduciary duties by the Company’s directors. The complaint seeks to enjoin the consummation of the merger, or in the event the merger is completed, seeks to rescind the merger or recover money damages on behalf of the Company’s stockholders caused by alleged breaches of fiduciary duties. On September 26, 2012, the Company and the director defendants filed an answer to the complaint and a motion for judgment on the pleadings.

9. Share-Based Payment Arrangements

At September 30, 2012, the Company had outstanding stock options and nonvested restricted stock granted according to the terms of two equity incentive plans. The stockholders and Board of Directors approved the 2003 Stock Option Plan (the “2003 Plan”) in September 2003, and amended and restated the 2003 Plan in February 2004 and April 2008, and approved the 2005 Long-Term Equity Incentive Plan (the “2005 Plan” and, together with the 2003 Plan, the “Stock Option Plans”) in December 2004, and amended and restated the 2005 Plan in April 2007, May 2010 and April 2012.

At September 30, 2012, the Company reserved 776,458 shares of common stock for issuance under the 2003 Plan, of which options to purchase 479,946 shares had been granted, and 3,952,105 shares for issuance under the 2005 Plan, of which 3,222,219 shares had been granted. In January 2006, the Compensation Committee of the Board of Directors terminated the ability to grant future stock options awards under the 2003 Plan. Under the terms of the Merger Agreement described in Note 3. Merger Agreement above, no further awards will be granted under the Stock Option Plans prior to the closing of the Merger or termination of the Merger Agreement without the approval of Enstar. The Company will terminate the Stock Options Plans and outstanding unvested awards will become fully vested at the effective time of the Merger.

	Shares Subject to Options			Weighted Average Exer- cise Price per Share		Weighted Average Re- maining Con- tractual Life (years)		Aggregate Intrinsic Value (in thousands)
Outstanding at December 31, 2011		1,474,040		$	10.94		5.1	$	404
Granted		43,838			8.49		−		−
Forfeited		(5,812	)		9.75		−		−
Exercised		(27,226	)		8.27		−		−
Cancelled		(24,222	)		13.88		−		−
Outstanding at September 30, 2012		1,460,618			10.88		4.5		2,155

Exercisable at September 30, 2012		1,190,217			11.08		3.7		1,881

As of September 30, 2012, there was approximately $0.7 million of total unrecognized compensation cost related to stock options granted under the 2005 Plan. In the normal course, that cost would be expected to be recognized over a weighted-average period of approximately 2.1 years, but is subject to acceleration upon closing of the Merger. At the effective time of the Merger described in Note 3. Merger Agreement above, each outstanding option to purchase shares of the common stock of the Company granted under the Stock Option Plans that is outstanding and unexercised, whether or not vested or exercisable, will become fully vested and exercisable. In addition, at the effective time of the Merger, the Company will cancel each outstanding and unexercised stock option granted under the Stock Option Plans, and each holder of an applicable option will receive a per share amount in cash equal to the excess, if any, of the per share merger consideration over the applicable per share exercise price of such stock option, less any applicable withholding taxes.

In March 2012, the Company granted, for the first time, shares of performance-based restricted stock to certain executives of the Company. These performance-based shares, which totaled 145,715, were issued under the 2005 Plan and will vest in varying amounts if the Company’s tangible book value per share, adjusted to exclude unrealized gains and losses and adjusted for dividends and share repurchases, as of December 31, 2012, equals or exceeds certain levels of improvement. The number of shares granted was based upon achievement of the target level of improvement, at which 100% will vest. The actual level of achievement of the performance-based goal was to be determined using the Company’s consolidated GAAP financial statements as of and for the year ending December 31, 2012, ranging from 50% of target at the threshold level to 200% of target at the maximum improvement level. If the threshold level of improvement is not achieved, all performance-based awards would be forfeited. Any shares that are earned through achievement of the performance-based goal were to vest in three equal installments on the following dates: the date in early 2013 on which the Company publicly releases its results for fiscal year 2012; December 31, 2013; and December 31, 2014. Grantees must remain employed in good standing by the Company at the vesting dates in order to receive the vested shares. Because the Company’s restricted stock awards do not qualify as liability awards under the FASB Accounting Standards Codification (“ASC”) Topic 718, Compensation – Stock Compensation, they are accounted for as equity awards.

As of September 30, 2012, there was approximately $4.4 million of total unrecognized compensation cost related to restricted stock granted under the 2005 Plan. In the normal course, that cost would be expected to be recognized over a weighted-average period of approximately 1.7 years, but is subject to acceleration upon closing of the Merger. At the effective time of the Merger, each issued and outstanding share of restricted stock of the Company will be canceled and converted automatically into the right to receive the per share merger consideration, less any applicable withholding taxes.

In April 2012, the Company granted, for the first time, restricted stock units (“RSUs”) to certain employees. Unlike restricted stock awards, RSUs do not represent shares of equity ownership in the Company, either at the grant date or upon vesting. Within 30 days following vesting, each RSU will be settled in cash based on the closing price of SeaBright’s common stock as reported on the New York Stock Exchange (the “NYSE”) on the date of vesting, or on the last trading day prior to the date of vesting if vesting occurs on a date when the NYSE is closed for trading. The RSUs are all subject to cliff vesting on the third anniversary of the grant date (similar to restricted stock). Holders of RSUs will not receive dividends declared on SeaBright’s common stock, nor do they have any voting rights or other rights typically associated with equity ownership.

Because RSUs are settled in cash, they are required to be accounted for as liability awards and will be remeasured at each financial statement date using the closing price of SeaBright’s common stock at the end of the period, adjusted to account for the fact that RSU holders do not receive stockholder dividends. Compensation cost will be recognized using the proportionate amount of the awards’ fair value that has been earned through service to date.

As of September 30, 2012, there was approximately $0.5 million of total unrecognized compensation cost (based on per share merger consideration of $11.11 per share) related to RSUs granted under the 2005 Plan. In the normal course, that cost would be expected to be recognized over a weighted-average period of approximately 2.6 years, but is subject to acceleration upon closing of the Merger. At the effective time of the Merger, each RSU that is outstanding, whether or not vested, will be cancelled and converted automatically into the right to receive the per share merger consideration, less any applicable withholding taxes.

Estimated fair value amounts, defined as the exit price of willing market participants, have been determined using available market information and other appropriate valuation methodologies. However, considerable judgment is required in developing the estimates of fair value. Accordingly, these estimates are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions or estimating methodologies may have an effect on the estimated fair value amounts.

•

Investment securities: The Company measures and reports its financial assets and liabilities, including investment securities, in accordance with ASC Topic 820, Fair Value Measurements and Disclosures. The estimated fair values for available-for-sale securities are generally based on quoted market prices for securities traded in the public marketplace. The Company also considers the impact of a significant decrease in volume and level of activity for an asset or liability when compared with normal activity. Additional information with respect to fair values of the Company’s investment securities is disclosed in Note 4.

•

Level 2 — Valuations for assets and liabilities traded in less active dealer or broker markets. Level 2 valuations are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 2 includes government sponsored agency securities, corporate fixed-income securities, municipal bonds, mortgage pass-through securities, collateralized mortgage obligations and asset-backed securities.

•

Level 3 — Valuations for assets and liabilities that are derived from other valuation methodologies, including discounted cash flow models and similar techniques, and not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities. As of September 30, 2012, the Company had no Level 3 financial assets or liabilities.

	Total		Level 1		Level 2		Level 3
	(In thousands)
U.S. Treasury securities	$	30,873	$	30,873	$	−	$	−
Government sponsored agency securities		33,924		−		33,924		−
Corporate securities		191,232		−		191,232		−
Taxable municipal securities		26,403		−		26,403		−
Tax-exempt municipal securities		287,718		−		287,718		−
Mortgage pass-through securities		86,202		−		86,202		−
Collateralized mortgage obligations		8,197		−		8,197		−
Asset-backed securities		45,036		−		45,036		−
Total	$	709,585	$	30,873	$	678,712	$	−

	Total		Level 1		Level 2		Level 3
	(In thousands)
U.S. Treasury securities	$	26,568	$	26,568	$	−	$	−
Government sponsored agency securities		16,897		−		16,897		−
Corporate securities		152,034		−		152,034		−
Taxable municipal securities		24,195				24,195
Tax-exempt municipal securities		326,855		−		326,855		−
Mortgage pass-through securities		80,931		−		80,931		−
Collateralized mortgage obligations		14,660		−		14,660		−
Asset-backed securities		58,206		−		58,206		−
Total	$	700,346	$	26,568	$	673,778	$	−

Active markets are those in which transactions occur with sufficient frequency and volume to provide reliable pricing information on an ongoing basis. Inactive markets are those in which there are few transactions for the asset, prices are not current, price quotations vary substantially either over time or among market makers, or in which little information is released publicly. When the market for an investment is judged to be inactive, appropriate adjustments must be made to observable inputs to account for such inactivity. As of September 30, 2012, the Company’s investment portfolio consisted of securities that it considered to be traded in active markets. Therefore, no adjustment for market inactivity or illiquidity was necessary. There were no transfers between levels during the three months and nine months ended September 30, 2012.

The Company obtains fair value inputs for securities in its investment portfolio from independent, nationally recognized pricing services. The pricing services utilize multidimensional pricing models that vary by asset class and incorporate relevant inputs such as available trade, bid and quote market data for identical or similar instruments, model-based valuation techniques for which significant assumptions were observable and other market information to arrive at a fair value price for each security. This process takes into consideration the relevance of observable inputs based on factors such as the level of trading activity and the volume and currency of available prices and includes appropriate adjustments for nonperformance and liquidity risks.

The Company also seeks input from independent portfolio managers and financial advisors engaged by the Company to assist in the management and oversight of its investment portfolio. The Company and an independent portfolio manager engaged by the Company review such amounts for reasonableness in relation to the following considerations, among others: recent trades of a particular security; the Company’s independent observations of recent developments affecting the economy in general and certain issuers in particular; and fair values from other sources, such as statements from the Company’s custodial banks.

The Company holds a limited amount ($21.7 million at September 30, 2012) of privately placed corporate bonds and estimates the fair value of these bonds using an internal matrix that is based in part on market information regarding interest rates, credit spreads and liquidity. The pricing matrix begins with current U.S. Treasury rates and uses credit spreads received from third-party sources to estimate fair value. The Company includes the fair value estimates of these corporate bonds in Level 2, since all significant inputs are market observable. As some of these securities are issued by public companies, the Company compares the estimates of fair value to the fair values of these companies’ publicly traded debt to test the validity of the internal pricing matrix.

You should read the following discussion and analysis in conjunction with our unaudited condensed consolidated financial statements and the related notes thereto included in Item 1 of Part I of this quarterly report. The information contained in this quarterly report is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this quarterly report and in our other reports filed with the U.S. Securities and Exchange Commission (the “SEC”), including our Annual Report on Form 10-K for the year ended December 31, 2011 filed with the SEC on March 5, 2012.

The discussion under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011 and in this Quarterly Report on Form 10-Q, and similar discussions in our other SEC filings, describe some of the important risk factors that may affect our business, results of operations and financial condition. You should carefully consider those risks, in addition to the other information in this report and in our other filings with the SEC, before deciding to purchase, hold or sell our common stock.

Some of the statements in this Item 2 and elsewhere in this quarterly report may include forward-looking statements that reflect our current views with respect to future events and financial performance. These statements include forward-looking statements, both with respect to us specifically and the insurance sector in general, and include statements about our expectations for future periods with respect to completion of the Merger, our adverse development cover with Lumbermens Mutual Casualty Company (“LMC”) and our capital needs. Statements that include the words “expect,” “intend,” “plan,” “believe,” “project,” “estimate,” “may,” “should,” “anticipate,” “will” and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the federal securities laws or otherwise.

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

The foregoing factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this quarterly report. We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.

If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary materially from what we project. Any forward-looking statements you read in this quarterly report reflect our views as of the date of this quarterly report with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. Before making an investment decision, you should carefully consider all of the factors identified in this quarterly report that could cause actual results to differ.

Additional information concerning these and other factors is contained in our SEC filings, including, but not limited to, our 2011 Annual Report on Form 10-K. See Part II Item 1A. “Risk Factors” in this Quarterly Report on Form 10-Q for additional risks and uncertainties related to the pending merger with Enstar. If we consummate the Merger, we will become a wholly-owned subsidiary of Enstar. Accordingly, the remainder of the discussion in this “Management’s Discussion and Analysis of Financial Condition and Results of Operation” section, which assumes we remain a standalone business, should be read with the understanding that should the Merger be completed, Enstar will control the conduct of our business.

We are a holding company whose wholly-owned subsidiary, SeaBright Insurance Company, operates as a specialty provider of multi-jurisdictional workers’ compensation insurance. Through our other wholly-owned subsidiaries, PointSure Insurance Services, Inc. and Paladin Managed Care Services, Inc., we also provide related wholesale brokerage services and integrated managed medical care services. SeaBright Insurance Company is domiciled in Illinois, commercially domiciled in California and headquartered in Seattle, Washington. SeaBright Insurance Company is licensed in 49 states, the District of Columbia and Guam, to write workers’ compensation and other lines of insurance. Traditional underwriters of workers’ compensation insurance provide coverage to employers under one or more state workers’ compensation laws, which prescribe benefits that employers are obligated to provide to their employees who are injured arising out of or in the course of employment. We focus on employers with complex workers’ compensation exposures and provide coverage under multiple state and federal acts, applicable common law or negotiated agreements. We also provide traditional state act coverage in markets we believe are underserved. Our workers’ compensation policies are issued to employers who also pay the premiums.

Our operations and financial performance have been impacted by changes in the U.S. economy. The significant downturn in the U.S. economy from 2008 through 2010 led to lower reported payrolls, which has had a negative impact on our gross premiums written, and the recovery that began in 2010 has not resulted in a significant improvement in reported payrolls. The economic downturn had a particularly severe impact on the construction industry. When our customers reduce their workforce levels, the level of workers’ compensation insurance coverage they require and, as a result the premiums that we charge, are reduced, and if our customers cease operations, they may cancel or choose not to renew their policies. The economic downturn and high levels of unemployment have the effect of increasing claims and claim severity and duration, which drives up our medical, indemnity and litigation costs. The economic downturn has also diminished opportunities for injured workers to return to transitional, modified duty positions during their recoveries, which has lengthened the periods of their recoveries and increased our medical, indemnity and litigation costs, particularly in California. The longer a claim remains open, the more exposed we become to the effects of medical cost inflation. All of these factors have had, and could continue to have, a significant negative impact on our claims costs.

If we fail to accurately assess our future claims costs, our loss reserves may be inadequate to cover our actual losses. As discussed under “Management's Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies, Estimates and Judgments – Unpaid Loss and Loss Adjustment Expenses” in our 2011 Annual Report on Form 10-K, there are many variables that can impact the adequacy of our loss and loss adjustment expense liabilities and we continually refine our loss reserve estimates. Quarterly, management determines what, if any, adjustments to prior accident years’ loss reserves are necessary after considering the results of actuarial studies performed by internal and/or consulting actuaries; the impact of recent operational initiatives on our claims costs and loss reserves; discussions with key executives in Underwriting, Claims, and other relevant functional areas; changing environmental conditions; and other factors. In response to the factors described in the preceding paragraph, we strengthened our loss reserves for prior accident years by $31.4 million in 2011. We may ultimately conclude that our current estimate of loss reserves is inadequate, if the negative claim trends experienced over the last several years described above continue or worsen. Future adverse development could require us to increase our loss reserves, which could have a material adverse effect on our earnings and financial position in the periods in which such increases are made.

It is uncertain if economic conditions will deteriorate further, or when economic conditions will show significant improvement. If the recovery from the recent economic recession continues to be slow, or the recovery fails to positively impact employment levels, or if we experience another recession, it could further reduce payrolls and increase our claims costs, which could have a significant negative impact on our business, financial condition or results of operations.

On August 27, 2012, we entered into an agreement and plan of merger (the “Merger Agreement”) with Enstar Group Limited, a Bermuda corporation (“Enstar”), and AML Acquisition, Corp., a Delaware corporation and wholly owned subsidiary of Enstar (“Merger Sub”), pursuant to which, upon the terms and subject to the conditions set forth in the Merger Agreement, we will merge with and into Merger Sub (the “Merger”) with SeaBright surviving the Merger as a wholly owned subsidiary of Enstar. At the effective time of the Merger, each share of our common stock issued and outstanding immediately prior to the effective time (other than shares held in our treasury, shares held by Enstar, Merger Sub or any of their or our respective subsidiaries and shares held by stockholders who properly exercise appraisal rights under Delaware law) will be automatically cancelled and converted into the right to receive $11.11 in cash without interest. The Merger is currently expected to close in the fourth quarter of 2012 or the first quarter of 2013. Consummation of the Merger is subject to customary closing conditions, including (i) approvals by the Company’s stockholders at a special meeting scheduled to be held on November 19, 2012, (ii) receipt of antitrust and insurance regulatory approvals and (iii) the absence of any law, order or injunction prohibiting the Merger.

During the three months ended September 30, 2012, we recorded approximately $1.5 million pre-tax (approximately $1.3 million after-tax) of costs in connection with the proposed Merger, and during the nine months ended September 30, 2012, we recorded approximately $1.8 million pre-tax (approximately $1.4 million after-tax) of costs in connection with the proposed Merger. These costs are included in other expenses in the consolidated statements of operations and comprehensive income.

Our “core” product lines contributed $42.0 million, or 71.6%, of the total gross premiums written for the three months ended September 30, 2012 compared to $33.0 million, or 58.1%, in the same period of 2011. The increase in our core product lines was partially offset by a net $5.6 million decrease in our “Program Business,” which contributed $14.8 million of gross premiums written for the quarter ended September 30, 2012. Our Program Business includes alternative markets and small maritime and small energy programs. For the nine months ended September 30, 2012, our core product lines contributed $137.1 million, or 71.3%, of gross premiums written in the period, as compared to $128.0 million or 66.0% of gross premiums written in the same period in 2011. Our Program Business contributed $53.4 million, or 27.8%, of gross premiums written in the nine months ended September 30, 2012, a decrease of $9.1 million from the $62.5 million of gross premiums written in the same period in 2011.

Excluding work we perform as the servicing carrier for the Washington State USL&H Compensation Act Assigned Risk Plan (the “Washington USL&H Plan”), the total number of customers we serviced decreased from approximately 1,560 at September 30, 2011 to approximately 1,390 at September 30, 2012. The majority of the customer decrease was in our core business, which was partially offset by an increase of approximately 30 customers in our Program Business. By design, our Program Business will have a larger number of customers with a smaller average premium size than our core book of business. Our average premium size at September 30, 2012 was approximately $304,000 in our core business and approximately $84,000 in our Program Business, compared to approximately $256,000 in our core business and approximately $105,000 in our Program Business one year earlier.

Total in-force payrolls, a factor used in determining premiums charged, increased 1.5% from $6.6 billion at September 30, 2011 to $6.7 billion a year later. California continues to be our largest market, accounting for approximately $87.7 million, or 35.8%, of our in-force premiums at September 30, 2012. This represents a decrease of $55.2 million, or 38.6%, from approximately $142.9 million, or 50.6% of total in-force premiums in California at September 30, 2011.

Premiums assumed from the NCCI residual market pools for the three months ended September 30, 2012 totaled $0.9 million, which was essentially flat compared with the same period in 2011. For the nine months ended September 30, 2012, assumed premiums decreased $2.8 million, or 116.7%, to ($0.4) million from $2.4 million for the same period in 2011. The decrease for the nine months ended September 30, 2012 was primarily the result of true-ups of our actuarial estimates for prior policy years based on current NCCI data and reapportionment figures. The balance of our gross premiums written (consisting of Washington USL&H Plan, general liability and other miscellaneous amounts) for the three month and nine month periods ended September 30, 2012 totaled $1.0 million and $2.2 million, respectively, compared to $2.4 million and $1.2 million, respectively, in the same periods in 2011.

Net Premiums Written. Net premiums written totaled $51.6 million for the three months ended September 30, 2012 compared to $46.6 million in the same period in 2011, representing an increase of $5.0 million, or 10.7%. For the nine months ended September 30, 2012, net premiums written totaled $175.5 million, an increase of $11.2 million, or 6.8%, from $164.3 million in the same period of 2011. The increase in net premiums written was primarily attributable to a decrease in ceded premiums written of $13.0 million for the nine months ended September 30, 2012 as a result of a lower ceding rate in our excess of loss reinsurance program that renewed in October 2011. Our ceding rate decreased by approximately 47% as a result of raising the attachment point from $0.25 million to $0.5 million and reducing maximum coverage from $100.0 million to $75.0 million. This decrease in ceded premiums was partially offset by the $1.8 million decrease for the nine months ended September 30, 2012 in gross premiums written.

In connection with the extension of our reinsurance program through March 31, 2013, the ceding rate on the $0.5 million in excess of $0.5 million layer increased by 25%, effective back to the October 1, 2011 inception date of the program. This coverage is more in line with historical levels. Two reinsurers have extended their participation only through the earlier of the closing date of the Merger and December 31, 2012. See Note 6 in Part I, Item 1 for a discussion of the extension of our October 1, 2011 reinsurance program through various dates.

Net Premiums Earned. Net premiums earned totaled $63.3 million for the three months ended September 30, 2012 compared to $64.0 million for the same period in 2011, representing a decrease of $0.7 million, or 1.1%. For the nine months ended September 30, 2012, net premiums earned totaled $179.0 million, a decrease of $3.8 million, or 2.1%, from $182.8 million in the same period of 2011. We record the entire annual policy premium as unearned premium when written and earn the premium over the life of the policy, which is generally twelve months. Consequently, the amount of premiums earned in any given year depends on when during the current or prior year the underlying policies were written and the actual reported payroll of the underlying policies. Our direct premiums earned totaled $69.9 million for the three months ended September 30, 2012, a decrease of $3.4 million, or 4.6%, from $73.3 million for the same period in 2011. Our direct premiums earned totaled $196.3 million for the nine months ended September 30, 2012, a decrease of $13.5 million, or 6.4%, from $209.8 million for the same period in 2011.

Net premiums earned are also affected by premiums ceded under reinsurance agreements. Ceded premiums earned for the three months ended September 30, 2012 totaled $7.9 million compared to $10.6 million for the same period in 2011, representing a decrease of $2.7 million, or 25.5%. Ceded premiums earned for the nine months ended September 30, 2012 totaled $17.0 million compared to $29.9 million for the same period in 2011, representing a decrease of $12.9 million, or 43.1%. This decrease was primarily attributable to lower ceding rates under our October 2011 reinsurance program. The decrease in ceded premiums earned was offset by a decrease in premiums assumed from the NCCI for residual market business. Assumed premiums earned decreased $3.2 million from $2.9 million for the nine months ended September 30, 2011 to ($0.3) million in the same period in 2012. This decrease was primarily due to true-ups of our actuarial estimates for prior policy years based on current NCCI data and reapportionment figures.

Net Investment Income. Net investment income was $4.4 million for the three months ended September 30, 2012 compared to $5.2 million for the same period in 2011, representing a decrease of $0.8 million, or 15.2%. Net investment income was $13.8 million for the nine months ended September 30, 2012, compared to $15.8 million for the same period in 2011, representing a decrease of $2.0 million, or 12.7%. Average invested assets were $755.5 million for the three months ended September 30, 2012, an increase of $45.1 million, or 6.3%, from $710.4 million for the same period in 2011. For the nine months ended September 30, 2012, average invested assets increased $39.9 million, or 5.7%, from $705.0 million in 2011 to $744.9 million in 2012. Our yield on average invested assets decreased from approximately 2.9% for the three months ended September 30, 2011 to approximately 2.3% for the same period in 2012, driven mainly by reduced reinvestment rates and sales of higher-yielding investment securities. For the nine months ended September 30, 2012, our yield on average invested assets was 2.5% compared to approximately 3.0% for the same period in 2011.

Net Realized Gains. Net realized gains totaled $37,000 for the three months ended September 30, 2012 compared to $0.3 million for the same period in 2011. For the nine months ended September 30, 2012, net realized gains totaled $10.1 million compared to $0.7 million in the same period of 2011. The increase in net realized gains for the nine months ended September 30, 2012 resulted from the sale of investment securities in order to reduce exposure to interest rate risk and realize our tax capital loss carry forwards. The majority of proceeds from these sales were reinvested in taxable securities in a continuing effort to shorten the overall portfolio duration and reduce the municipal exposure.

Other Income. Other income totaled $1.1 million for the three months ended September 30, 2012 compared to $1.0 million for the same period in 2011, representing an increase of $0.1 million, or 7.4%. For the nine months ended September 30, 2012, other income totaled $3.0 million compared to $3.3 million in the same period of 2011, representing a decrease of $0.3 million, or 10.0%. Other income is derived primarily from the operations of PointSure, our wholesale insurance broker, and PMCS, our provider of medical bill review, utilization review, nurse case management and related services.

Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses totaled $46.5 million for the three months ended September 30, 2012 compared to $48.6 million for the same period in 2011, representing a decrease of $2.1 million, or 4.3%. For the nine months ended September 30, 2012, loss and loss adjustment expenses totaled $133.2 million, compared to $164.6 million for the same period in 2011, representing a decrease of $31.3 million, or 19.0%. Our net loss ratio, which is calculated by dividing loss and loss adjustment expenses less claims service income by premiums earned, for the three months ended September 30, 2012 was 72.8% compared to 75.5% for the same period in 2011. Our net loss ratio for the nine months ended September 30, 2012 was 73.9% compared to 89.5% for the same period in 2011. The decrease in our net loss ratio for the three months ended September 30, 2012 was primarily attributable to $0.4 million of favorable development of prior accident years’ loss reserves recorded in the three months ended September 30, 2012 compared with $2.8 million of net adverse development in the three months ended September 30, 2011. Net favorable development of prior years’ reserves in the nine months ended September 30, 2012 totaled $1.4 million compared to $31.2 million adverse development in the same period of 2011.

As discussed under the heading “Critical Accounting Policies, Estimates and Judgments – Unpaid Loss and Loss Adjustment Expenses – Actuarial Loss Reserve Estimation Methods” in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2011, we use an expected loss ratio (“ELR”) method to establish the loss reserves for the current accident year. Once the accident year is complete and begins to age, the ELR method is blended with the actual paid and incurred loss development to determine the revised estimated ultimate losses for the accident year.

Accident year 2012 is incomplete, as only nine months of the year have been earned as of September 30, 2012. An ELR was established for each jurisdiction and type of loss (indemnity, medical, ALAE) and was multiplied by the booked accident year earned premium to produce the ultimate losses to date. The ELR selections are reviewed quarterly with each internal reserve study. Given the short experience period for the current accident year, the ELRs are usually maintained at least through the first 12 months of the accident year and revised thereafter as the underlying data matures. The net ELR used in the first nine months of 2012 was 65.0%, compared to 62.5% used for the 2011 accident year in the same period last year. The 2011 net ELR was subsequently increased to 65.0% in the fourth quarter of 2011, after reviewing the year-to-date results for the 2011 accident year and considering the adverse development in recent accident years. The 2012 accident year ELR takes into consideration the following factors, among others: the development of recent accident years, the impact of recent rate increases, and provisions of the excess-of-loss reinsurance treaty that we entered into on October 1, 2011.

For prior accident years, the net ultimate loss estimates at September 30, 2012 were lower when compared to June 30, 2012 and resulted in a net decrease of $0.4 million in our loss reserves in the third quarter of 2012, compared to a net increase of $2.8 million recorded in the same period of last year. Adverse development of prior year direct loss reserves totaled $0.4 million and was offset by $0.8 million of net favorable development of other amounts such as ULAE, loss based assessments and losses assumed from the NCCI pools. In the three months ended September 30, 2011, we increased our loss reserves by a net amount of $2.3 million. Adverse development of prior year direct loss reserves totaled $3.0 million and related to accident year 2010. This adverse development was partially offset by $0.2 million of net favorable development of ULAE, loss based assessments and NCCI pool reserves and a reinsurance commutation gain of $0.5 million.

As of September 30, 2012, we had recorded a receivable of approximately $3.1 million for KEIC loss development under the adverse development cover we entered into with LMC on September 30, 2003, the date we acquired KEIC from LMC. This receivable is reported as other assets in the accompanying condensed consolidated balance sheets. At September 30, 2012, we had access to approximately $3.1 million under the related collateralized reinsurance trust in the event that LMC fails to satisfy its obligations under the adverse development cover. December 31, 2011 was the date as of which the parties are to settle amounts due under the adverse development cover. We are currently working through the final settlement of the receivable from LMC. For an update regarding the status of LMC, see the discussion under Note 8.d., “Contingencies” in Item 1 of Part I of this Quarterly Report on Form 10-Q.

Underwriting, Acquisition and Insurance Expenses. Underwriting expenses totaled $17.7 million for the three months ended September 30, 2012, compared to $18.4 million for the same period in 2011, representing a decrease of $0.7 million, or 3.7%. For the nine months ended September 30, 2012, underwriting expenses totaled $51.3 million, a decrease of $5.2 million, or 9.1%, from $56.5 million in the same period of 2011. Our net underwriting expense ratio, which is calculated by dividing underwriting, acquisition and insurance expenses by premiums earned, for the three months ended September 30, 2012 was 27.9%, compared to 28.7% for the same period in 2011. For the nine months ended September 30, 2012, our net underwriting expense ratio was 28.7%, compared to 30.9% in the same period of 2011. The primary driver of the decreases in underwriting expenses was a reduction in commission expense, of which approximately $1.0 million resulted from true-ups of our actuarial estimates of commissions assumed from the NCCI pools for prior policy years. Direct commission expense for the nine months ended September 30, 2012 decreased approximately $2.5 million from the same period in 2011 due to a change in product mix and lower commission rates.

Revenue from the work we perform as the servicing carrier for the Washington USL&H Plan totaled approximately $0.3 million in the three months ended September 30, 2012, and approximately $1.0 million in the nine months then ended and is netted against our underwriting, acquisition and insurance expenses. The current servicing carrier contract expires at the end of this year. We had previously been awarded the servicing carrier contract for the five-year contract period beginning January 1, 2013. However, in light of our pending merger with Enstar, that contract has now been awarded to another insurance company. Although we will continue to receive claims handling fees for claims incurred through December 31, 2012, the total amount of servicing carrier income we receive after December 31, 2012 will be reduced significantly.

Interest Expense. Interest expense related to the surplus notes issued by our insurance subsidiary in May 2004 totaled $137,000 for the three months ended September 30, 2012, compared to $131,000 for the same period in 2011, representing an increase of $6,000, or 4.6%. For the nine months ended September 30, 2012, interest expense totaled $409,000, an increase of $19,000, or 4.9%, from $390,000 in the same period of 2011. The surplus notes interest rate, which is calculated at the beginning of each interest payment period using the 3-month LIBOR plus 400 basis points, was 4.4% at September 30, 2012 as compared to 4.3% at September 30, 2011.

Other Expenses. Other expenses totaled $3.3 million for the three months ended September 30, 2012 compared to $2.0 million for the same period in 2011, representing an increase of $1.3 million, or 66.0%. For the nine months ended September 30, 2012, other expenses totaled $7.8 million compared to $6.1 million in the same period of 2011. Other expenses result primarily from the operations of PointSure and PMCS, which together accounted for approximately $2.0 million and $5.3 million of expenses for the three months and nine months ended September 30, 2012, respectively, compared to approximately $1.5 million and $4.9 million for the same periods in 2011, respectively. Other expenses also included approximately $1.5 million and $1.8 million of expenses for the three months and nine months ended September 30, 2012, respectively, related to the pending merger with Enstar, primarily legal costs.

Income Tax Expense. The effective tax rate for the three months ended September 30, 2012 was 11.6%, compared to 5.6% for the same period in 2011. The effective tax rate for the nine months ended September 30, 2012 was 23.4% compared to 40.3% in the same period of 2011. Our effective tax rate differed from the statutory tax rate of 35.0% primarily as a result of tax exempt interest income. At September 30, 2012, approximately 40.5% of our investment portfolio was invested in tax exempt municipal bonds, compared to approximately 45.2% at September 30, 2011.

Net Income (Loss). Net income was $1.4 million for the three months ended September 30, 2012, compared to $1.6 million for the same period in 2011. Net income for the nine months ended September 30, 2012 totaled $10.9 million, a difference of $25.1 million from a net loss of $14.2 million in the same period of 2011. The decrease in net income for the three months ended September 30, 2012 was primarily the result of an increase in other expenses. The increase in net income for the nine months ended September 30, 2012 was primarily the result of a decrease in loss and loss adjustment expenses and an increase in net realized gains.

Our investment portfolio is structured so that investments mature periodically over time in reasonable relation to current expectations of future claim payments. Since we have limited claims history, we have derived our expected future claim payments from industry and predecessor trends. Our investment portfolio as of September 30, 2012 had an effective duration of 4.0 years with individual maturities extending out to 29 years. Currently, we make claim payments from positive cash flow from operations and invest excess cash in securities with appropriate maturity dates to balance against anticipated future claim payments. As these securities mature, we intend to invest any excess funds in investments with appropriate durations to match against expected future claim payments.

At September 30, 2012, our investment portfolio consisted of investment-grade fixed income securities with fair values subject to fluctuations in interest rates, as well as other factors such as credit. All of the securities in our investment portfolio are accounted for as “available for sale” securities. While we have structured our investment portfolio to provide an appropriate matching of maturities with anticipated claim payments, if we decide or are required in the future to sell securities in a rising interest rate environment, we would expect to incur losses from such sales.

Our ability to adequately provide funds to pay claims depends on our underwriting and pricing standards and the purchase of reinsurance to protect us against severe claims and catastrophic events. Effective October 1, 2011, our reinsurance program provides for retention of the first $0.5 million of each loss occurrence. The next $0.5 million of losses per occurrence (excess of the first $0.5 million of losses retained by us) are 50% reinsured. Losses in excess of $1.0 million per loss occurrence are fully reinsured through the program limit of $75.0 million per loss occurrence, subject to various deductibles, limitations and exclusions as more fully described in the treaties. See Note 6 in Part I, Item 1 for a discussion of the extension of our October 1, 2011 reinsurance program through various dates. Given industry and predecessor trends, we believe we are sufficiently capitalized to cover our retained losses.

SeaBright is a holding company with minimal unconsolidated revenue. As SeaBright has capital needs in the future, we anticipate that it will be necessary for our insurance subsidiary to pay dividends to SeaBright. Our insurance subsidiary is required by law to maintain a certain minimum level of surplus on a statutory basis. The payment of such dividends will be regulated as described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of Part II of our Annual Report on Form 10-K for the year ended December 31, 2011.

Under the Merger Agreement, we are prohibited from making any material commitments of capital outside of the normal course of business or assuming any indebtedness. This prohibition includes, but is not limited to, issuing or granting new shares of stock, repurchasing outstanding shares of stock, borrowing money, declaring or paying dividends, and making material purchases of capital assets. For more information, please refer to our Current Report on Form 8-K filed with the SEC on August 28, 2012 and the Definitive Proxy Statement on Schedule 14A filed with the SEC on October 16, 2012.

It is important to understand our accounting policies in order to understand our financial statements. Management considers some 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. Some of the estimates result from judgments that can be subjective and complex, and consequently, actual results reflected in future periods might differ from these estimates.

The most critical accounting policies involve the reporting of unpaid loss and loss adjustment expenses including losses that have occurred but were not reported to us by the financial reporting date, the amount and recoverability of reinsurance recoverable balances, deferred policy acquisition costs, income taxes, the valuation of goodwill, the impairment of investment securities, earned but unbilled premiums and retrospective premiums. These critical accounting policies are described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of Part II of our Annual Report on Form 10-K for the year ended December 31, 2011.

On July 21, 2010, the President signed into law the Dodd Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which has significant implications for the insurance industry. In addition to imposing a number of new compliance obligations on publicly traded companies, the Dodd-Frank Act established the Financial Services Oversight Council (“FSOC”), which is authorized to recommend that certain systemically significant non-bank financial companies, including insurance companies, be regulated by the Board of Governors of the Federal Reserve. The Dodd-Frank Act also created within the United States Department of the Treasury a new Federal Insurance Office (“FIO”) and authorizes the federal preemption of certain state insurance laws. The FSOC and the FIO are authorized to study, monitor and report to Congress on the U.S. insurance industry and the significance of global reinsurance to the U.S. insurance market. Many sections of the Dodd-Frank Act become effective over time, and certain provisions of the Dodd-Frank Act require the implementation of regulations that have not yet been adopted. The potential impact of the Dodd-Frank Act on the U.S. insurance industry is not clear. However, our business could be affected by changes to the U.S. system of insurance regulation or our designation or the designation of insurers or reinsurers with which we do business as systemically significant non-bank financial companies.

As previously disclosed, on July 29, 2011, we were notified by the Illinois Department of Insurance that our insurance subsidiary was due for a routine comprehensive examination of its condition and affairs as of and for the five year period ended December 31, 2010. The field work portion of the comprehensive financial examination began on August 29, 2011 and concluded this year. On June 29, 2012, the Illinois Director of Insurance officially adopted, without fines or penalties assessed, the Report of Examination prepared by the Illinois Department of Insurance. On July 9, 2012, we were notified by the Illinois Department of Insurance that due to concerns arising in connection with its December 31, 2010 examination, it intends to conduct an actuarial examination of our reserves for unpaid loss and loss adjustment expense as of December 31, 2011. That work has not yet commenced.

Credit risk is the potential economic loss principally arising from adverse changes in the financial condition of a specific debt issuer. We address this risk by investing generally in fixed-income securities which are rated “A” or higher by Standard & Poor’s or another major rating agency. We also independently, and through our outside investment managers, monitor the financial condition of all of the issuers of fixed-income securities in the portfolio. To limit our exposure to risk, we employ stringent diversification rules that limit the credit exposure to any single issuer or business sector.

We had fixed-income investments with a fair value of $709.6 million at September 30, 2012 and $700.3 million at December 31, 2011 that are subject to interest rate risk. We manage the exposure to interest rate risk through a disciplined asset/liability matching and capital management process. In the management of this risk, the characteristics of duration, credit and variability of cash flows are critical elements. These risks are assessed regularly and balanced within the context of the liability and capital position.

Under the supervision and with the participation of management, including our Chief Executive Officer and our Chief Financial Officer, we carried out an evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information we are required to disclose in reports that are filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms specified by the SEC and is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Daks v. SeaBright Holdings, Inc., et al. On September 13, 2012, a purported stockholder in our company, Mitchell Daks, filed a lawsuit in the Superior Court of the State of Washington in and for the County of King against our company, the members of our board of directors, and Merger Sub. On October 5, 2012, the plaintiff filed an amended complaint, along with a motion to expedite discovery and for a briefing and hearing schedule on the plaintiff’s anticipated motion for a temporary injunction. The amended complaint, which purports to be brought as a class action on behalf of all of our stockholders (except the defendants and their affiliates), alleges, among other things, that (1) the members of the board of directors breached their fiduciary duties to stockholders by failing to take steps to maximize the value of our company, failing to properly value our company, and ignoring or failing to protect against conflicts of interest, (2) the members of the board of directors also breached their fiduciary duties to stockholders by making materially inadequate disclosures and material disclosure omissions with regard to the merger, and (3) our company and Merger Sub aided and abetted these alleged breaches of fiduciary duties by our directors. The amended complaint seeks to enjoin consummation of the merger, or, in the event the merger is completed, seeks to rescind the merger or recover money damages on behalf of our stockholders caused by the alleged breaches of fiduciary duties. On October 11, 2012, our company and John G. Pasqualetto, two of the defendants, filed an opposition to plaintiff’s motion for expedited discovery and for a briefing and hearing schedule on the plaintiff’s anticipated motion for a preliminary injunction. On October 12, 2012, the plaintiff filed a reply. The motion remains pending.

Lochner v. Pasqualetto, et al. On September 20, 2012, a purported stockholder in our company, Craig Lochner, filed a lawsuit in the Court of Chancery for the State of Delaware against our company, the members of our board of directors, Enstar and Merger Sub. The complaint, which purports to be brought as a class action on behalf of all of our stockholders (except the defendants and their affiliates, immediate families, legal representatives, heirs, successors or assigns and any entity in which defendants have or had a controlling interest), alleges, among other things, that (1) the members of the board of directors violated their fiduciary duties because they failed to take steps to maximize the value of our company to its public stockholders and took steps to avoid competitive bidding and they failed to properly value our company, and (2) our company, Enstar and Merger Sub aided and abetted these alleged breaches of fiduciary duties by our directors. The complaint seeks to enjoin the consummation of the merger, or in the event the merger is completed, seeks to rescind the merger or recover money damages on behalf of our stockholders caused by the alleged breaches of fiduciary duties. On September 26, 2012, our company and the director defendants filed an answer to the complaint and a motion for judgment on the pleadings.

•

costs relating to the Merger Agreement, such as legal fees, must be paid by us even if the Merger is not completed, and we may be required to pay a termination fee of $7.5 million to Enstar under certain circumstances, or to reimburse Enstar for up to $1.0 million of its expenses if the Merger Agreement is terminated by us or by Enstar should our stockholders fail to adopt the Merger Agreement at the special meeting of stockholders.

Completion of the Merger is conditioned upon, among other matters, certain insurance regulatory approvals and antitrust clearance. Enstar and certain of its affiliates have filed applications for approvals with the California Department of Insurance and the Illinois Department of Insurance. There is no assurance that regulatory approvals will be obtained or that such approvals will not be materially conditioned or delayed. If these regulatory approvals are not obtained, or if they are materially conditioned or delayed, it could result in the termination of the Merger Agreement and abandonment of the Merger. If the Merger is not completed on a timely basis, or at all, our business could be adversely affected.

As a result of the uncertainty surrounding the conduct of our business following the completion of the Merger, we may lose key customers and business partners. For example, two reinsurers in our reinsurance program declined to extend their participation through March 31, 2013, and have extended their participation only through the earlier of the closing date of the Merger and December 31, 2012. In addition, our employees may be uncertain about their future roles and relationships with us following the completion of the Merger, which may adversely affect our ability to retain them. If we lose key customers, business partners and personnel as a result of uncertainties associated with the Merger, it could have a material adverse effect on our results of operations and our stock price.

If we fail to accurately assess the risks associated with the businesses we insure, our loss reserves may be inadequate to cover our actual losses and we may fail to establish appropriate premium rates. We establish loss reserves in our financial statements that represent an estimate of amounts needed to pay and administer claims with respect to insured events that have occurred, including events that have not yet been reported to us. Loss reserves are estimates and are inherently uncertain; they do not and cannot represent an exact measure of liability. Accordingly, our loss reserves may prove to be inadequate to cover our actual losses. Any changes in these estimates are reflected in our results of operations during the period in which the changes are made, with increases in our loss reserves resulting in a charge to our earnings and a reduction of our statutory surplus. For example, we increased loss reserves for prior accident years by approximately $30.9 million in 2011 and approximately $32.0 million in 2010. See the discussion under the heading “Loss Reserves” in Part I, Item 1 of our 2011 annual report on Form 10-K. On July 9, 2012, we were notified by the Illinois Department of Insurance, one of our two principal regulators, that due to concerns arising in connection with its December 31, 2010 examination, it intends to conduct an actuarial examination of our reserves for unpaid loss and loss adjustment expense as of December 31, 2011. That work has not yet commenced. We cannot assure you that the examination will not result in future increases of our loss reserve estimates.

Our loss reserve estimates are based on estimates of the ultimate cost of individual claims and on actuarial estimation techniques. Several factors contribute to the uncertainty in establishing these estimates. Judgment is required in actuarial estimation to ascertain the relevance of historical payment and claim settlement patterns under current facts and circumstances. Key assumptions in the estimation process are the average cost of claims over time, which we refer to as severity trends, including the increasing level of medical, legal and rehabilitation costs, and costs associated with fraud or other abuses of the medical claim process; frequency of claims; the length of time to achieve ultimate resolution; judicial theories of liabilities; and other third-party factors beyond our control. If there are unfavorable changes in severity trends, we may need to increase our loss reserves, as described above. If we need to increase our loss reserves in the future, it would have a negative impact on our net income and comprehensive income in the period in which our loss estimates are revised, and any material increase to our loss reserve estimates may result in a downgrade in the A.M. Best rating of our insurance subsidiary. See the risk factor “A downgrade in the A.M. Best rating of our insurance subsidiary could reduce the amount of business we are able to write” in our 2011 annual report on Form 10-K.

The assets that SeaBright acquired in the Acquisition were acquired from LMC and certain of its affiliates in 2003. In connection with the Acquisition, we established various arrangements with LMC and certain of its affiliates, including (1) servicing arrangements entitling us to fee income for providing claims administration services for Eagle and (2) other protective arrangements designed to minimize our exposure to any past business underwritten by KEIC, the shell entity that we acquired from LMC for its insurance licenses, and any adverse developments in KEIC’s loss reserves as they existed at the date of the Acquisition. See the discussion under the heading “Loss Reserves — KEIC Loss Reserves” in Part I, Item 1 of our 2011 annual report on Form 10-K.

Until recently, LMC and its insurance company affiliates have operated under a voluntary “run-off” plan approved by the Illinois Department of Insurance in 2004. However, on July 2, 2012, LMC and one of its affiliates, American Manufacturers Mutual Insurance Company (“AMM”), were placed into rehabilitation by order of the Circuit Court of Cook County, Illinois. By virtue of that order, the Illinois Director of Insurance (acting through a special deputy receiver) became the rehabilitator of LMC and AMM and was vested with title to all of the property, contracts and rights of action of LMC and AMM, as well as authority to deal with the property, business and affairs of LMC and AMM. Rehabilitation may reorganize the business of a company so that it can be restored to normal operation. However, a company in rehabilitation can be found to be insolvent or otherwise incapable of being rehabilitated, in which case the Director of Insurance would apply to the circuit court for an order placing the company into liquidation. In a liquidation, the Director of Insurance would be charged with winding up the business of the company, marshaling its assets, identifying claims and eventually distributing its assets in accordance with the distribution priority prescribed by the Illinois Insurance Code.

•

As discussed under “Loss Reserves — KEIC Loss Reserves” in Part I, Item 1 of our 2011 annual report on Form 10-K, to minimize our exposure to any past business underwritten by KEIC, we entered into an arrangement with LMC at the time of the Acquisition requiring LMC to indemnify us in the event of adverse development of the loss reserves in KEIC’s balance sheet as they existed on the date of closing of the Acquisition. We refer to this arrangement as the adverse development cover. To support LMC’s obligations under the adverse development cover, LMC funded a trust account at the time of the Acquisition. The minimum amount that must be maintained in the trust account is equal to the greater of (a) $1.6 million or (b) 102% of the then existing quarterly estimate of LMC’s total obligations under the adverse development cover. We refer to this trust account as the collateralized reinsurance trust because the funds on deposit in the trust account serve as collateral for LMC’s potential future obligations to us under the adverse development cover. The liability of LMC under the adverse development cover was approximately $3.1 million at September 30, 2012 and December 31, 2011. The balance of the trust account, including accumulated interest, at September 30, 2012 was approximately $3.1 million. December 31, 2011 is the date to which the parties are to look to determine whether the loss reserves with respect to KEIC’s insurance policies in effect at the date of the Acquisition have increased or decreased from the $16.0 million balance existing at the date of the Acquisition. Given that LMC has been placed into rehabilitation, if the amount held in the collateralized reinsurance trust is inadequate to satisfy the obligations of LMC to us under the adverse development cover, it is unlikely that we would recover any future amounts owed by LMC to us under the adverse development cover in excess of the amounts currently held in trust because the special deputy receiver now has control of the assets of LMC.

•

Some of our customers are insured under Eagle insurance policies that we service pursuant to the claims administration servicing agreement described above. Although SeaBright is a separate legal entity from LMC and its affiliates, including Eagle, Eagle’s policyholders may not readily distinguish SeaBright from Eagle and LMC if those policies are not honored in the event LMC is found to be insolvent or otherwise incapable of being rehabilitated and is placed into court-ordered liquidation. If that were to occur, our market reputation, credibility and ability to renew the underlying policies could be adversely affected.

•

In connection with the Acquisition, LMC and its affiliates made various transfers and payments to SeaBright in 2003, including approximately $13.0 million under the commutation agreement and an initial amount of approximately $1.6 million to fund the collateralized reinsurance trust. Given that LMC has been placed into rehabilitation, it is possible that the special deputy receiver or a creditor could assert a claim seeking to unwind or recover these payments under applicable voidable preference and fraudulent transfer laws.

Exhibit Number		Description
	2.1	Agreement and Plan of Merger, dated as of August 27, 2012, among Enstar Group Limited, AML Auqusition Corp. and SeaBright Holding Inc. (incorporated by reference from Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on August 28, 2012)

	10.1*	Amended and Restated 2005 Long-Term Equity Incentive Plan

	31.1*	Rule 13a-14(a) Certification (Chief Executive Officer)

	31.2*	Rule 13a-14(a) Certification (Chief Financial Officer)

	32.1*	Section 1350 Certification (Chief Executive Officer)

	32.2*	Section 1350 Certification (Chief Financial Officer)

	101	Interactive Data Files

Delaware		56-2393241
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

Class		Shares outstanding as of November 1, 2012
Common Stock, $0.01 Par Value		22,455,088

			Insurer Ratings		Average Underlying
Bond Insurer	Fair Value		S&P	Moody’s	Bond Rating
	(Millions)
National Public Finance Guarantee Corporationy	$	34.0	BBB	Baa2	AA-

	Cost or Amortized Cost		Estimated Fair Value
	(in thousands)
Maturity
Due in one year or less	$	37,665	$	38,052
Due after one year through five years		203,975		212,153
Due after five years through ten years		275,727		296,701
Due after ten years		21,788		23,244
Securities not due at a single maturity date		135,725		139,435
Total fixed income securities	$	674,880	$	709,585

	September 30, 2012			December 31, 2011
	(in thousands)
Current:
Premiums receivable	$	17,508		$	19,362
Allowance for doubtful accounts		(1,170	)		(1,030	)
Premiums receivable, net of allowance	$	16,338		$	18,332

Reinsurance Layer	Combined Participation
$1.0 million in excess of $1.0 million		7.5	%
$3.0 million in excess of $2.0 million		22.0	%
$5.0 million in excess of $5.0 million		27.5	%

	Number of Shares			Weighted Average Grant Date Fair Value
Outstanding at December 31, 2011		1,160,556		$	10.15
Granted		204,576			8.86
Vested		(332,480	)		10.38
Forfeited		(9,750	)		8.97
Outstanding at September 30, 2012		1,022,902			9.83

	Number of Shares		Weighted Average Fair Value
Outstanding at December 31, 2011		−	$	−
Granted		51,000		8.31
Vested		−		−
Forfeited		500		8.89
Outstanding at September 30, 2012		50,500	$	11.11

	SEABRIGHT HOLDINGS, INC.


Date: November 2, 2012

	By:	/s/ John G. Pasqualetto
		John G. Pasqualetto Chairman, President and Chief Executive Officer
		(Principal Executive Officer)

	By:	/s/ Neal A. Fuller
		Neal A. Fuller
		Senior Vice President – Chief Financial Officer and Assistant Secretary
		(Principal Financial Officer)