UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

For the fiscal year ended December 31, 2012

OR

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

For the transition period from                      to                     

Commission File Number 001-32899

EASTERN INSURANCE HOLDINGS, INC.

Incorporated in Pennsylvania	I.R.S. Employer Identification No.
25 Race Avenue, Lancaster, Pennsylvania 17603-3179 (717) 396-7095	20-2653793

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class	Name of Each Exchange on Which Registered
Common Stock, No Par Value	NASDAQ Global Market

Securities registered pursuant to Section 12(g) of the Act: None.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act:    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act:    Yes  ¨    No  x

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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

Large accelerated filer  ¨      Accelerated filer  x      Non-accelerated filer  ¨      Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act):    Yes  ¨    No  x

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. The market value of the registrant’s common stock held by non-affiliates, based on the closing price of the registrant’s common stock on June 30, 2012, as reported by the NASDAQ Global Market, was $109,858,403.

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

Title of Each Class	Number of Shares Outstanding as of March 6, 2013
Common Stock, No Par Value	7,910,609 (Outstanding Shares)

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement in connection with the 2013 Annual Meeting of Stockholders—Part III.

Table of Contents

Eastern Insurance Holdings, Inc. and Subsidiaries

Item	Description	Page
Part I
Item 1	Business		1
Item 1A	Risk Factors		21
Item 1B	Unresolved Staff Comments		27
Item 2	Properties		27
Item 3	Legal Proceedings		28
Item 4	Mine Safety Disclosures		29
Part II
Item 5	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		30
Item 6	Selected Financial Data		34
Item 7	Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations		36
Item 7A	Quantitative and Qualitative Disclosures about Market Risk		58
Item 8	Financial Statements and Supplementary Data		60
Item 9	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		98
Item 9A	Controls and Procedures		98
Item 9B	Other Information		98
Part III
Item 10	Directors, Executive Officers and Corporate Governance		99
Item 11	Executive Compensation		99
Item 12	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		99
Item 13	Certain Relationships and Related Transactions, and Director Independence		99
Item 14	Principal Accounting Fees and Services		99
Part IV
Item 15	Exhibits and Financial Statement Schedules		100

PART I

Item 1—Business

Our History and Overview

Eastern Insurance Holdings, Inc. (“EIHI”) is an insurance holding company offering workers’ compensation insurance and reinsurance products through its direct and indirect wholly-owned subsidiaries, Global Alliance Holdings, Ltd. (“Global Alliance”), Eastern Alliance Insurance Company (“Eastern Alliance”), Allied Eastern Indemnity Company (“Allied Eastern”), Eastern Advantage Assurance Company (“Eastern Advantage”), Employers Security Insurance Company (“Employers Security”), Employers Alliance, Inc. (“Employers Alliance”), Eastern Re Ltd., SPC (“Eastern Re”), and Eastern Services Corporation (“Eastern Services”), collectively referred to as the “Company”, “we” and/or “our”.

EIHI was organized as a Pennsylvania business corporation in 2005. The following provides a brief description of EIHI’s direct and indirect wholly-owned subsidiaries:

• Global Alliance is a holding company domiciled in the Commonwealth of Pennsylvania;

• Eastern Alliance, Allied Eastern and Eastern Advantage are stock property/casualty insurance companies domiciled in the Commonwealth of Pennsylvania and, along with Employers Security, conduct business as Eastern Alliance Insurance Group (“EAIG”). The four insurance companies provide EAIG with increased underwriting and pricing flexibility through the use of a tiered rating structure;

• Employers Security is a stock property/casualty insurance company domiciled in the State of Indiana;

• Employers Alliance is a Pennsylvania corporation offering claims administration and risk management services to self-insured property/casualty customers;

• Eastern Re is a segregated portfolio cell reinsurance company domiciled in the Cayman Islands; and

• Eastern Services is a Pennsylvania corporation that currently has no significant business activity.

On December 9, 2010, EIHI completed the sale of Eastern Atlantic RE (“Atlantic RE”). Atlantic RE was a Cayman Islands reinsurance company formed for the purpose of transferring certain assets and liabilities related to EIHI’s former run-off specialty reinsurance segment. The run-off specialty reinsurance segment reported net premiums earned totaling $1,000 and revenue totaling $4.2 million for the year ended December 31, 2010. Total revenue for the year ended December 31, 2010 excludes the loss on the sale of Atlantic RE of $14.0 million.

On June 21, 2010, EIHI completed the sale of Eastern Life and Health Insurance Company (“Eastern Life”), its former group benefits insurance subsidiary. Eastern Life’s net premiums earned totaled $18.3 million (prior to the sale) for the year ended December 31, 2010. Eastern Life’s revenue totaled $20.6 million (prior to the sale) for the year ended December 31, 2010.

The Company currently operates in three business segments: workers’ compensation insurance, segregated portfolio cell reinsurance, and corporate/other. Prior to the sale of Atlantic RE and Eastern Life, the Company’s operations included a run-off specialty reinsurance segment and a group benefits insurance segment. The components of the run-off specialty reinsurance segment that were not transferred to Atlantic RE have been included in the corporate/other segment for the years ended December 31, 2012 2011 and 2010.

Overview of Business Segments

The following discussion provides information on each of our business segments:

Workers’ Compensation Insurance. The Company offers workers’ compensation insurance coverage to employers, generally with 1,000 employees or less, primarily in the Mid-Atlantic, Southeast, and Midwest regions of the continental United States. During 2012, the Company expanded into the Gulf South region, with a primary focus in the states of Mississippi, Alabama, Arkansas and Louisiana. The Company’s workers’ compensation products include guaranteed cost policies, policyholder dividend policies, retrospectively-rated policies, deductible policies and alternative market programs.

Segregated Portfolio Cell Reinsurance. The Company offers alternative market workers’ compensation solutions to individual companies, groups and associations (referred to as “segregated portfolio cell dividend participants”) through the creation of segregated portfolio cells. The segregated portfolio cells are segregated pools of assets and liabilities that function

1

as insurance companies within an insurance company. The pool of assets and associated liabilities of each segregated portfolio cell are solely for the benefit of the segregated portfolio cell dividend participants, and the pool of assets of one segregated portfolio cell are statutorily protected from the creditors of the others. This permits the Company to provide customers with a turn-key alternative markets solution that includes program design, fronting, claims administration, risk management, segregated portfolio cell rental, asset management and segregated portfolio management services. The Company outsources the asset management and segregated portfolio cell management services to a third party. The segregated portfolio cell structure provides dividend participants the opportunity to share in both underwriting profit and investment income derived from their respective segregated portfolio cell’s financial results.

Workers’ compensation insurance coverage is underwritten through EAIG’s alternative markets business unit and ceded 100% to the segregated portfolio cell reinsurance segment. The Company receives fee revenue, based on a percentage of direct premiums written, for fronting, claims administration, risk management and segregated portfolio cell rental services. As of December 31, 2012, the segregated portfolio cells and dividend participants provided $50.7 million of irrevocable, unconditional letters of credit to secure unfunded liabilities and collateralize reserves for unpaid losses and loss adjustment expenses (“LAE”) and unearned premiums.

The Company is a preferred shareholder in certain of the segregated portfolio cells. For those segregated portfolio cells in which the Company participates, the Company shares in the operating and investment results of those cells and recognizes its share of the segregated portfolio dividend in the consolidated statements of operations and comprehensive income (loss). The Company’s share of the segregated portfolio dividend is included in the corporate/other segment.

Corporate/Other. The corporate/other segment primarily includes the expenses of EIHI, the third party administration activities of the Company, and the results of operations of Eastern Re, as well as certain eliminations necessary to reconcile the segment information to the consolidated statements of operations and comprehensive income (loss). The Company cancelled the remaining reinsurance contracts at Eastern Re in 1999 on a run-off basis and continues to have exposure for outstanding claims as of December 31, 2012. The corporate/other segment also included the Company’s 10% interest in a segregated portfolio cell with an unaffiliated primary carrier that wrote insurance coverage for sprinkler contractors, known as “SprinklerPro”. The Company non-renewed the contract for its 10% interest in SprinklerPro on a run-off basis effective April 1, 2009. The Company commuted the SprinklerPro contract during the second quarter of 2012 and recognized a realized loss of $641,000 related to the commutation.

Products

Workers’ Compensation Insurance

The Company offers a complete line of workers’ compensation products including guaranteed cost policies, policyholder dividend policies, retrospectively-rated policies, deductible policies, and alternative market products. Direct premiums written in the workers’ compensation insurance segment totaled $182.9 million for the year ended December 31, 2012.

• Guaranteed cost policies. Guaranteed cost policies charge a fixed premium, which does not increase or decrease based upon loss experience during the policy period. For the year ended December 31, 2012, 57.7% of direct premiums written in the workers’ compensation insurance segment were derived from guaranteed cost policies.

• Policyholder dividend policies. Policyholder dividend policies charge a fixed premium, but the customer may receive a dividend in the event of favorable loss experience during the policy period. Policyholder dividend plans are generally restricted to accounts with minimum annual premiums in excess of $20,000. For the year ended December 31, 2012, 11.3% of direct premiums written in the workers’ compensation insurance segment were derived from policyholder dividend policies.

• Retrospectively-rated policies. Retrospectively-rated policies charge an initial premium that is subject to adjustment after the policy period expires, based upon the insured’s actual loss experience incurred during the policy period, subject to a minimum and maximum premium. These policies are typically subject to annual adjustment until all claims related to the policy year are closed. Retrospectively-rated policies are generally offered to employers with minimum annual premiums in excess of $150,000. For the year ended December 31, 2012, 3.2% of direct premiums written in the workers’ compensation insurance segment were derived from retrospectively-rated policies.

• Deductible policies. Deductible policies generally result in a lower premium; however, the insured retains a greater share of the underwriting risk than under guaranteed cost or dividend paying policies, which reduces the risk to the

2

Company and further encourages loss control practices by the insured. The insured is contractually obligated to pay its own losses up to the amount of the deductible for each occurrence, subject to an aggregate retention. The Company requires the insured to provide collateral in the form of a letter of credit or cash to secure amounts due the Company under the deductible policy. For the year ended December 31, 2012, 3.6% of direct premiums written in the workers’ compensation insurance segment were derived from deductible policies.

• Alternative market products. Alternative market products are offered to individual companies, groups, and trade associations. As described above in “Overview of Business Segments—Segregated Portfolio Cell Reinsurance” a policy is issued to an insured and 100% of the premium written, less a ceding commission, is ceded to a segregated portfolio cell at Eastern Re. For the year ended December 31, 2012, 24.2% of direct premiums written in the workers’ compensation insurance segment were derived from alternative market products.

Segregated Portfolio Cell Reinsurance

Segregated portfolio cells, or segregated cells or rent-a-captives, are all referred to as alternative market programs or products. The Company provides a variety of products to this marketplace, including program design, fronting, claims administration, risk management, segregated portfolio cell rental, asset management and segregated portfolio management services. The Company outsources the asset management and segregated portfolio cell management services to a third party. Direct premiums written in the segregated portfolio cell reinsurance segment totaled $37.8 million for the year ended December 31, 2012. The segregated portfolio cell reinsurance segment generated fee revenue to the Company’s workers’ compensation insurance and corporate/other segments totaling $6.1 million for the year ended December 31, 2012.

Marketing and Distribution

Workers’ Compensation Insurance

The Company distributes its workers’ compensation products and services primarily in the Mid-Atlantic, Southeast, Midwest and Gulf South regions of the continental United States through a network of carefully chosen independent insurance agents. The following table provides direct premiums written, by state, for the year ended December 31, 2012 (dollars in thousands):

State	Direct Premiums Written		Percentage
Pennsylvania	$	119,281		65.2	%
Indiana		16,825		9.2	%
North Carolina		12,081		6.6	%
Virginia		7,810		4.3	%
Maryland		5,084		2.8	%
South Carolina		4,027		2.2	%
Delaware		3,669		2.0	%
New Jersey		3,222		1.8	%
Tennessee		3,045		1.7	%
Other		7,880		4.2	%
Total	$	182,924		100.0	%

The Company has its greatest agency representation and largest workers’ compensation premium volume in central Pennsylvania.

The Company’s agents are compensated through a fixed base commission plan with an opportunity for profit sharing depending on the agent’s premium volume and loss experience.

The Company proactively manages its valued relationships with agents through a detailed management process. The process is driven by regular interaction with the Company’s underwriting and marketing personnel and strong relationships between senior management of the Company and the principals of each agent. The primary components of the agency management process are as follows:

• The Company carefully selects agents through a process that assesses financial results, market potential, business philosophy and reputation of the agency and its staff. The Senior Vice President of Marketing and Field Operations

3

approves all agent appointments following extensive meetings with the agent’s principals. Following the agreement to appoint, the Company’s Senior Vice President of Marketing and Field Operations and other key personnel conduct a formal orientation process focusing on the Company’s workers’ compensation insurance products and services, dedicated service team and the joint business objectives of the Company and the agent.

• The Company’s senior management team conducts annual business planning meetings with the agency principals to mutually agree upon the agent’s financial goals for the following year. Senior management, marketing personnel and the underwriting staff conduct regular visits to monitor results and build relationships.

• The Company has established an Agency Advisory Council to promote an active dialogue between the Company and its agents. The Agency Advisory Council is comprised of experienced insurance agency professionals. The Council meets twice a year to discuss such topics as market conditions, customer service, products, competition and areas of opportunity. In addition to the Agency Advisory Council, the Company has established a Select Business Focus Group with its agents. This group meets once a year to concentrate on issues that impact small workers’ compensation clients (under $20,000 in annual premium).

• Agency management reports are distributed on a monthly basis, providing the agent with the data necessary to manage its relationship with the Company.

The Company attempts to optimize the franchise value of a workers’ compensation agency appointment by limiting the number of appointments in identified marketing territories. As a result of this agency management strategy, the average direct premiums written per agency contract was $1.2 million for the year ended December 31, 2012.

The Company’s ten largest agents in its workers’ compensation insurance segment accounted for 53.2% of its direct premiums written for the year ended December 31, 2012. The Company’s largest agent, Keystone Insurers Group, accounted for 10.1% of its direct premiums written for the year ended December 31, 2012. The Keystone Insurers Group is subject to the terms and conditions of the Company’s Agency Agreement, which sets forth binding authority, premium remittance and collection and termination provisions, among other things. No other agent accounted for more than 10.0% of the Company’s direct premiums written in its workers’ compensation insurance segment for the year ended December 31, 2012.

Segregated Portfolio Cell Reinsurance

The marketing and distribution of policies that may be submitted for consideration for the Company’s alternative market programs are substantially the same as that of the workers’ compensation insurance segment. The Company’s independent agents market the products to potential customer groups within the Company’s geographic target markets.

Underwriting, Risk Management and Pricing

Workers’ Compensation Insurance

The Company’s workers’ compensation insurance segment is committed to an individual account underwriting strategy that is focused on selecting quality accounts. The goal of the workers’ compensation underwriting professionals is to select a diverse book of business with respect to risk classification, hazard level and geographic location. The Company expects to remain a rural underwriter focusing on territories, accounts and agencies that generate acceptable underwriting margins.

The workers’ compensation underwriting strategy is focused on accounts with strong return to work and safety programs in low to middle hazard levels such as clerical office, light manufacturing, healthcare, auto dealers and service industries.

For the year ended December 31, 2012, the average annual workers’ compensation traditional premium per policy was $21,956.

Within the workers’ compensation underwriting operation, the Company operates a risk management unit, which delivers loss consulting services to the Company’s underwriters, agents and insureds. The objective of the risk management operation is to protect the Company from catastrophic loss, reduce claims frequency and provide value added consulting services to policyholders. These services are provided at no additional cost to the insured. Management believes the quality of the services differentiates the Company’s workers’ compensation offerings from its competitors. The risk management unit also provides risk pre-screening in support of the underwriting selection process.

4

Segregated Portfolio Cell Reinsurance

Underwriting and risk management services for the segregated portfolio cell reinsurance segment are substantially the same as the workers’ compensation insurance segment, although a separate alternative markets unit has been formed for the coordination of services on a group program basis. The independent agents’ knowledge of the Company’s workers’ compensation product offerings is an important component in the offering of different product proposals to customers, including the alternative market option. After successful completion of the underwriting process, if the risk is deemed to be an appropriate candidate for alternative markets, the risk is submitted for consideration of intercompany reinsurance. In general, a pool of risks such as a trade group, or for similarly situated customers of an agency, are most appropriate for submission to the alternative markets unit. If a pool of risks is accepted, reinsurance agreements and dividend participant agreements are executed, external reinsurance is bound and a segregated portfolio cell is established and presented to the Cayman Islands Monetary Authority for approval.

Claims

Workers’ Compensation Insurance

Workers’ compensation claims management focuses on early intervention and aggressive disability management, utilizing the professional services of in-house and third-party medical case managers to supplement the expertise of in-house claims professionals when appropriate.

The Company believes in thorough education of its insureds and their employees regarding the workers’ compensation law and workplace safety. The Company utilizes frequent communication with all parties as a means to maintain control of claims and to minimize the influence of factors that increase costs such as attorney involvement and “doctor shopping.” The Company provides assistance and support to its insureds in the implementation of physician panels and return to work programs.

The Company utilizes strategic vendor relationships rather than in-house personnel for services such as legal representation, private investigation, vocational rehabilitation and medical case management. During 2012, the Company commenced the process of establishing an internal medical case management and utilization review department, as management believes this will improve the effectiveness and efficiency of its claims management process. During 2012, the Company hired a Medical Cost Management Director, and management expects to implement its internal medical case management and utilization review operation in the first half of 2013.

During 2012, the Company established a claim support center for the claim in-take function. Prior to 2012, the claim in-take function was handled through a partnership with a third-party vendor. The third-party vendor continues to handle claims reported after the Company’s normal business hours. Management believes the establishment of the claim support center has improved the effectiveness and efficiency of its claims in-take process, including improvement in customer service and data integrity.

Medical cost management initiatives have been implemented with strategic vendors to reduce claim costs. Medical cost management services include catastrophic medical management, medical case management, preferred provider networks, physical therapy networks and a prescription drug program.

The Company attempts to aggressively achieve final resolution of and close claims from prior accident years as expeditiously as possible. The table below shows the total number of workers’ compensation claims received and open and closed claims, by accident year, as of December 31, 2012.

5

Traditional Business

(Exclusive of Alternative Markets)

Open Lost Time Claims (1)

Accident Year	Total Claims		Open		Closed		% Closed			Open Reinsured Claims
1994		1		—		1		100.00	%		—
1995		18		—		18		100.00	%		—
1996		342		—		342		100.00	%		—
1997		431		1		430		99.80	%		1
1998		567		1		566		99.80	%		1
1999		798		1		797		99.90	%		—
2000		1,503		1		1,502		99.90	%		1
2001		1,947		3		1,944		99.80	%		2
2002		1,194		3		1,191		99.70	%		3
2003		825		5		820		99.40	%		1
2004		1,137		8		1,129		99.30	%		5
2005		1,087		4		1,083		99.60	%		1
2006		1,263		5		1,258		99.60	%		2
2007		1,211		12		1,199		99.00	%		3
2008		1,280		27		1,253		97.90	%		2
2009		1,317		42		1,275		96.80	%		2
2010		1,522		93		1,429		93.90	%		4
2011		1,714		256		1,458		85.10	%		1
2012		1,600		843		757		47.30	%		2
		19,757		1,305		18,452		93.40	%		31

(1) Excludes medical only claims because such claims are opened and closed in a short period of time.

The table below shows the number of open lost time claims for accident years 2011 and prior as of December 31, 2012 and 2011:

Traditional Business

(Exclusive of Alternative Markets)

Open Lost Time Claims (1)

Accident Year	12/31/2012 Open		12/31/2011 Open		2011 and Prior Claims Closed During 2012			% of 2011 Open Claims Closed During 2012
1997		1		1		—			—
1998		1		1		—			—
1999		1		—		(1	)		—
2000		1		2		1			50.00	%
2001		3		3		—			—
2002		3		3		—			—
2003		5		5		—			—
2004		8		10		2			20.00	%
2005		4		7		3			42.90	%
2006		5		11		6			54.50	%
2007		12		22		10			45.50	%
2008		27		55		28			50.90	%
2009		42		96		54			56.30	%
2010		93		240		147			61.30	%
2011		256		877		621			70.80	%
		462		1,333		871			65.30	%

(1) Excludes medical only claims because such claims are opened and closed in a short period of time.

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Segregated Portfolio Cell Reinsurance

The claims administration strategy for the alternative market programs is consistent with the workers’ compensation insurance segment.

Reinsurance

The Company’s insurance subsidiaries reinsure a portion of their loss exposure and pay to the reinsurers a portion of the premiums received on all policies reinsured. Insurance policies written by the Company’s insurance subsidiaries are reinsured with other insurance companies principally to:

• reduce net liability on individual risks;

• mitigate the effect of individual loss occurrences (including catastrophic losses);

• stabilize underwriting results; and

• decrease leverage and, accordingly, increase underwriting capacity.

Reinsurance does not legally discharge the Company from primary liability for the full amount due under the reinsured policies. However, the assuming reinsurer is obligated to reimburse the Company to the extent of the coverage ceded. As of December 31, 2012, the Company’s reinsurance recoverables, by segment, were as follows (in thousands):

Segment	Amount
Workers’ compensation insurance	$	14,344
Segregated portfolio cell reinsurance		5,332
Total	$	19,676

The Company determines the amount and scope of reinsurance coverage to purchase each year based on a number of factors, including the evaluation of the risks accepted, consultations with reinsurance representatives and a review of market conditions, including the availability and pricing of reinsurance.

The Company monitors the solvency of its reinsurers on an annual basis, at a minimum, through review of their financial statements and, if available, their A.M. Best financial strength ratings. The Company has not experienced difficulty collecting amounts due from reinsurers; however, the insolvency or inability of any reinsurer to meet its obligations could have a material adverse effect on the Company’s financial condition and results of operations.

Workers’ Compensation Insurance

The Company’s workers’ compensation traditional business is reinsured under an excess of loss arrangement under which the Company retains the first $500,000 on each loss occurrence. Loss occurrences in excess of $500,000 are covered up to a maximum of $39.5 million per claim.

The following table sets forth the amounts recoverable from reinsurers for the workers’ compensation insurance segment as of December 31, 2012 (dollars in thousands):

Name	Reinsurance Recoverable		A.M. Best Rating			Percentage of Shareholders’ Equity			Percentage of Reinsurance Recoverable
Lloyd’s of London	$	5,634		A			4.2	%		28.6	%
Aspen Insurance UK Limited		3,395		A			2.5	%		17.2	%
General Reinsurance Corporation		3,221		A++			2.4	%		16.4	%
Swiss Reinsurance America Corporation		1,828		A+			1.3	%		9.3	%
Catalina London Limited		266		NR	(1)		0.2	%		1.4	%
	$	14,344					10.6	%		72.9	%

(1) Rating assigned to companies that are not rated by A.M. Best.

7

Segregated Portfolio Cell Reinsurance

Intercompany Reinsurance Structure. Intercompany reinsurance agreements are the mechanisms by which premiums paid by alternative market customers are ceded to the segregated portfolio cells. Each segregated portfolio cell has the following reinsurance agreements:

• 100% Quota Share Reinsurance Agreements—Under this reinsurance agreement, all premiums received from the specific customer are ceded to the respective segregated portfolio cell, net of a ceding commission. As with any reinsurance arrangement, the ultimate liability for the payment of claims resides with the primary insurance company. The ceding commission paid by the segregated portfolio cell consists of charges customary to such arrangements including fronting fees, external reinsurance, agent’s commissions, premium taxes and assessments, claims administration and risk management services and segregated portfolio cell rental fees. In addition, the ceding commission includes the risk assumed under the aggregate excess reinsurance agreement described directly below.

• Aggregate Excess Reinsurance Agreements—An aggregate excess reinsurance agreement exists for each respective segregated portfolio cell whereby EAIG assumes 100% of aggregate losses over an aggregate attachment point (expressed as a percentage of direct premiums written), with a maximum loss limit of $100,000. The attachment points for the aggregate excess reinsurance agreements average 89.0% of direct premiums written. For example, in the case of a segregated portfolio cell with $1.0 million in assumed premium and an 89.0% attachment point, the segregated portfolio cell pays the first $890,000 in net losses and LAE, EAIG pays the next $100,000 in net losses and LAE and the external aggregate reinsurer (as described below) pays net losses and LAE beyond the initial $990,000 covered by the segregated portfolio cell and EAIG.

External Reinsurance. Each segregated portfolio cell purchases reinsurance coverage through the external reinsurance market. The segregated portfolio cell purchases per occurrence coverage to cover severity of claims and aggregate reinsurance coverage to cover frequency of claims on its segregated portfolio cell business.

Per Occurrence Reinsurance Agreements. Per occurrence reinsurance agreements cover each segregated portfolio cell for a catastrophic claim resulting from one event with respect to its segregated portfolio cell business. The specific retentions for per occurrence coverage for segregated portfolio cells range from $250,000 to $350,000, with limits ranging from $39.75 million to $39.65 million. For example, in the case of a segregated portfolio cell with a $300,000 retention that has a $3.0 million claim relating to the injury and/or death of a covered employee, the segregated portfolio cell would cover the first $300,000 of the claim with the third party reinsurer paying the remaining $2.7 million in claims.

Aggregate Reinsurance Coverage. Aggregate reinsurance agreements cover each segregated portfolio cell for losses and LAE beyond the $100,000 aggregate coverage provided by EAIG. The need for this coverage would arise in the event of a series of losses as opposed to a single, catastrophic event. Aggregate reinsurance coverage purchased through Lloyd’s of London has ultimate loss limits of $1.0 million or $2.0 million, depending on the underlying risks. This external reinsurance combined with the aggregate coverage provided by EAIG provides aggregate loss limits for each segregated portfolio cell ranging from $1.1 million to $2.1 million.

In addition to the reinsurance coverage on the segregated portfolio cell business, the dividend participants of each segregated portfolio cell provide a letter of credit to EAIG that is equal to the difference between the loss fund (amount of funds available to pay losses after deduction of ceding commission) and the aggregate attachment point of the reinsurance. This is sometimes called the GAP, or unfunded liability. As an example, if a program has $1.0 million of assumed premiums, a 40% ceding commission and a 90% aggregate attachment point, the letter of credit amount is $300,000 calculated as follows:

Aggregate attachment point ($1,000,000 x .90)	$	900,000
Loss fund ($1,000,000 – ($1,000,000 x .40))	$	600,000
GAP	$	300,000

The difference between the premium and the ceding commission is deposited in each respective segregated portfolio cell’s Cayman Island bank account to create the loss fund.

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The following table sets forth the amounts recoverable from reinsurers for the segregated portfolio cell reinsurance segment as of December 31, 2012 (dollars in thousands):

Name	Reinsurance Recoverable		A.M. Best Rating			Percentage of Shareholders’ Equity			Percentage of Reinsurance Recoverable
Lloyd’s of London	$	3,410		A			2.5	%		17.3	%
Aspen Insurance UK Limited		1,711		A			1.3	%		8.7	%
Catalina London Limited		129		NR	(1)		0.1	%		0.7	%
Swiss Reinsurance America Corporation		82		A+			0.1	%		0.4	%
	$	5,332					4.0	%		27.1	%

(1) Rating assigned to companies that are not rated by A.M. Best.

Loss and LAE Reserves

The Company estimates its reserves for unpaid losses and LAE as of the balance sheet date. The adequacy of the Company’s reserves is inherently uncertain and represents a significant risk to the business. The Company attempts to mitigate the uncertainty inherent in its reserves by continually reviewing loss cost trends, attempting to set premium rates that are adequate to cover anticipated future costs, and by professionally managing its claims administration function. Additionally, the Company attempts to minimize the estimation risk inherent in its reserves by employing actuarial techniques on a quarterly basis. Significant judgment is required in actuarial estimation to ascertain the relevance of historical payment and claim settlement patterns under current facts and circumstances. No assurance can be given as to whether the ultimate liability for unpaid losses and LAE will be more or less than the Company’s current estimates. While management believes that the assumptions underlying the amounts recorded for the reserves for unpaid losses and LAE as of December 31, 2012 are reasonable, the ultimate net liability may differ materially from the amount provided.

The following table provides a summary of the activity in the Company’s reserves for unpaid losses and LAE for the years ended December 31, 2012, 2011 and 2010 (in thousands):

	2012			2011			2010
Balance, beginning of period	$	106,077		$	95,963		$	89,509
Reinsurance recoverables on unpaid losses and LAE		11,805			7,864			8,512
Net balance, beginning of period		94,272			88,099			80,997
Incurred related to:
Current year		105,477			84,723			76,794
Prior year		(87	)		(1,001	)		780
Total incurred		105,390			83,722			77,574
Paid related to:
Current year		40,187			31,514			30,755
Prior year		56,831			46,035			39,717
Total paid		97,018			77,549			70,472
Net balance, end of period		102,644			94,272			88,099
Reinsurance recoverables on unpaid losses and LAE		15,084			11,805			7,864
Balance, end of period	$	117,728		$	106,077		$	95,963

Incurred losses by segment were as follows for the year ended December 31, 2012 (in thousands):

	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Total
Incurred related to:
Current year, gross of discount	$	85,331		$	23,020		$	108,351
Current period discount		(2,179	)		(695	)		(2,874	)
Prior year, gross of discount		—			(2,116	)		(2,116	)
Accretion of prior period discount		1,430			599			2,029
Total incurred	$	84,582		$	20,808		$	105,390

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Incurred losses by segment were as follows for the year ended December 31, 2011 (in thousands):

	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Total
Incurred related to:
Current year, gross of discount	$	68,895		$	18,769		$	87,664
Current period discount		(2,252	)		(689	)		(2,941	)
Prior year, gross of discount		—			(2,875	)		(2,875	)
Accretion of prior period discount		1,159			715			1,874
Total incurred	$	67,802		$	15,920		$	83,722

Incurred losses by segment were as follows for the year ended December 31, 2010 (in thousands):

	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Total
Incurred related to:
Current year, gross of discount	$	59,614		$	19,747		$	79,361
Current period discount		(1,901	)		(666	)		(2,567	)
Prior year, gross of discount		—			(1,432	)		(1,432	)
Accretion of prior period discount		1,562			650			2,212
Total incurred	$	59,275		$	18,299		$	77,574

For the years ended December 31, 2012, 2011 and 2010, the Company increased (decreased) its workers’ compensation insurance and segregated portfolio cell reinsurance reserves for unpaid losses and LAE, including the accretion of prior period discount, by the following amounts (in thousands):

	2012			2011			2010
Workers’ compensation insurance	$	1,430		$	1,159		$	1,562
Segregated portfolio cell reinsurance		(1,517	)		(2,160	)		(782	)
Total	$	(87	)	$	(1,001	)	$	780

Workers’ Compensation Insurance

For the years ended December 31, 2012, 2011 and 2010, the Company increased (decreased) its workers’ compensation insurance reserves for unpaid losses and LAE by the following amounts by accident year (in thousands):

Accident Year	2012		2011		2010
2011	$	—	$	—	$	—
2010		—		—		—
2009		—		—		—
2008		—		—		—
2007		—		—		—
2006		—		—		—
2005		—		—		—
2004		—		—		—
2003		—		—		—
2002		—		—		—
2001 and prior		—		—		—
Total before discount accretion		—		—		—
Discount accretion		1,430		1,159		1,562
Total	$	1,430	$	1,159	$	1,562

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For the years ended December 31, 2012, 2011 and 2010, the estimates of ultimate losses and LAE for prior accident periods produced from our actuarial methods were reasonably consistent with the estimates we prepared as of December 31, 2011 and , therefore, we have not changed our best estimate of these amounts. Accordingly, the Company did not recognize any development on prior accident period workers’ compensation insurance reserves for the years ended December 31, 2012, 2011 or 2010.

Segregated Portfolio Cell Reinsurance

For the years ended December 31, 2012, 2011 and 2010, the Company increased (decreased) its segregated portfolio cell reinsurance reserves for unpaid losses and LAE by the following amounts, by accident year (in thousands):

Accident Year	2012			2011			2010
2011	$	490		$	—		$	—
2010		(1,518	)		(1,862	)		—
2009		116			(602	)		(1,372	)
2008		(236	)		(109	)		(418	)
2007		38			(136	)		423
2006		(252	)		(85	)		(12	)
2005		(107	)		(12	)		103
2004		(184	)		(54	)		(124	)
2003		(229	)		(2	)		(51	)
2002		(182	)		(2	)		(10	)
2001 and prior		(52	)		(11	)		29
Total before discount accretion		(2,116	)		(2,875	)		(1,432	)
Discount accretion		599			715			650
Total	$	(1,517	)	$	(2,160	)	$	(782	)

The Company estimates and records reserves for its segregated portfolio cell reinsurance segment in the same manner as for its workers’ compensation insurance segment. Furthermore, the Company’s underwriting, claim administration and risk management services are consistent between its workers’ compensation insurance and segregated portfolio cell reinsurance segments. This is because the workers’ compensation insurance and segregated portfolio cell reinsurance segments derive their books of business from the same general business demographics and geography. Prior period reserve development in the segregated portfolio cell reinsurance segment results in an increase or decrease in the segment’s losses and LAE incurred and a corresponding decrease or increase in the segregated portfolio cell dividend expense.

For the year ended December 31, 2012, the Company recognized net favorable development on prior accident year segregated portfolio cell reinsurance reserves of $2.1 million, representing 9.6% of the Company’s estimated segregated portfolio cell reinsurance reserves as of December 31, 2011 and 6.6% of the Company’s segregated portfolio cell reinsurance net premiums earned for the year ended December 31, 2012. The favorable development arose primarily from accident year 2010, but was generally prevalent in most prior accident years, and resulted from actual loss development being somewhat lower than the Company had expected based on its historical loss development experience, reflecting continued improvements in loss mitigation and underwriting. The unfavorable development recorded in 2012 related to accident year 2011 primarily reflects the emergence of unexpected loss trends and a large loss in one of the segregated portfolio cells.

For the year ended December 31, 2011, the Company recognized net favorable development on prior accident year segregated portfolio cell reinsurance reserves of $2.9 million, representing 12.6% of the Company’s estimated segregated portfolio cell reinsurance reserves as of December 31, 2010 and 10.1% of the Company’s segregated portfolio cell reinsurance net premiums earned for the year ended December 31, 2011. The favorable development arose primarily from accident years 2010 and 2009, but was generally prevalent in most prior accident years, and resulted from actual loss development being somewhat lower than the Company had expected based on its historical loss development experience, reflecting continued improvements in loss mitigation and underwriting.

For the year ended December 31, 2010, the Company recognized net favorable development on prior accident year segregated portfolio cell reinsurance reserves of $1.4 million, representing 6.5% of the Company’s estimated segregated portfolio cell reinsurance reserves as of December 31, 2009 and 5.8% of the Company’s segregated portfolio cell reinsurance net premiums earned for the year ended December 31, 2010. The favorable development arose primarily from accident years 2008 and 2009, but was generally prevalent in most prior accident years, and resulted from actual loss development being

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somewhat lower than the Company had expected based on its historical loss development experience, reflecting continued improvements in loss mitigation and underwriting. The unfavorable development recorded in 2010 related to accident year 2007 was driven by limited return to work options in one specific segregated portfolio cell program.

The analysis in the following table presents the development of the Company’s reserves for unpaid losses and LAE from December 31, 2002 to December 31, 2012 for both the workers’ compensation insurance and segregated portfolio cell reinsurance segments. The first line in the table shows the reserves for unpaid losses and LAE, net of reinsurance, as estimated at the end of each calendar year. The first section below that line shows the cumulative actual payments of losses and LAE, net of reinsurance, that relate to each year-end liability as they were paid at the end of subsequent annual periods. The next section shows revised estimates of the original unpaid amounts, net of reinsurance, that are based on the subsequent payments and re-estimates of the remaining unpaid liabilities. The next line shows the favorable or unfavorable development of the original estimates, net of reinsurance. Loss reserve development in this table is cumulative, the estimated favorable or unfavorable development for a particular year represents the cumulative amount by which all previous liabilities are currently estimated to have been over- or under-estimated. The “cumulative redundancy/(deficiency)” is as of December 31, 2012, which represents the difference between the latest re-estimated liability and the amounts as originally estimated. A redundancy means the original estimate was higher than the current estimate; a deficiency means that the current estimate is higher than the original estimate (in thousands).

	As of December 31,
	2002			2003			2004		2005		2006		2007		2008		2009			2010			2011			2012
Reserves for unpaid losses and LAE, net of reinsurance	$	18,995		$	35,372		$	50,258	$	54,610	$	62,863	$	63,726	$	77,090	$	79,442		$	86,906		$	94,066		$	102,438
Cumulative amount of liability paid through:
One year later		12,595			16,954			18,403		19,386		21,424		25,664		34,737		39,297			44,453			57,242			—
Two years later		20,609			25,590			27,612		28,171		32,792		40,100		51,284		58,229			64,153			—			—
Three years later		24,154			29,299			31,982		33,080		39,352		46,854		59,850		68,663			—			—			—
Four years later		25,433			30,580			33,336		35,830		41,593		51,295		64,721		—			—			—			—
Five years later		25,764			31,123			34,369		37,038		43,060		53,224		—		—			—			—			—
Six years later		25,825			31,430			34,596		38,119		44,086		—		—		—			—			—			—
Seven years later		25,868			31,469			35,171		38,577		—		—		—		—			—			—			—
Eight years later		25,933			31,704			35,466		—		—		—		—		—			—			—			—
Nine years later		26,061			31,746			—		—		—		—		—		—			—			—			—
Ten years later		26,067			—			—		—		—		—		—		—			—			—			—
Liability estimated as of:
One year later		26,511			37,625			43,208		49,301		52,791		60,491		72,216		80,220			85,906			93,730			—
Two years later		27,993			36,038			41,797		42,940		51,223		56,054		72,711		78,459			83,140			—			—
Three years later		27,848			35,358			39,392		42,327		48,507		56,489		71,564		77,376			—			—			—
Four years later		27,942			34,347			38,789		41,266		48,768		56,001		70,656		—			—			—			—
Five years later		27,670			34,061			37,582		41,320		48,677		55,055		—		—			—			—			—
Six years later		27,484			33,199			37,498		41,312		47,696		—		—		—			—			—			—
Seven years later		26,843			33,218			37,488		40,563		—		—		—		—			—			—			—
Eight years later		26,904			33,260			36,878		—		—		—		—		—			—			—			—
Nine years later		26,935			32,822			—		—		—		—		—		—			—			—			—
Ten years later		26,717			—			—		—		—		—		—		—			—			—			—
Cumulative total (deficiency) redundancy		(7,722	)		2,550			13,380		14,047		15,167		8,671		6,434		2,066			3,766			336			—
Gross liability—end of year		20,361			37,455			53,108		60,430		67,232		68,468		84,925		87,954			94,770			105,871			117,522
Reinsurance recoverables		1,366			2,083			2,850		5,820		4,369		4,742		7,835		8,512			7,864			11,805			15,084
Net liability—end of year	$	18,995		$	35,372		$	50,258	$	54,610	$	62,863	$	63,726	$	77,090	$	79,442		$	86,906		$	94,066		$	102,438
Gross re-estimated liability—latest		31,507			38,009			43,718		48,581		56,059		64,011		83,743		89,824			96,247			107,063
Re-estimated reinsurance recoverables—latest		4,790			5,187			6,840		8,018		8,363		8,956		13,087		12,448			13,107			13,333
Net re-estimated liability—latest	$	26,717		$	32,822		$	36,878	$	40,563	$	47,696	$	55,055	$	70,656	$	77,376		$	83,140		$	93,730
Gross cumulative (deficiency) redundancy	$	(11,146	)	$	(554	)	$	9,390	$	11,849	$	11,173	$	4,457	$	1,182	$	(1,870	)	$	(1,477	)	$	(1,192	)

(1) The reserves for unpaid losses and LAE as of December 31, 2010, 2009, 2008, 2007 and 2006 are reflected before the impact of purchase accounting adjustments of $330, $555, $1,068, $1,102 and $1,602, respectively.

(2) The above table excludes reserves for unpaid losses and LAE of $206, $206, $861 and $1,000 as of December 31, 2012, 2011, 2010 and 2009, respectively, related to the Company’s previous run-off specialty reinsurance segment that is now reported in the corporate/other segment.

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A.M. Best Rating

A.M. Best rates insurance companies based on factors of concern to policyholders. In evaluating a company’s financial and operating performance, A.M. Best reviews the company’s profitability, leverage and liquidity, its book of business, the adequacy and soundness of its reinsurance programs, the quality and estimated fair value of its investments, the adequacy of its reserves and surplus, its capital structure, the experience and competence of its management, and its marketing presence. A.M. Best ratings are intended to provide an independent opinion of an insurer’s ability to meet its obligations to its policyholders. Their evaluation is not directed at investors. As of December 31, 2012, Eastern Alliance Insurance Group and Eastern Re had a financial strength rating of “A” (Excellent) with a stable outlook. An “A” (Excellent) financial strength rating is the third highest out of 16 rating classifications.

The financial strength ratings assigned by A.M. Best to the Company’s insurance subsidiaries are subject to periodic review and may be upgraded or downgraded by A.M. Best as a result of changes in the views of the rating agency or positive or adverse developments in the insurance subsidiaries’ financial condition or results of operations.

Competition

The Company’s ability to compete successfully in its principal markets is dependent upon a number of factors, many of which are outside its control. Workers’ compensation insurance is subject to significant price competition. In addition to price, competition in the workers’ compensation insurance line of business is based on quality of the products, quality and delivery of service, financial strength, ratings, distribution systems and technical expertise.

The property and casualty insurance market is highly competitive. The Company competes with stock insurance companies, mutual insurance companies, local cooperatives and other underwriting organizations. The Company considers its principal competitors to be Accident Fund Insurance Company of America, Amerisure Insurance, Brickstreet, Cincinnati Insurance Company, Companion Property & Casualty Insurance Company, Employers, Erie Insurance Group, Highmark Casualty Insurance Company, Key Risk, Lackawanna Insurance Group, Liberty Mutual Insurance Company, Old Republic Insurance Company, Travelers Insurance, Selective Insurance Group, and Zenith Insurance Company.

Investments

The Company’s investment portfolio consists of fixed income securities, convertible bonds, equity securities, and other long-term investments in various limited partnerships. The management and accounting for the Company’s investment function is outsourced to third parties. The Company has established an investment policy, approved by the Finance/Investment Committee of the Board of Directors, which has been communicated to the Company’s external investment managers. In addition, the Company has hired an independent investment consultant to oversee the Company’s investment managers and to assist the Company in setting and monitoring its investment policy. The independent investment consultant meets with the Finance/Investment Committee on at least a quarterly basis to review the Company’s investment portfolio. Management has monthly and quarterly controls in place to review the investment accounting process that is outsourced to a third party.

The Company’s investment objectives are:

• to meet insurance regulatory requirements;

• to maintain adequate liquidity in its insurance subsidiaries;

• to preserve capital through a well diversified, high quality investment portfolio; and

• to maximize after tax income while generating competitive after tax total rates of return.

The Company evaluates the performance of its investments through the use of various industry benchmarks. Benchmarks have been selected for each investment manager and/or portfolio and are reviewed on a quarterly basis by management and the Company’s Finance/Investment Committee. For the year ended December 31, 2012, the Company’s taxable equivalent total return, excluding investments held in the segregated portfolio cell reinsurance segment, net of management fees, was 5.69%.

The Company’s investments in fixed income and equity securities are classified as “available for sale” and are reported at estimated fair value, with changes in fair value reported as a component of accumulated other comprehensive income (loss), net of applicable taxes. The Company’s convertible bonds are considered hybrid financial instruments and are

13

reported at estimated fair value, with changes in fair value reported as a realized gain or loss in the consolidated statements of operations and comprehensive income (loss). The Company periodically evaluates its investments for other-than-temporary impairment. At the time an investment is determined to be other-than-temporarily impaired, the Company records a realized loss in the consolidated statements of operations and comprehensive income (loss). Any subsequent increase in the investment’s market value would be reported as an unrealized gain.

The Company’s other long-term investments include interests in various limited partnerships. The Company accounts for its limited partnership investments under the equity method. The carrying value of the Company’s limited partnership investments are based on the Company’s allocable share of the limited partnership’s net asset value. The increase or decrease in the Company’s interest in the limited partnerships is recorded in the change in equity interest in limited partnerships in the consolidated statements of operations and comprehensive income (loss).

The following table sets forth consolidated information concerning the Company’s investments as of December 31, 2012 and 2011 (in thousands).

	As of December 31,
	2012				2011
	Amortized Cost or Cost		Estimated Fair Market Value		Amortized Cost or Cost		Estimated Fair Market Value
U.S. Treasuries and government agencies	$	19,780	$	20,139	$	15,524	$	16,143
State, municipalities and political subdivisions		42,942		45,150		39,904		42,316
Corporate securities		36,624		36,941		44,748		45,498
Residential mortgage-backed securities		27,983		28,434		21,499		22,360
Commercial mortgage-backed securities		148		167		187		206
Collateralized mortgage obligations		17,009		17,122		5,753		5,876
Other structured securities		1,000		1,023		1,004		1,023
Total fixed income securities		145,486		148,976		128,619		133,422
Equity securities		20,462		23,200		16,566		17,629
Convertible bonds		18,207		19,747		16,856		17,574
Other long-term investments		7,000		9,974		8,100		10,209
Total investments	$	191,155	$	201,897	$	170,141	$	178,834

Corporate securities include an investment in a fixed income mutual fund, held by the segregated portfolio cell reinsurance segment, with a cost and estimated fair value of $26,600 and $26,656, respectively, as of December 31, 2012. The fixed income mutual fund’s investment objective is to provide a total return that is consistent with the preservation of capital through investing in high grade U.S. Dollar fixed income securities with a maximum maturity not exceeding five years.

Other structured securities include two asset-backed securities collateralized by auto loan receivables and one security in an equipment trust made up of fixed retail installment contracts and retail installment loans.

As of December 31, 2012 and 2011, the estimated fair value of the Company’s other long-term investments, by investment strategy, were as follows (in thousands):

	2012		2011
Multi-strategy fund of funds	$	6,063	$	5,578
Natural resources		—		1,262
Structured finance opportunity fund		3,278		2,769
Open-ended investment fund		633		600
Total	$	9,974	$	10,209

During 2012, the Company liquidated its interest in the natural resources fund, which is reflected in the change in equity interest in limited partnerships in the consolidated statements of operations and comprehensive income (loss).

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The gross unrealized losses and estimated fair value of fixed income securities, excluding those securities in the segregated portfolio cell reinsurance segment, classified as available-for-sale by category and length of time an individual security is in a continuous unrealized loss position as of December 31, 2012 were as follows (in thousands):

	Less Than 12 Months							12 Months or More							Total
2012	Estimated Fair Value		Gross Unrealized Losses			# of Securities		Estimated Fair Value		Gross Unrealized Losses			# of Securities		Estimated Fair Value		Gross Unrealized Losses			# of Securities
U.S. Treasuries and government agencies	$	594	$	(5	)		1	$	—	$	—			—	$	594	$	(5	)		1
States, municipalities, and political subdivisions		3,922		(31	)		17		—		—			—		3,922		(31	)		17
Residential mortgage-backed securities		11,922		(30	)		10		—		—			—		11,922		(30	)		10
Collateralized mortgage obligations		4,943		(56	)		9		122		(3	)		2		5,065		(59	)		11
Total fixed income securities		21,381		(122	)		37		122		(3	)		2		21,503		(125	)		39
Equity securities		1,034		(135	)		11		—		—			—		1,034		(135	)		11
Total fixed income and equity securities	$	22,415	$	(257	)		48	$	122	$	(3	)		2	$	22,537	$	(260	)		50

	Less Than 12 Months							12 Months or More						Total
2011	Estimated Fair Value		Gross Unrealized Losses			# of Securities		Estimated Fair Value		Gross Unrealized Losses		# of Securities		Estimated Fair Value		Gross Unrealized Losses			# of Securities
States, municipalities, and political subdivisions	$	1,604	$	(4	)		4	$	—	$	—		—	$	1,604	$	(4	)		4
Collateralized mortgage obligations		375		(11	)		2		—		—		—		375		(11	)		2
Total fixed income securities		1,979		(15	)		6		—		—		—		1,979		(15	)		6
Equity securities		3,302		(374	)		6		—		—		—		3,302		(374	)		6
Total fixed income and equity securities	$	5,281	$	(389	)		12	$	—	$	—		—	$	5,281	$	(389	)		12

Note: The Company has excluded the segregated portfolio cell reinsurance segment’s gross unrealized losses from the above table because changes in the estimated fair value of the segregated portfolio cell reinsurance segment’s fixed income and equity securities inures to the segregated portfolio cell dividend participant and, accordingly, is included in the segregated portfolio cell dividend payable and the related segregated portfolio dividend expense in the Company’s consolidated balance sheet and consolidated statement of operations, respectively. Management believes the exclusion of the segregated portfolio cell reinsurance segment from this disclosure provides a more transparent understanding of gross unrealized losses in the Company’s fixed income and equity security portfolios that could impact its consolidated financial position or results of operations.

Management has evaluated the unrealized losses related to its fixed income securities and determined that they are primarily due to a fluctuation in interest rates and not to credit issues of the issuer or the underlying assets in the case of asset-backed securities. The Company does not intend to sell the fixed income securities and it is not more likely than not that the Company will be required to sell the fixed income securities before recovery of their amortized cost bases, which may be maturity; therefore, management does not consider the fixed income securities to be other–than-temporarily impaired as of December 31, 2012.

Management has evaluated the unrealized losses related to its equity securities and determined that they are primarily related to the current market conditions and not due to underlying issues related to the issuer or the industry in which the issuer operates. The equity securities have been in an unrealized loss position for less than twelve months and none of the securities had an estimated fair value less than 80% of its cost basis. The Company does not intend to sell the equity securities and it is not more likely than not that the Company will be required to sell the equity securities before recovery of their cost bases; therefore, management does not consider the equity securities to be other-than-temporarily impaired as of December 31, 2012.

For the years ended December 31, 2012, 2011 and 2010, the Company recorded other-than-temporary impairments, excluding impairments in the segregated portfolio cell reinsurance segment, totaling $127,000, $0, and $6,000, respectively. Other-than-temporary impairments in the segregated portfolio cell reinsurance segment totaled $0, $78,000 and $80,000 for the years ended December 31, 2012, 2011 and 2010, respectively.

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As of December 31, 2012, the Company held asset-backed securities with an estimated fair value of $46.7 million. The types of underlying assets collateralizing these securities, the weighted average issuance date, average credit rating and the estimated fair value as of December 31, 2012 are as follows (in thousands):

Asset Type	Weighted Average Year of Issuance		Weighted Average Credit Rating		Estimated Fair Value
Residential mortgage-backed securities (RMBS)		2011		AAA	$	28,434
Commercial mortgage-backed securities (CMBS)		2006		AAA		167
Collateralized mortgage obligations (CMO)		2010		AAA		17,122
Auto loan receivables		2010		AAA		664
Equipment trust		2011		AAA		359
Total					$	46,746

The Company held 47 RMBS securities as of December 31, 2012, all of which were rated AAA. These securities were all issued by government agencies.

The Company held 27 CMO securities as of December 31, 2012, all of which were rated AAA, except for two securities with a CC rating. The amortized cost and estimated fair value of the two CC-rated securities totaled $124,000 and $122,000 as of December 31, 2012, respectively.

The Company held one CMBS security as of December 31, 2012, which was rated AAA.

The Company held two securities collateralized by auto loan receivables as of December 31, 2012, both of which were rated AAA.

The Company held one security in an equipment trust made up of fixed rate retail installment sale contracts and retail installment loans as of December 31, 2012, which was rated AAA.

As of December 31, 2012, the Company held insurance enhanced securities, net of pre-refunded municipal bonds that are escrowed in U.S. government obligations, with an estimated fair value of $14.2 million, which represents approximately 7.0% of the Company’s total investments as of December 31, 2012. Municipal bonds made up 100% of the insurance enhanced securities.

The following table provides a breakdown of the ratings for these insurance enhanced securities, net of pre-refunded municipal bonds, with and without insurance, at estimated fair value (in thousands):

Ratings	Ratings With Insurance		Ratings Without Insurance
AA	$	13,059	$	12,324
A		1,103		1,838
BBB		38		38
Total	$	14,200	$	14,200

These securities had an average credit rating of AA with and without the insurance enhancement as of December 31, 2012.

The Company’s indirect exposure to third party insurers, by percentage of estimated fair value as of December 31, 2012, was as follows:

Insurer	Percentage of Estimated Fair Value
National Re		31.9	%
Assured Guaranty Municipal Corporation		31.6	%
National Re FGIC		22.7	%
AMBAC Financial Group, Inc.		11.4	%
Financial Guaranty Insurance Company		2.4	%
Total		100.0	%

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The following table shows the ratings distribution of the Company’s fixed income securities and convertible bonds, excluding fixed income securities of the segregated portfolio cell reinsurance segment, as a percentage of the estimated fair value of the fixed income and convertible bond portfolio as of December 31, 2012 (dollars in thousands).

	Estimated Fair Value		Percentage of Total
“AAA”	$	67,938		49.3	%
“AA”		36,689		26.6	%
“A”		17,184		12.5	%
“BBB”		10,382		7.5	%
Below Investment Grade		5,600		4.1	%
Total	$	137,793		100.0	%

Note: The Company has excluded the segregated portfolio cell reinsurance segment’s investment credit ratings from the above table because management believes the exclusion of the credit ratings of the segregated portfolio cell reinsurance segment’s fixed income securities provides a more transparent understanding of the underlying risk in the Company’s fixed income and convertible bond portfolios. Also, the Company has reported securities issued and/or guaranteed by the United States Government in the “AAA” classification. As of December 31, 2012, these securities were rated “AAA” by Moody’s and Fitch and “AA” by S&P.

The amortized cost and estimated fair value of fixed income securities and convertible bonds, excluding fixed income securities held by the segregated portfolio cell reinsurance segment, as of December 31, 2012, by contractual maturity, are shown below (in thousands). Expected maturities could differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties.

	Amortized Cost		Estimated Fair Value
Less than one year	$	10,908	$	11,184
One through five years		34,153		35,621
Five through ten years		24,094		25,344
Greater than ten years		16,530		17,829
Mortgage/asset-backed securities		46,140		46,745
Total	$	131,825	$	136,723

Company Web Sites

The Company operates two Web sites. The Company’s Corporate Web site (www.eihi.com) provides investor relations information and news. We make our annual report on Form 10-K, our quarterly reports on Form 10-Q, and our current reports on Form 8-K, and any amendments to those reports available, free of charge, on this website as soon as reasonably practical after they are filed with or furnished to the SEC. EAIG’s Web site (www.eains.com) provides information and news regarding workers’ compensation insurance products and services, in addition to secured content accessible to agents and insureds. The secured sections include a risk management library that allows EAIG’s risk management personnel to disseminate safety information quickly and effectively to agents and insureds.

Employees

As of December 31, 2012, the Company had 220 employees. The Company’s employees are not represented by a union. The Company considers its relationship with its employees to be excellent.

Regulation

General

Insurance companies are subject to supervision and regulation in the jurisdictions in which they conduct business. Insurance authorities in each jurisdiction have broad administrative powers to administer statutes and regulations with respect to all aspects of the insurance business, including:

• licensing of insurers and their agents;

• approval of policy forms and premium rates;

• mandating certain insurance benefits;

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• standards of solvency, including establishing statutory and risk-based capital requirements for statutory surplus;

• classifying assets as admissible for purposes of determining statutory surplus;

• regulating unfair trade and claim practices, including through the imposition of restrictions on marketing and sales practices, distribution arrangements and payment of inducements;

• restrictions on the nature, quality and concentration of investments;

• assessments by guaranty and other associations;

• restrictions on the ability of insurance companies to pay dividends;

• restrictions on transactions between insurance companies and their affiliates;

• restrictions on acquisitions and dispositions of insurance companies;

• restrictions on the size of risks insurable under a single policy;

• requiring deposits for the benefit of policyholders;

• requiring certain methods of accounting;

• conducting periodic examinations of insurance company operations and finances;

• reviewing claims administration practices;

• prescribing the form and content of records of financial condition required to be filed; and

• requiring reserves for unearned premiums, losses and other purposes.

State insurance laws and regulations require insurance companies to file financial statements with insurance departments everywhere they do business, and the operations of insurance companies are subject to examination by those departments at any time. EIHI’s domestic insurance subsidiaries prepare statutory financial statements in accordance with accounting practices and procedures prescribed or permitted by these departments.

Examinations

Examinations of EIHI’s insurance subsidiaries are conducted by the domiciliary insurance department every three to five years. The Pennsylvania Insurance Department is currently performing a financial examination of Eastern Alliance, Allied Eastern and Eastern Advantage as of and for the five-year period ending December 31, 2011. The Indiana Insurance Department is currently performing a financial examination of Employers Security as of and for the two-year period ending December 31, 2011. The Indiana Insurance Department is performing its examination in order to get on the same examination rotation as the Pennsylvania Insurance Department. The examinations are in process and have not been completed. The Pennsylvania Insurance Department’s most recent examinations of Eastern Alliance and Allied Eastern for which a report was issued were as of December 31, 2006. The Indiana Insurance Department’s most recent examination of Employers Security for which a report was issued was as of December 31, 2009. These examinations did not result in any adjustments to the financial position of the insurance companies. In addition, there were no substantive qualitative matters indicated in the examination reports that had a material adverse impact on the Company’s operations. The Pennsylvania Insurance Department conducted an organizational examination of Eastern Advantage as of October 24, 2007.

Risk-Based Capital Requirements

Pennsylvania and Indiana impose the NAIC risk-based capital requirements that require insurance companies to calculate and report information under a risk-based formula. These risk-based capital requirements attempt to measure statutory capital and surplus needs based on the risks in an insurance company’s mix of products and investment portfolio. Under the formula, a company first determines its “authorized control level” risk-based capital. This authorized control level takes into account (i) the risk with respect to the insurer’s assets; (ii) the risk of adverse insurance experience with respect to the insurer’s liabilities and obligations; (iii) the interest rate risk with respect to the insurer’s business; and (iv) all other business and other relevant risks as are set forth in the risk-based capital instructions. The capital levels of EIHI’s insurance subsidiaries exceeded minimum statutory capital and surplus requirements as of December 31, 2012.

Market Conduct Regulation

State insurance laws and regulations include numerous provisions governing trade practices and the marketplace activities of insurers, including provisions governing the form and content of disclosure to consumers, illustrations, advertising, sales practices and complaint handling. State regulatory authorities generally enforce these provisions through periodic market conduct examinations. To our knowledge, the Company is currently in compliance with these provisions.

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Sarbanes-Oxley Act of 2002

The Company is subject to the Sarbanes-Oxley Act of 2002, which implemented legislative reforms intended to address corporate and accounting fraud. Among other reforms, the Sarbanes-Oxley Act requires chief executive officers and chief financial officers, or their equivalent, to certify to the accuracy of periodic reports filed with the SEC, subject to civil and criminal penalties if they knowingly or willfully violate this certification requirement. The Sarbanes-Oxley Act also increases the oversight of, and codifies, certain requirements relating to audit committees of public companies and how they interact with the company’s auditors. Audit committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees from the Company. In addition, companies must disclose whether at least one member of the committee is a “financial expert,” as such term is defined by the SEC, and if not, why not. Pursuant to the Sarbanes-Oxley Act, the SEC has adopted rules requiring inclusion of an internal control report and assessment by management in the annual report to shareholders. The Sarbanes-Oxley Act requires the auditor that issues the audit report to perform an audit of the effectiveness of internal control over financial reporting that is integrated with the audit of the financial statements.

Insurance Guaranty Funds

Almost all states have guaranty fund laws under which insurers doing business in the state can be assessed to fund policyholder liabilities of insolvent insurance companies. Pennsylvania, Indiana and the other states in which our insurance companies conduct business have such laws. Under these laws, an insurer is subject to assessment depending upon its market share in the state of a given line of business. The most significant assessment fund to which the Company is subject is the Pennsylvania Workers’ Compensation Security Fund (the “Security Fund”), which assesses workers’ compensation insurers doing business in Pennsylvania for the purpose of providing funds to cover obligations to policyholders of insolvent insurance companies. The maximum assessment the Security Fund can impose is equal to 1.0% of the Company’s net workers’ compensation insurance premiums written in Pennsylvania in the year of assessment. The Company would establish reserves relating to specific insurance company insolvencies upon notification of an assessment by the respective state guaranty association. We cannot predict the amount or timing of any future assessments under these laws.

Cayman Islands Regulation

Eastern Re is organized and licensed as a Cayman Islands unrestricted Class B insurance company and is subject to regulation by the Cayman Islands Monetary Authority. Applicable laws and regulations govern the types of policies that the Company can insure or reinsure, the amount of capital that it must maintain and the way it can be invested, and the payment of dividends without approval by the Cayman Islands Monetary Authority. Eastern Re is required to maintain minimum capital of $120,000.

Holding Company Regulation

EIHI is registered as an insurance holding company under the Insurance Holding Company Act amendments to the Pennsylvania Insurance Code of 1921, as amended, and is subject to regulation and supervision by the Pennsylvania Insurance Department. EIHI is required to annually file a report of its operations with, and is subject to examination by, the Pennsylvania Insurance Department.

Each insurance company in a holding company system is required to register with the insurance supervisory agency of its state of domicile and furnish certain information. This includes information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system. Pursuant to these laws, the respective insurance departments may examine insurance companies and their holding companies at any time, require disclosure of material transactions by insurance companies and their holding companies and require prior notice or approval of certain transactions, such as “extraordinary dividends” distributed by insurance companies.

All transactions within the holding company system affecting insurance companies and their holding companies must be fair and equitable. Notice of certain material transactions between insurance companies and any person or entity in their holding company system will be required to be given to the applicable insurance commissioner. In some states, certain transactions cannot be completed without the prior approval of the insurance commissioner.

Approval by the state insurance commissioner is required prior to any transaction affecting the control of an insurer domiciled in that state. In Pennsylvania, the acquisition of 10% or more of the outstanding capital stock of an insurer or its holding company is presumed to be a change in control. Pennsylvania law also prohibits any person from (i) making a tender

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offer for, or a request or invitation for tenders of, or seeking to acquire or acquiring any voting security of a Pennsylvania insurer if, after the acquisition, the person would be in control of the insurer, or (ii) effecting or attempting to effect an acquisition of control of or merger with a Pennsylvania insurer, unless the offer, request, invitation, acquisition, effectuation or attempt has received the prior approval of the Insurance Department.

Dividend Restrictions

EIHI’s ability to declare and pay dividends will depend in part on dividends received from its insurance subsidiaries. Our domestic insurance subsidiaries’ ability to pay dividends to the Company is limited by the insurance laws and regulations of Pennsylvania and Indiana. The maximum annual dividends that the domestic insurance entities may pay without prior approval from the Pennsylvania or Indiana Insurance Departments is limited to the greater of 10% of statutory surplus or 100% of statutory net income for the most recently filed annual statement, or $10.0 million in 2013. The maximum dividend that may be paid by Eastern Alliance, Allied Eastern and Eastern Advantage in 2013, without prior approval from the Pennsylvania Insurance Department, is $5.7 million, $2.0 million and $1.0 million, respectively. The maximum dividend that may be paid by Employers Security in 2013, without prior approval from the Indiana Insurance Department, is $1.3 million.

Eastern Re must receive approval from the Cayman Islands Monetary Authority before it can pay any dividend to EIHI.

Note on Forward-Looking Statements

This document contains forward-looking statements, which can be identified by the use of such words as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect” and similar expressions. These forward-looking statements include:

• statements of goals, intentions and expectations;

• statements regarding prospects and business strategy; and

• estimates of future costs, benefits and results.

These forward-looking statements are subject to significant risks, assumptions and uncertainties, including, among other things, the factors discussed under the heading “Risk Factors” that could affect the actual outcome of future events.

All of these factors are difficult to predict and many are beyond our control. These important factors include those discussed under “Risk Factors” and those listed below:

• the ability to carry out our business plans;

• future economic conditions in the regional and national markets in which we compete that are less favorable than expected;

• the effect of legislative, judicial, economic, demographic and regulatory events in the states in which we do business;

• the ability to obtain licenses and enter new markets successfully and capitalize on growth opportunities either through mergers or the expansion of our agency network;

• financial market conditions, including, but not limited to, changes in interest rates and the credit and equity markets causing a reduction of investment income or investment gains, an acceleration of the amortization of deferred policy acquisition costs, reduction in the value of our investment portfolio or a reduction in the demand for our products;

• the impact of acts of terrorism and acts of war;

• the effects of terrorist related insurance legislation and laws;

• changes in general economic conditions, including inflation, unemployment, interest rates and other factors;

• the cost, availability and collectibility of reinsurance;

• estimates and adequacy of loss reserves and trends in losses and LAE;

• heightened competition, including specifically the intensification of price competition, increased underwriting capacity and the entry of new competitors and the development of new products by new and existing competitors;

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• the effects of mergers, acquisitions and dispositions;

• changes in the coverage terms selected by insurance customers, including higher deductibles and lower limits;

• changes in the underwriting criteria that we use resulting from competitive pressures;

• our inability to obtain regulatory approval of, or to implement, premium rate increases;

• the potential impact on our reported earnings that could result from the adoption of future accounting standards issued by the Financial Accounting Standards Board or other standard-setting bodies;

• our inability to carry out marketing and sales plans, including, among others, development of new products or changes to existing products and acceptance of the new or revised products in the market;

• unanticipated changes in industry trends and ratings assigned by nationally recognized rating organizations;

• adverse litigation or arbitration results including, without limitation, the AIG Arbitration; and

• adverse changes in applicable laws, regulations or rules governing insurance holding companies and insurance companies, and tax or accounting matters including limitations on premium levels, increases in minimum capital and reserves, and other financial viability requirements, and changes that affect the cost of, or demand for our products.

Because forward-looking information is subject to various risks and uncertainties, actual results may differ materially from that expressed or implied by the forward-looking information. Therefore, we caution you not to place undue reliance on this forward-looking information.

All subsequent written and oral forward-looking information attributable to the Company or any person acting on our behalf is expressly qualified in its entirety by the cautionary statements contained or referred to in this section. We do not undertake any obligation to publicly release any revisions that may be made to any forward-looking statements.

Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. The Company has no obligation to update or revise any forward-looking statements to reflect any changed assumptions, any unanticipated events or any changes in the future.

Item 1A—Risk Factors

Our business is subject to numerous risks and uncertainties, the outcome of which may impact future results of operations and financial condition. These risks are as follows:

Risk Factors Relating to Our Business

Our results may be adversely affected if our actual losses exceed our loss reserves.

The Company maintains loss reserves to cover estimated amounts needed to pay for insured losses and for the LAE necessary to settle claims with respect to insured events that have occurred, including events that have not yet been reported to us. Estimating the reserves for unpaid losses and LAE is a difficult and complex process involving many variables and subjective judgments; reserves do not represent an exact measure of liability. Accordingly, our loss reserves may prove to be inadequate to cover our actual losses. We regularly review our reserving techniques and our overall amount of reserves. We review historical data and consider the impact of various factors such as:

• trends in claim frequency and severity;

• information regarding each claim for losses;

• legislative enactments, judicial decisions and legal developments regarding damages; and

• trends in general economic conditions, including inflation and levels of employment.

If we determine that our reserves for unpaid losses and LAE are inadequate, we will have to increase them. This adjustment would reduce income during the period in which the adjustment is made, which could have a material adverse impact on our financial condition and results of operations. For additional information, see “Item 1—Business, Loss and LAE Reserves” and “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations, Critical Accounting Polices and Estimates.”

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If we do not accurately establish our premium rates, our results of operations may be adversely affected.

In general, the premium rates for our insurance policies are established when coverage is initiated and therefore, before all of the underlying costs are known. Like other insurance companies, we rely on estimates and assumptions in setting our premium rates. Establishing adequate rates is necessary, together with investment income, to generate sufficient revenue to offset losses, LAE and other underwriting expenses and to earn a profit. If we fail to accurately assess the risks that we assume, we may fail to charge adequate premium rates to cover our losses and expenses, which could reduce income and cause us to become unprofitable. As a result, our actual costs for providing insurance coverage to our policyholders may be significantly higher than our premiums.

In order to set premium rates accurately, we must collect and properly analyze a substantial volume of data; develop, test, and apply appropriate rating formulae; closely monitor and recognize changes in trends; project both severity and frequency of losses with reasonable accuracy; and estimate customer retention. Customer retention represents the amount of exposure a policyholder retains on any one risk or group of risks. The term may apply to an insurance policy, where the policyholder is an individual, family or business, or a reinsurance policy, where the policyholder is an insurance company. We must also implement our pricing accurately in accordance with our assumptions. For example, as we expand the geographic market in which we offer our workers’ compensation insurance products we may not price these products accurately or adequately. Our ability to undertake these efforts successfully, and as a result set premium rates accurately, is subject to a number of risks and uncertainties, including:

• inaccurate assessment of new markets in which we have little or no prior experience;

• insufficient or unreliable data;

• incorrect or incomplete analysis of available data;

• uncertainties generally inherent in estimates and assumptions;

• our inability to implement appropriate rating formula or other pricing methodologies;

• costs of ongoing medical treatment;

• our inability to accurately estimate customer retention, investment yields and the duration of our liability for losses and LAE; and

• unanticipated court decisions, legislation or regulatory action.

Consequently, we could set our premium rates too low, which could negatively affect our results of operations and our profitability, or we could set our premium rates too high, which could reduce our ability to obtain new or retain existing business and lead to lower net premiums earned.

If we do not effectively manage the growth of our operations we may not be able to compete or operate profitably.

Our growth strategy includes enhancing our market share in our existing markets, entering new geographic markets, introducing new insurance products and programs, further developing our agency relationships, and pursuing merger and acquisition opportunities. Our strategy is subject to various risks, including risks associated with our ability to:

• identify profitable new geographic markets to enter;

• obtain licenses in new states in which we wish to market and sell our products;

• successfully implement our underwriting, pricing, claims management, and product strategies over a larger operating region;

• properly design and price new and existing products and programs and reinsurance facilities;

• identify, train and retain qualified employees;

• identify, recruit and integrate new independent agents;

• formulate and execute a merger and acquisition strategy; and

• augment our internal monitoring and control systems as we expand our business.

We also may encounter difficulties in the implementation of our growth strategies, including unanticipated expenditures. In addition, our growth strategies may result in us entering into markets or product lines in which we have little or no prior experience. Any such difficulties could result in diversion of senior management time and adversely affect our financial results.

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Our ability to manage our exposure to underwriting risks depends on the availability and cost of reinsurance coverage.

We use reinsurance arrangements to limit and manage the amount of risk we retain, to stabilize our underwriting results and to increase our underwriting capacity. Although we have not recently experienced difficulty in obtaining reinsurance at reasonable prices, the availability and cost of reinsurance is subject to current market conditions and may vary significantly over time. Any decrease in the amount of our reinsurance will increase our risk of loss. We may be unable to maintain our desired reinsurance coverage or to obtain other reinsurance coverage in adequate amounts and at favorable rates. If we are unable to renew our expiring coverage or obtain new coverage, it will be difficult for us to manage our underwriting risks and operate our business profitably.

It is also possible that the losses we experience on insured risks for which we have obtained reinsurance will exceed the coverage limits of the reinsurance. If the amount of our reinsurance coverage is insufficient, our insurance losses could increase substantially.

If our reinsurers do not pay our claims in a timely manner, we may incur losses.

We are subject to credit risk with respect to the reinsurers with whom we deal because buying reinsurance does not relieve us of our liability to policyholders. The Company had net reinsurance recoverables of $19.7 million as of December 31, 2012. If our reinsurers are not capable of fulfilling their financial obligations to us, including the inability to secure the necessary collateral provided under the reinsurance agreements, our insurance losses would increase, which would negatively affect our financial condition and results of operations.

Our investment performance may suffer as a result of adverse capital market developments, which may affect our financial results and ability to conduct business.

We invest the premiums we receive from policyholders until cash is needed to pay insured claims or other expenses. As of December 31, 2012, the Company held investments with an estimated fair value of $201.9 million. For the year ended December 31, 2012, the Company had $3.9 million of net investment income, representing 2.3% of its total revenues. Our investments are subject to a variety of investment risks, including risks relating to general economic conditions, market volatility, interest rate fluctuations, liquidity risk and credit risk. In particular, an unexpected increase in the volume or severity of claims may force us to liquidate investments, which may cause us to incur capital losses. If we do not structure the duration of our investments to match our insurance and reinsurance liabilities, we may be forced to liquidate investments prior to maturity at a significant loss to cover such payments. Investment losses could significantly decrease our asset base and statutory surplus, thereby affecting our ability to conduct business.

Our revenues may fluctuate with changes in interest rates.

Our investment portfolio contains a significant amount of fixed income securities, including bonds, mortgage-backed securities (“MBSs”), collateralized mortgage obligations (“CMOs”), and other asset-backed securities. The market values of all of our investments fluctuate depending on economic and political conditions and other factors beyond our control. The market values of our fixed income securities are particularly sensitive to changes in interest rates.

For example, if interest rates rise, fixed income securities generally will decrease in value. If interest rates decline, these securities generally will increase in value, except for MBSs, which may decline due to higher prepayments on the mortgages underlying the securities.

As of December 31, 2012, MBSs, including CMOs, constituted 22.6% of the estimated fair value of the Company’s investment portfolio. MBSs and CMOs are subject to prepayment risks that vary with, among other things, interest rates. During periods of declining interest rates, MBSs generally prepay faster as the underlying mortgages are prepaid and/or refinanced by the borrowers in order to take advantage of lower interest rates. MBSs that have an amortized cost that is greater than par (i.e., purchased at a premium) may incur a reduction in yield or a loss as a result of prepayments. In addition, during such periods, we generally will be unable to reinvest the proceeds of any prepayment at comparable yields. Conversely, during periods of rising interest rates, the frequency of prepayments generally decreases, and we may receive interest payments that are below the then prevailing interest rate for longer than expected. MBSs that have an amortized cost that is less than par (i.e., purchased at a discount) may incur a decrease in yield or a loss as a result of slower prepayments.

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If we fail to comply with insurance industry regulations, or if those regulations become more burdensome, we may not be able to operate profitably.

Our insurance subsidiaries are regulated by government agencies in the states in which we conduct business, and we must comply with a number of state and federal laws and regulations. Most insurance regulations are intended to protect the interests of policyholders rather than those of shareholders and other investors.

If we fail to comply with these laws and regulations, state insurance departments can exercise a range of remedies from the imposition of fines to being placed in rehabilitation or liquidation. State insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to financial condition, holding company issues and other matters. These regulatory requirements may adversely affect or inhibit our ability to achieve some or all of our business objectives.

Part of our strategy includes expanded licensing and product filings for the Company. Regulatory authorities, however, have broad discretion to deny or revoke licenses for various reasons, including the violation of regulations. If we do not have or obtain the requisite licenses and approvals or do not comply with applicable regulatory requirements, insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities, including our expansion objectives, or otherwise penalize us. Furthermore, changes in the level of regulation of the insurance industry or changes in laws or regulations or interpretations of such laws and regulations by regulatory authorities could adversely affect our ability to operate our business.

We are subject to various accounting and financial requirements established by the NAIC. Eastern Re is subject to the laws of the Cayman Islands and regulations promulgated by the Cayman Islands Monetary Authority. Failure to comply with these laws, regulations and requirements could result in consequences ranging from a regulatory examination to a regulatory takeover of one or more of our insurance subsidiaries. This would make our business less profitable. In addition, state regulators and the NAIC continually re-examine existing laws and regulations, with an emphasis on insurance company solvency issues and fair treatment of policyholders. Insurance laws and regulations could change or additional restrictions could be imposed that are more burdensome and make our business less profitable. Because these laws and regulations are for the protection of policyholders, any changes may not be in your best interest as a shareholder.

Compliance with applicable laws and regulations is time consuming and personnel-intensive, and changes in these laws and regulations may materially increase our direct and indirect compliance and other expenses of doing business, thus adversely affecting our financial condition and results of operations.

Workers’ compensation insurance markets in which we operate are highly competitive.

Competition in these markets is based on many factors. These factors include the perceived financial strength of the insurer, premiums charged, policy terms and conditions, services provided, reputation, financial ratings assigned by independent rating agencies and the experience of the insurer in the line of insurance to be written. The Company’s insurance subsidiaries compete with stock insurance companies, mutual companies, local cooperatives and other underwriting organizations. We consider our principal competitors to be Accident Fund Insurance Company of America, Amerisure Insurance, Brickstreet, Cincinnati Insurance Company, Companion Property & Casualty Insurance Company, Employers, Erie Insurance Group, Highmark Casualty Insurance Company, Key Risk, Lackawanna Insurance Group, Liberty Mutual Insurance Company, Old Republic Insurance Company, Travelers Insurance, Selective Insurance Group and Zenith Insurance Company. The workers’ compensation line of insurance is subject to significant price competition. If competitors price their products aggressively, our ability to grow or renew our business may be adversely affected. We pay agents on a commission basis to produce business. Some competitors may offer higher commissions to independent agents or offer insurance at lower premium rates through the use of salaried personnel or other distribution methods that do not rely on independent agents. Increased competition could adversely affect our ability to attract and retain business and thereby reduce our profits from operations.

We could be adversely affected by the loss of our key personnel.

The success of our business is dependent, to a large extent, on the efforts of certain key personnel, in particular, Michael L. Boguski, our President and Chief Executive Officer, Kevin M. Shook, our Executive Vice President, Treasurer and Chief Financial Officer, Robert A. Gilpin, our Senior Vice President of Marketing and Field Operations, Suzanne M. Emmet, our Senior Vice President of Claims and Corporate Compliance, and Cynthia Sklar, Senior Vice President, Underwriting and Risk Management. We have employment agreements with each of Messrs. Boguski, Shook, Gilpin, Ms. Emmet and

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Ms. Sklar, which contain covenants not to compete. We do not maintain key man life insurance on any of these executives. The loss of key personnel could prevent us from fully implementing our business strategy and could significantly and negatively affect our financial condition and results of operations. As we continue to grow, we will need to recruit and retain additional qualified management personnel, and our ability to do so will depend upon a number of factors, such as our results of operations and prospects and the level of competition then prevailing in the market for qualified personnel. The current market for qualified insurance personnel is highly competitive.

Our results of operations may be adversely affected by any loss of business from key agents and by the creditworthiness of our agents.

Our products are marketed by independent agents. Other insurance companies compete with the Company for the services and allegiance of these agents. Because they are independent, these agents are not obligated to direct business to the Company and may choose to direct business to our competitors, or may direct less desirable risks to us. The Company’s ten largest agents in its workers’ compensation insurance segment accounted for 53.2% of its direct premiums written for the year ended December 31, 2012. The Company’s largest agent, Keystone Insurers Group, accounted for 10.1% of direct premiums written for the year ended December 31, 2012. No other agent accounted for more than 10.0% of direct premiums written in the Company’s workers’ compensation insurance segment for the year ended December 31, 2012. If premium volume produced by any of the Company’s large agents were to decrease significantly, it would have a material adverse effect on us.

In addition, in accordance with industry practice, our customers sometimes pay the premiums for their policies to agents for payment to us. These premiums are considered paid when received by the agent and, thereafter, the customer is no longer liable to us for those amounts, whether or not we have actually received the premiums from the agent. Consequently, we assume a degree of credit risk associated with our reliance on agents in connection with the collection of insurance premiums.

If we are unable to collect receivables created as a result of our sale of Atlantic RE and Eastern Life, we could recognize a loss.

In connection with the sale of Atlantic RE, a portion of the purchase price consisted of a contingent profit commission of $3.0 million, payable upon the earlier of extinguishment of all Atlantic RE’s reinsurance obligations, commutation of those obligations, or ten years from the date of closing (December 9, 2020). The amount of the contingent profit commission is based upon the adequacy of the Company’s loss and LAE reserves as of September 30, 2010 compared to a predetermined targeted amount of loss and LAE reserves. The Company has recorded a receivable for the contingent profit commission on its consolidated balance sheet as of December 31, 2012. However, the ultimate amount of the contingent profit commission payment is dependent upon the amount of future claims incurred and the ability of the purchaser to manage the outstanding claims, both of which are outside the control of the Company. Accordingly, no assurance can be given that the Company will be collect all or any of the contingent profit commission in the future. If the Company determines at any future date that all or any portion of the contingent profit commission will not be collected, the Company will recognize a loss in the period in which such determination is made.

In connection with the sale of Eastern Life to Security Life Insurance Company of America (“Security Life”), a portion of the purchase price was payable by the delivery to Eastern Life by Security Life’s parent corporation, Security American Financial Enterprises, Inc. (“Security American”), of a three-year $1.75 million promissory note payable in full at maturity in 2013. The ability of Security American to repay the promissory note will be dependent upon its financial condition and the financial condition of Security Life when the note matures. If Security American is unable to repay the note at maturity, or if Security American’s financial condition deteriorates prior to the maturity date and it is more likely than not that they will be unable to repay the note, the Company will incur a loss.

Because the Company’s workers’ compensation insurance business is concentrated in Pennsylvania, the Company is subject to local economic risks as well as to changes in the regulatory and legal climate in Pennsylvania.

For the year ended December 31, 2012, 65.2% of the Company’s workers’ compensation premium was written in Pennsylvania. The Company’s workers’ compensation insurance business is affected by the economic health of Pennsylvania for two principal reasons. First, premium growth is dependent upon payroll growth, which, in turn, is affected by economic conditions. Second, losses and LAE can increase in weak economic conditions because it is more difficult to return injured workers to the job when employers are otherwise reducing payrolls. Finally, as a result of the Company’s high concentration of Pennsylvania business, the Company can be adversely affected by any material change in Pennsylvania law or regulation or any Pennsylvania court decision affecting workers’ compensation carriers generally.

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Future changes in financial accounting standards or practices or existing tax laws may adversely affect our reported results of operations.

Financial accounting standards in the United States are constantly under review and may be changed from time to time. We would be required to apply these changes when adopted. Once implemented, these changes could materially affect our results of operations and/or the way in which such results of operations are reported. Similarly, we are subject to taxation in the United States and a number of state jurisdictions. Rates of taxation, definitions of income, exclusions from income, and other tax policies are subject to change over time. Eastern Re is domiciled in the Cayman Islands. Changes in Cayman Islands tax laws could have a material impact on our consolidated results of operations.

Proposals to federally regulate the insurance business could affect our business.

Currently, the U.S. federal government does not directly regulate the insurance business. However, federal legislation and administrative policies in several areas can significantly and adversely affect insurance companies. These areas include financial services regulation, securities regulation, pension regulation, privacy, tort reform legislation and taxation. In addition, various forms of direct federal regulation of insurance have been proposed. These proposals include the State Modernization and Regulatory Transparency Act, which would maintain state-based regulation of insurance but would affect state regulation of certain aspects of the insurance business, including rates, agency and company licensing, and market conduct examinations, and the National Insurance Act of 2007, which would provide for optional federal charters for insurance companies. We cannot predict whether this or other proposals will be adopted, or what impact, if any, such proposals or, if enacted, such laws may have on our business, financial condition or results of operations.

Risk Factors Relating to Our Common Stock

Directors and management could effectively control certain situations that may be viewed as contrary to your interests.

The extent of management’s control over the Company is related to the following factors:

• Directors and management owned approximately 18.3% of the Company’s outstanding stock as of December 31, 2012.

• The employee stock ownership plan (“ESOP”) owns 8.75%, or 692,030 shares, of the Company’s outstanding stock as of December 31, 2012. The shares held by the ESOP will be voted in the manner directed by the ESOP participants.

• We have implemented a stock compensation plan pursuant to which shares of restricted stock and stock options have been issued to certain of our directors, officers and employees.

As a result of these factors, the Company’s directors and management, directly or indirectly, hold a substantial equity interest in the Company. If all members of management were to act together as a group, they could have a significant influence over the outcome of the election of directors and any other shareholder vote. Therefore, management might have the power to take actions that nonaffiliated shareholders may deem to be contrary to the shareholders’ best interests.

Provisions in our articles and bylaws and statutory provisions may serve to entrench management and also may discourage takeover attempts that you may believe are in your best interests.

We are subject to provisions of Pennsylvania corporate and insurance law that hinder a change of control. Pennsylvania law requires the Pennsylvania Insurance Department’s prior approval of a change of control of an insurance holding company. Under Pennsylvania law, the acquisition of 10% or more of the outstanding capital stock of an insurer or its holding company is presumed to be a change in control. Approval by the Pennsylvania Insurance Department may be withheld even if the transaction would be in the shareholders’ best interest if, among other things, the Pennsylvania Insurance Department determines that the transaction would be detrimental to policyholders.

Our articles of incorporation and bylaws also contain provisions that may discourage a change in control. These provisions include:

• a classified Board of Directors divided into three classes serving for successive terms of three years each;

• a provision that the Board of Directors has the authority to issue shares of authorized but unissued common stock and preferred stock and to establish the terms of any one or more series of preferred stock, including voting rights, without additional shareholder approval;

26

• the prohibition of cumulative voting in the election of directors;

• the requirement that nominations for the election of directors made by shareholders and any shareholder proposals for inclusion on the agenda at any annual meeting must be made by notice (in writing) delivered or mailed to us not less than 90 days or more than 120 days prior to the meeting;

• the prohibition of shareholder action without a meeting and the prohibition of shareholders being able to call a special meeting;

• the requirement that certain provisions of our articles of incorporation can only be amended by an affirmative vote of shareholders entitled to cast at least 80% of all votes that shareholders are entitled to cast, unless approved by an affirmative vote of at least 80% of the members of the Board of Directors; and

• the requirement that certain provisions of our bylaws can only be amended by an affirmative vote of shareholders entitled to cast at least 66 2/3%, or in certain cases 80%, of all votes that shareholders are entitled to cast.

These provisions may serve to entrench management and may discourage a takeover attempt that you may consider to be in your best interest or in which you would receive a substantial premium over the current market price. These provisions may make it extremely difficult for any one person or group of affiliated persons to acquire voting control of the Company, with the result that it may be extremely difficult to bring about a change in the Board of Directors or management. Some of these provisions also may perpetuate present management because of the additional time required to cause a change in the control of the board. Other provisions make it difficult for shareholders owning less than a majority of the voting stock to be able to elect even a single director.

Provisions of the Pennsylvania Business Corporation Law (“PBCL”), which we refer to as the PBCL, that are applicable to publicly traded companies provide, among other things, that we may not engage in a business combination with an “interested shareholder” during the five-year period after the interested shareholder became such, except under certain specified circumstances. Under the PBCL, an interested shareholder is generally a holder of 20% or more of our voting stock. The PBCL also contains provisions providing for the ability of shareholders to object to the acquisition by a person, or group of persons acting in concert, of 20% or more of our outstanding voting securities and to demand that they be paid a cash payment for the fair value of their shares from the controlling person or group.

If our insurance subsidiaries are not sufficiently profitable, our ability to pay dividends will be limited by regulatory restrictions.

Our domestic insurance subsidiaries’ ability to pay dividends to the Company is limited by the insurance laws and regulations of Pennsylvania and Indiana. The maximum dividend that the domestic insurance entities may pay without prior approval from the Pennsylvania Insurance Department and the Indiana Insurance Department is limited to the greater of 10% of statutory surplus or 100% of statutory net income for the most recently filed annual statement.

Eastern Re must receive approval from the Cayman Islands Monetary Authority before it can pay any dividend. Furthermore, any dividends paid in excess of Eastern Re’s cumulative earnings and profits subsequent to June 16, 2006, the date on which Eastern Re became an United States owned foreign corporation, would be subject to U.S. federal income tax.

Item 1B—Unresolved Staff Comments

None.

Item 2—Properties

The Company’s corporate headquarters and its Mid-Atlantic Regional Office are located at 25 Race Avenue in Lancaster, Pennsylvania. The Company leases its home office building under a 15-year, non-cancelable operating lease through February 2017. The base rent is subject to an annual increase based upon the consumer price index at the end of each preceding calendar year. In addition to the base rent, the Company is responsible for its proportionate share of expenses related to the building including, but not limited to, utilities, maintenance, real estate taxes, and insurance. The Company has a 5% interest in the limited partnership that owns the building.

The Company’s other regional offices are located in Charlotte, North Carolina (Southeast Region), Indianapolis, Indiana (Midwest Region), and Madison, Mississippi (Gulf South Region). The Company has satellite offices located in Wexford, Pennsylvania (Mid-Atlantic Region), Franklin, Tennessee (Southeast Region) and Richmond, Virginia (Southeast Region).

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These offices are leased by the Company under multi-year operating leases. The Company also has an office located in Camp Hill, Pennsylvania, which serves as the Company’s data back-up and recovery site, as well as additional office space for the Mid-Atlantic Regional Office.

The home office building and the Camp Hill office are used by the workers’ compensation insurance and corporate/other segments. The office space in Western Pennsylvania, North Carolina, Indiana, Tennessee and Virginia is primarily used by the workers’ compensation insurance segment to provide underwriting, marketing, claims and risk management services to insureds in the respective geographic markets.

Item 3—Legal Proceedings

The Company is, from time to time, involved in legal proceedings that arise in the ordinary course of business. We believe we have sufficient loss reserves and reinsurance to cover claims under insurance policies issued by us. Although there can be no assurance as to the ultimate disposition of these matters, we do not believe, based upon the information available at this time, that any current pending legal proceedings, individually or in the aggregate, will have a material adverse effect on our business, financial condition, or results of operations.

AIG Arbitration

On September 6, 2011, the Company served a written demand (the “Arbitration Demand”) initiating arbitration proceedings against various AIG Companies under 24 reinsurance treaties pursuant to which the Company reinsured AIG Companies for certain pollution liability risks related to underground storage tanks for the policy years 1990 through 1999 (the “Treaties”). The Treaties were cancelled by Eastern Re in 1999. In the Arbitration Demand, the Company seeks an award from the arbitration panel compelling AIG Companies to permit the Company to examine the bases for certain paid losses and loss reserves ceded by AIG Companies to Eastern Re under the Treaties. The Company believes that the Treaties permit such an audit.

On October 3, 2011, AIG Companies responded to the Arbitration Demand by advising that they will seek an award from the arbitration panel of approximately $1.9 million plus future amounts that may become due under the Treaties before the final hearing in the arbitration. Both the Company and AIG Companies seek attorney’s fees and costs in the arbitration.

Both the Company and AIG Companies have appointed arbitrators. The parties are currently in the process of attempting to select an umpire. As of this date, the parties have obtained completed questionnaires from a selected pool of umpire candidates who are being evaluated by the parties.

The arbitration proceedings initiated by the Company against AIG Companies are on-going and there has been no further action in 2012 related to the arbitration process.

During the first quarter of 2012, the Company received quarterly claims data from AIG Companies that reflected unfavorable claim development under the reinsurance treaties. The Company is unable to substantiate the reliability of the claims data reported by AIG Companies and, as a result, has not adjusted its consolidated financial statements for the amounts reported by AIG Companies. The Company continues to believe it has adequately reserved the claims at issue.

The Company commenced an audit of the claims covered under the Treaties during the third quarter of 2012. The claim audit is on-going and the Company has requested and is awaiting additional files and further information from AIG Companies, which will allow the Company to complete the audit. All of the information obtained and reviewed will be evaluated to determine whether such information would cause the Company to revise its estimates or position with respect to the pending arbitration.

It is reasonably possible that the final outcome of the arbitration could go against the Company, which could result in a material, adverse effect on the Company’s results of operations and financial condition.

Eastern Alliance Insurance Co. v. Managepoint, LLC, d/b/a Management 2000 Group, Inc., a/k/a Management, Inc.

Eastern Alliance brought this action against Managepoint, Inc., Managepoint, LLC, and Management 2000 Group, Inc. (collectively, the “Defendants”) to recover amounts due and owing under five workers’ compensation deductible insurance policies issued to the Defendants. As of December 31, 2012, the aggregate amount due and unpaid for claims under the

28

policies was approximately $259,000, all of which has been reserved for. In addition, there are outstanding claim reserves totaling approximately $274,000 under the policies as of December 31, 2012. Eastern Alliance seeks recovery of all amounts presently due, together with amounts which will have accrued and become due and owing as of the time of trial.

On November 21, 2012, the Defendants filed a complaint, denying Eastern Alliance’s assertion that they operate as the same entity, and thus, are liable for the debts of the other, and renouncing any liability for any amounts set forth in the complaint. The Defendants also raised a number of affirmative defenses, including that Eastern Alliance breached its duty of good faith and fair dealing by, among other things, failing to obtain required approvals to settling workers’ compensation claims and improperly invoicing, collecting, and retaining various overpayments by the Defendants.

This matter is presently in discovery, and it is too early and there is not enough information to predict an outcome. It is reasonably possible that the final outcome of this matter could go against the Company, which could result in a material, adverse effect on the Company’s results of operations and financial condition.

Item 4—Mine Safety Disclosures

Not applicable.

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PART II

Item 5—Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock trades on the NASDAQ Global Market under the symbol “EIHI”. As of March 6, 2013, there were 474 registered holders of our common stock.

During 2012, the Company paid four quarterly dividends of $0.07/share. Any payment of dividends in the future on the common stock is subject to determination and declaration by the Company’s Board of Directors, who will take into consideration the Company’s financial condition, results of operations and future prospects. EIHI’s ability to pay dividends will depend in part on dividends received from its insurance subsidiaries. On March 1, 2013, the Company announced that its Board of Directors approved an increase in its quarterly cash dividend on its issued and outstanding shares of common stock, from $0.07 per share to $0.09 per share.

The table below sets forth information with respect to the amount and frequency of dividends declared on our common stock for the years ended December 31, 2012 and 2011. It is currently expected that cash dividends will continue to be paid in the future.

Date of Declaration by EIHI Board	Type of and Amount of Dividend	Record Date for Payment	Payment Date
February 16, 2012	Regular     $0.07 cash per share	March 16, 2012	March 30, 2012
May 10, 2012	Regular     $0.07 cash per share	June 15, 2012	June 29, 2012
August 16, 2012	Regular     $0.07 cash per share	September 14, 2012	September 28, 2012
November 8, 2012	Regular     $0.07 cash per share	December 14, 2012	December 28, 2012
February 17, 2011	Regular     $0.07 cash per share	March 17, 2011	March 31, 2011
May 12, 2011	Regular     $0.07 cash per share	June 16, 2011	June 30, 2011
August 18, 2011	Regular     $0.07 cash per share	September 16, 2011	September 30, 2011
November 10, 2011	Regular     $0.07 cash per share	December 16, 2011	December 30, 2011

Information regarding restrictions and limitations on the payment of cash dividends can be found in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the “Financial Condition, Liquidity and Capital Resources” section.

The table below sets forth the high and low sales prices of our common stock for each quarterly period as reported by the NASDAQ for the years ended December 31, 2012 and 2011.

	2012				2011
	Low		High		Low		High
1st quarter	$	13.63	$	14.75	$	11.45	$	13.40
2nd quarter	$	14.14	$	17.21	$	12.90	$	13.82
3rd quarter	$	15.51	$	17.74	$	12.34	$	13.50
4th quarter	$	16.03	$	17.70	$	12.91	$	14.15

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Equity Compensation Plan Information

The Company adopted the Eastern Insurance Holdings, Inc. 2006 Stock Incentive Plan (the “Stock Incentive Plan”) on December 18, 2006. Under the terms of the Stock Incentive Plan, stock awards may be made in the form of incentive stock options, non-qualified stock options or restricted stock. The following table provides the total number of stock awards outstanding, including the weighted average exercise price, as of December 31, 2012:

Plan category	Number of securities to be issued upon exercise of outstanding options, warrants and rights		Weighted–average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
	(a)		(b)		(c)
Equity compensation plans approved by security holders		1,028,494	$	13.55		57,268	(1)
Equity compensation plans not approved by security holders		—		—		—
Total		1,028,494	$	13.55		57,268	(1)

(1) The number of securities available for future issuance under the Stock Incentive Plan is automatically increased on January 1 by an amount equal to 1.0% of the total outstanding common shares on the last trading day of December of the immediately preceding calendar year. The number of securities available for future issuance can be in the form of stock options or restricted stock.

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Performance Graph

Set forth below is a line graph comparing the dollar change in the cumulative total shareholder return on the Company’s common stock for the year ended December 31, 2012 compared to the cumulative total return of the NASDAQ Composite Index and the cumulative total return of the SNL Insurance Underwriter Index. The chart depicts the value on December 31, 2012 of a $100 investment made on December 31, 2007.

	Period Ending
Index	12/31/07		12/31/08		12/31/09		12/31/10		12/31/11		12/31/12
Eastern Insurance Holdings, Inc.		100.00		49.79		55.10		78.11		93.73		116.56
NASDAQ Composite		100.00		60.02		87.24		103.08		102.26		120.42
SNL Insurance Underwriter Index		100.00		51.97		60.34		72.15		67.39		79.31

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Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

As of December 31, 2012, the Company has repurchased 4,017,105 shares of its common stock. The share repurchases will be held as treasury stock and are available for issuance in connection with the Company’s Stock Incentive Plan.

The following tables presents information with respect to those purchases of our common stock made during the years ended December 31, 2012 and 2011, respectively. On August 23, 2011, the Company’s Board of Directors increased the repurchase authorization of its issued and outstanding shares of common stock by 1,000,000 shares.

Period	Total number of shares purchased		Average price paid per share		Total number of shares purchased as part of publicly announced plans or programs		Maximum number (or approximate dollar value) of shares that may yet be purchased under the plans or programs
January 1-31, 2012		—	$	—		—		1,086,567
February 1-29, 2012		—	$	—		—		1,086,567
March 1-31, 2012		—	$	—		—		1,086,567
April 1-30, 2012		—	$	—		—		1,086,567
May 1-31, 2012		166,537	$	14.49		166,537		920,030
June 1-30, 2012		—	$	—		—		920,030
July 1-31, 2012		—	$	—		—		920,030
August 1-31, 2012		—	$	—		—		920,030
September 1-30, 2012		—	$	—		—		920,030
October 1-31, 2012		—	$	—		—		920,030
November 1-30, 2012		—	$	—		—		920,030
December 1-31, 2012		—	$	—		—		920,030
Total		166,537	$	14.49		166,537

Period	Total number of shares purchased		Average price paid per share		Total number of shares purchased as part of publicly announced plans or programs		Maximum number (or approximate dollar value) of shares that may yet be purchased under the plans or programs
January 1-31, 2011		129,110	$	12.34		129,110		987,855
February 1-28, 2011		31,976	$	13.02		31,976		955,879
March 1-31, 2011		360,832	$	12.57		360,832		595,047
April 1-30, 2011		72,948	$	12.86		72,948		522,099
May 1-31, 2011		111,984	$	13.24		111,984		410,115
June 1-30, 2011		26,405	$	13.21		26,405		383,710
July 1-31, 2011		70,063	$	13.24		70,063		313,647
August 1-31, 2011		123,012	$	13.10		123,012		1,190,635
September 1-30, 2011		79,998	$	13.14		79,998		1,110,637
October 1-31, 2011		11,970	$	13.10		11,970		1,098,667
November 1-30, 2011		12,100	$	13.31		12,100		1,086,567
December 1-31, 2011		—	$	—		—		1,086,567
Total		1,030,398	$	12.83		1,030,398

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Item 6—Selected Financial Data

The following table sets forth selected historical financial information for the Company for the years ended and as of the dates indicated. This information is derived from the Company’s consolidated financial statements. You should read the following selected financial information along with the information contained in this annual report, including Part II, Item 7 of this annual report entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes and the reports of the independent registered public accounting firm included in Part II, Item 8 and elsewhere in this report. These historical results are not necessarily indicative of results to be expected from any future period (in thousands, except per share and share amounts).

	At or for the Years Ended December 31,
	2012			2011			2010			2009			2008 (1)
Income Statement Data:
Direct premiums written	$	182,924		$	155,746		$	126,843		$	110,108		$	101,907
Reinsurance premiums assumed		40,970			36,041			30,232			29,747			29,765
Net premiums written		169,958			142,121			116,621			102,336			94,653
Net premiums earned	$	159,614		$	132,173		$	109,152		$	97,916		$	89,402
Investment income, net of expenses		3,882			3,698			3,365			4,453			5,710
Change in equity interest in limited partnerships		1,007			5			1,052			1,066			(3,540	)
Net realized investment gains (losses)		3,246			1,654			3,465			(839	)		(5,311	)
Other revenue		319			425			582			643			853
Total revenue	$	168,068		$	137,955		$	117,616		$	103,239		$	87,114
Expenses:
Losses and LAE incurred	$	105,390		$	83,722		$	77,574		$	58,766		$	49,717
Acquisition and other underwriting expenses		19,609			13,491			11,274			12,252			10,413
Other expenses		25,596			25,097			22,037			20,507			19,894
Amortization of intangibles		806			1,026			1,284			1,732			1,373
Policyholder dividend expense		766			1,360			1,046			311			551
Segregated portfolio dividend expense (2)		1,457			3,469			229			1,238			2,155
Total expenses	$	153,624		$	128,165		$	113,444		$	94,806		$	84,103
Income before income taxes		14,444			9,790			4,172			8,433			3,011
Income tax expense		4,094			2,436			1,242			2,502			954
Net income	$	10,350		$	7,354		$	2,930		$	5,931		$	2,057
Selected Balance Sheet Data (at period end):
Total investments and cash and cash equivalents	$	249,972		$	231,282		$	223,784		$	194,617		$	180,605
Total assets (3)		380,752			345,679			322,664			397,321			382,642
Reserves for unpaid losses and LAE		117,728			106,077			95,963			89,509			86,962
Unearned premiums		73,775			63,432			53,485			46,016			41,308
Total liabilities (4)		244,897			217,420			187,953			243,456			244,504
Total shareholders’ equity		135,855			128,259			134,711			153,865			138,137
U.S. GAAP Ratios:
Loss and LAE ratio (5)		66.0	%		63.3	%		71.1	%		60.0	%		55.6	%
Expense ratio (6)		28.8	%		30.0	%		31.7	%		35.1	%		35.4	%
Policyholder dividend expense ratio (7)		0.5	%		1.0	%		1.0	%		0.4	%		0.6	%
Combined ratio (8)		95.3	%		94.3	%		103.8	%		95.5	%		91.6	%
Per Share Data:
Basic earnings per share:
Continuing operations	$	1.35		$	0.93		$	0.36		$	0.64		$	0.27
Discontinued operations		N/A			0.05			(1.43	)		0.28			(2.17	)
Diluted earnings per share:
Continuing operations	$	1.32		$	0.91		$	0.36		$	0.64		$	0.26
Discontinued operations	$	N/A		$	0.05		$	(1.43	)	$	0.27		$	(2.17	)
Weighted Average Shares:
Basic—continuing operations		7,529,656			7,860,207			8,458,731			8,984,644			8,954,098
Basic—discontinued operations		N/A			7,860,207			8,458,731			8,984,644			8,954,098
Diluted—continuing operations		7,673,399			7,981,930			8,532,697			9,051,701			9,289,638
Diluted—discontinued operations		N/A			7,981,930			8,458,731			9,051,701			8,954,098
Cash dividends per share	$	0.28		$	0.28		$	0.28		$	0.28		$	0.28

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(1) Includes Employers Security Holding Company’s results of operations for the period from October 1, 2008 to December 31, 2008.

(2) The net income of the segregated portfolio cell reinsurance segment is recorded as a segregated portfolio dividend expense, which represents the dividend earned by the segregated portfolio dividend participants during the period.

(3) Total assets as of December 31, 2009 and 2008 include assets reclassified to discontinued operations totaling $115,207 and $116,445, respectively.

(4) Total liabilities as of December 31, 2009 and 2008 include liabilities reclassified to discontinued operations totaling $65,054 and $77,048, respectively.

(5) Calculated by dividing losses and LAE incurred by net premiums earned.

(6) Calculated by dividing the sum of acquisition and other underwriting expenses, other expenses and amortization of intangibles by net premiums earned.

(7) Calculated by dividing the policyholder dividend expense by net premiums earned.

(8) The sum of the loss and LAE ratio, expense ratio and the policyholder dividend expense ratio.

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Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

The Company reported net income from continuing operations of $10.4 million for the year ended December 31, 2012, compared to $7.4 million for the year ended December 31, 2011. The Company’s consolidated combined ratio was 95.3% in 2012, compared to 94.3% in 2011. The Company’s results of operations for the year ended December 31, 2012, when compared to the same period in 2011, reflect the following:

• Net premiums earned increased 20.8%, from $132.2 million in 2011 to $159.6 million in 2012. The increase in net premiums earned reflects new business of $37.7 million, audit premium received from customers of $4.6 million, an increase in the earned but unbilled premium estimate of $1.7 million, and average renewal rate increases of 3.7%. The Company’s renewal retention decreased from 88.6% in 2011 to 83.5% in 2012, primarily reflecting the loss of seven accounts with total annual premiums of approximately $4.3 million in 2012.

• The Company recognized an increase in its equity interest in limited partnerships from 2011 to 2012 totaling $1.0 million, primarily reflecting an increase in its multi-strategy fund of funds and structured finance opportunity fund interests.

• Net realized investment gains totaled $3.2 million in 2012, compared to $1.7 million in 2011, primarily reflecting an increase in the estimated fair value of the convertible bond portfolio totaling $789,000 in 2012, compared to a decrease of $1.1 million in 2011.

• The Company’s consolidated loss ratio increased from 63.3% in 2011 to 66.0% in 2012. The increase primarily reflects increased loss experience in the segregated portfolio cell reinsurance segment related to the 2012 accident year.

• The Company’s consolidated expense ratio decreased from 30.0% in 2011 to 28.8% in 2012. The decrease in the expense ratio primarily reflects the increase in net premiums earned, including the impact of audit premium, partially offset by an increase in the expense ratio of 1.5 percentage points related to the Company’s adoption of ASU 2010-6, which reduced the amount of underwriting salaries capitalized and deferred over the life of the underlying workers’ compensation insurance policies.

• The consolidated effective tax rate increased from 24.9% in 2011 to 28.3% in 2012, which primarily reflects the improvement in the Company’s pre-tax operating results.

Principal Revenue and Expense Items

The Company derives its revenue primarily from net premiums earned, including assumed premiums earned, net investment income and net realized investment gains.

Direct and net premiums written. Direct premiums written is the sum of both direct premiums and assumed premiums before the effect of ceded reinsurance. Direct premiums written include all premiums billed during a specified policy period. Net premiums written is the difference between direct premiums written and premiums ceded or paid to reinsurers (ceded premiums written). In the segregated portfolio cell reinsurance segment, assumed premiums are derived from insurance contracts written by EAIG and ceded to the segregated portfolio cells.

Net premiums earned. Net premiums earned represent the earned portion of the Company’s net premiums written. Premiums are earned over the term of the related policies. At the end of each accounting period, the portion of the premiums that are not yet earned are included in unearned premiums and are realized as revenue in subsequent periods over the remaining term of the policy. The Company’s workers’ compensation policies typically have a term of twelve months. Thus, for example, for a policy that is written on July 1, 2012, one-half of the premiums would be earned in 2012 and the other half would be earned in 2013. Workers’ compensation premiums are determined based upon the payroll of the insured, the applicable premium rates and, where applicable, an experience based modification factor. An audit of the insured’s records is conducted after policy expiration to make a final determination of applicable premiums. Included with net premiums earned is an estimate for EBUB premiums. The Company can estimate EBUB premiums because it keeps track, by policy, of how much additional premium is billed in final audit invoices to estimate the probable additional amount that it has earned but not yet billed as of the balance sheet date.

Net investment income and realized gains and losses on investments. The Company invests its surplus and the funds supporting its insurance liabilities (including unearned premiums and unpaid losses and LAE) in cash, cash equivalents, fixed income securities, convertible bonds, equity securities, and limited partnership investments. Investment income includes

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interest earned on invested assets, including the impacts of premium amortization and discount accretion. Realized gains and losses on invested assets are reported separately from net investment income. The Company recognizes realized gains when invested assets are sold for an amount greater than their cost or amortized cost (in the case of fixed income securities) and recognizes realized losses when investment securities are written down as a result of an other than temporary impairment or sold for an amount less than their cost or amortized cost. Realized gains and losses also include the change in the estimated fair value of convertible bonds.

Other revenue. Other revenue includes fees earned for claim administration and risk management services provided to self-insured property/casualty customers. There are other revenue items that the Company recognizes on a segmental basis that are eliminated in consolidation. Such items consist primarily of fees paid by the segregated portfolio cells to other entities within the consolidated group. The segregated portfolio cells recognize an expense for such items (included as part of its ceding commission) and a corresponding revenue item is recognized by the affiliate providing the service. For segment reporting purposes, such revenue items primarily include claims administration, risk management, and cell rental fees. Fronting fees are included in acquisition and other underwriting expenses as an offset to the direct costs incurred. For segment reporting purposes, such fees are recognized ratably over the period in which the service is provided, which generally corresponds to the earned portion of net premiums written for the underlying policies.

The Company’s expenses consist primarily of losses and LAE, acquisition and other underwriting expenses, other expenses, policyholder dividends, and income taxes.

Losses and LAE. Losses and LAE represent the largest expense item and include: (1) claim payments made, (2) estimates for future claim payments and changes in those estimates for prior periods, and (3) costs associated with investigating, defending and adjusting claims.

Acquisition and other underwriting expenses. In the workers’ compensation insurance segment, expenses incurred to underwrite risks are referred to as acquisition and other underwriting expenses, which consist primarily of commissions, premium taxes, assessments and fees and other underwriting expenses incurred in acquiring, writing and administering the Company’s business. In the segregated portfolio cell reinsurance segment, acquisition and other underwriting expenses consist of ceding commissions incurred under the respective reinsurance agreements. Ceding commissions received in the workers’ compensation insurance segment are netted against acquisition and other underwriting expenses.

Other expenses. Other expenses consist of general administrative expenses such as salaries, stock compensation, rent, office supplies, depreciation and all other operating expenses not otherwise classified separately.

Policyholder dividend expense. Policyholder dividends represent the amount of dividends incurred during the period that are expected to be returned to policyholders. The dividend expense is based on the loss experience of the underlying workers’ compensation insurance policy.

Income tax expense. EIHI and certain of its subsidiaries pay federal, state and local income taxes. Income tax expense includes an amount for both current and deferred income taxes. Current income tax expense includes an amount for the Company’s current year federal income tax liability and any adjustments related to differences between the prior year federal income tax estimate and the actual income tax expense reported in the federal income tax return. Deferred tax expense represents the change in the Company’s net deferred tax asset, exclusive of the tax effect related to changes in unrealized gains and losses in the Company’s investment portfolio and changes in the unrecognized amounts related to the Company’s benefit plan liabilities.

Key Financial Measures

The Company evaluates its insurance operations by monitoring certain key measures of growth and profitability. The Company measures growth by monitoring changes in direct premiums written and net premiums written. The Company measures underwriting profitability by examining loss, expense, policyholder dividend expense and combined ratios. On a segmental basis, the Company measures a segment’s operating results by examining net income, diluted earnings per share, and return on average equity.

Loss ratio. The loss ratio is the ratio (expressed as a percentage) of losses and LAE incurred to net premiums earned and measures the underwriting profitability of a company’s insurance business. The Company measures the loss ratio on an accident year and calendar year loss basis to measure underwriting profitability. An accident year loss ratio measures losses and LAE for insured events occurring in a particular policy year, regardless of when they are reported, as a percentage of net

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premiums earned during that year. A calendar year loss ratio measures losses and LAE for insured events occurring during a particular policy year and the change in loss reserves from prior accident years as a percentage of net premiums earned during that year.

Expense ratio. The expense ratio is the ratio (expressed as a percentage) of the sum of the acquisition and other underwriting expenses, other expenses and amortization of intangibles to net premiums earned, and measures the Company’s operational efficiency in producing, underwriting and administering its insurance business.

Policyholder dividend expense ratio. The policyholder dividend expense ratio is the ratio (expressed as a percentage) of policyholder dividend expense to net premiums earned and measures the impact of the Company’s policyholder dividend policies on its workers’ compensation insurance segment.

Combined ratio. The combined ratio is the sum of the loss ratio, expense ratio and policyholder dividend expense ratio and measures the Company’s overall underwriting profit. If the combined ratio is below 100%, the Company is making an underwriting profit. If the Company’s combined ratio is at or above 100%, the Company is not profitable without investment income and may not be profitable if investment income is insufficient.

Net premiums written to statutory surplus ratio. The net premiums written to statutory surplus ratio represents the ratio of net premiums written to statutory surplus. This ratio measures the Company’s insurance subsidiaries’ exposure to pricing errors in its current book of business. The higher the ratio, the greater the impact on surplus should pricing prove inadequate.

Net income, diluted earnings per share, and return on average equity. The Company uses net income and diluted earnings per share to measure its profits and return on average equity to measure its effectiveness in utilizing shareholders’ equity to generate net income. In determining return on average equity for a given year, net income is divided by the average of the beginning and ending shareholders’ equity for that year.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with U.S. GAAP requires both the use of estimates and judgment relative to the application of appropriate accounting policies. The Company is required to make estimates and assumptions in certain circumstances that affect amounts reported in the consolidated financial statements and related footnotes. The Company evaluates these estimates and assumptions on an on-going basis based on historical developments, market conditions, industry trends and other information that is believed to be reasonable under the circumstances. There can be no assurance that actual results will conform to the estimates and assumptions and that reported results of operations will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. The Company believes the following policies are the most sensitive to estimates and judgments.

Reserves for Unpaid Losses and LAE

The Company establishes reserves for unpaid losses and LAE for its workers’ compensation insurance and segregated portfolio cell reinsurance products, which are estimates of future payments of reported and unreported claims for losses and related expenses. The adequacy of the Company’s reserves for unpaid losses and LAE are inherently uncertain because the ultimate amount that the Company may pay under many of the claims incurred as of the balance sheet date will not be known for many years. Establishing reserves is an imprecise process, requiring the use of informed estimates and judgments. The Company’s estimates and judgments may be revised as additional experience and other data becomes available and are reviewed as new or improved methodologies are developed, or as current laws change. Any such revisions could result in future changes in estimates of losses or reinsurance recoverables and would be reflected in the Company’s results of operations in the period in which the estimates are changed. Estimating the ultimate claims liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management’s informed estimates and judgments using data currently available. If the Company’s ultimate losses, net of reinsurance, prove to differ substantially from the amounts recorded as of December 31, 2012, the related adjustments could have a material adverse effect on the Company’s financial condition, results of operations or liquidity.

Workers’ Compensation Insurance

On a quarterly basis, the Company prepares actuarial analyses to assess the reasonableness of the recorded reserves for unpaid losses and LAE in its workers’ compensation insurance segment. These actuarial analyses incorporate various methodologies, including paid loss development, incurred loss development and a combination of other actuarial

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methodologies that incorporate characteristics of paid and incurred methodologies combined with a review of the Company’s exposure base. The recorded amount in each accident year is then compared to the results of these methodologies, with consideration being given to the age of the accident year. As accident years mature, the various methodologies generally produce consistent loss estimates. For more recent accident years, the methodologies produce results that are not as consistent. Accordingly, more emphasis is placed on supplementing the methodologies in more recent accident years with trends in exposure base, medical expense inflation, general inflation, severity, and claim counts, among other things.

The Company’s reserves for unpaid losses and LAE in its workers’ compensation insurance segment as of December 31, 2012 and 2011 are summarized below (in thousands):

	2012			2011
Case reserves	$	42,376		$	39,380
Case incurred development, IBNR and unallocated LAE reserves		42,042			37,249
Amount of discount		(5,277	)		(4,527	)
Net reserves before reinsurance recoverables		79,141			72,102
Reinsurance recoverables on unpaid losses and LAE		10,086			9,007
Reserves for unpaid losses and LAE	$	89,227		$	81,109

In its workers’ compensation insurance segment, the Company records reserves for estimated losses under insurance policies and for LAE related to the investigation and settlement of policy claims. The Company’s reserves for unpaid losses and LAE represent the estimated cost of reported and unreported losses and LAE incurred and unpaid at a given point in time. In establishing its workers’ compensation insurance reserves, the Company uses loss discounting, which involves recognizing the time value of money and offsetting estimates of future payments by future expected investment income.

When a claim is reported, the Company’s claims adjusters establish a case reserve, which consists of anticipated medical costs, indemnity costs and certain defense and cost containment expenses that the Company refers to as allocated loss adjustment expenses, or ALAE. At any point in time, the amount paid on a claim, plus the case reserve for future amounts to be paid, represents the claims adjuster’s estimate at that time of the total cost of the claim, or the case incurred amount. The case reserve for each reported claim is based upon various factors, including:

• type of loss;

• severity of the injury or damage;

• age and occupation of the injured employee;

• estimated length of temporary disability;

• anticipated permanent disability;

• expected medical procedures, costs and duration;

• knowledge of the circumstances surrounding the claim;

• insurance policy provisions, including coverage, related to the claim;

• jurisdiction of the occurrence; and

• other benefits defined by applicable statute.

The case incurred amount can vary over time due to changes in expectations with respect to medical treatment and outcome, length and degree of disability, employment availability and wage levels and judicial determinations. As changes occur, the case incurred amount is adjusted. The initial estimate of the case incurred amount can vary significantly from the amount ultimately paid, especially in circumstances involving severe injuries with comprehensive medical treatment. Changes in case incurred amounts, or case incurred development, is an important component of the Company’s historical claim data.

In addition to case reserves, the Company establishes loss and ALAE reserves on an aggregate basis for case incurred development and IBNR claims. Case incurred development and IBNR reserves are primarily intended to provide for aggregate changes in preexisting case incurred amounts and, secondarily, to provide for the unpaid cost of IBNR claims for which an initial case reserve has not been established.

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The third component of the Company’s reserves for unpaid losses and LAE is unallocated loss adjustment expense, or ULAE. The Company’s ULAE reserve is established for the costs of future unallocated loss adjustment expenses for known and unknown claims. The Company’s ULAE reserve covers primarily the estimated cost of administering claims.

In estimating case incurred development and IBNR reserves, the Company performs most of its detailed analysis on a net of reinsurance basis, and then considers expected recoveries in arriving at its recorded amounts for unpaid losses and LAE. To estimate such reserves, the Company relies primarily on the historical claim data and trends from its workers’ compensation insurance book of business. Using standard actuarial methods, the Company estimates reserves based on historical patterns of case development, payment patterns, mix of business, premium rates charged, case reserving adequacy, operational changes, adjustment philosophy and severity and duration trends. However, the number of variables and judgments involved in establishing reserve estimates, combined with some random variation in loss development patterns, results in uncertainty regarding projected ultimate losses.

To estimate reserves, the Company stratifies its data using variations of the following different categorizations of claims:

• All loss and LAE data developed together;

• Lost time claims developed independently;

• Medical only claims developed independently;

• The indemnity portion of lost time claims developed independently;

• The medical portion of a lost time claim and medical only claims developed together; and

• LAE developed independently.

The term “developed together” refers to the summation of the claims data for a particular data stratification. For example, “All loss and LAE data developed together” represents all loss and LAE data of the Company, regardless of medical, indemnity or expense components, developed together using the historical data for this particular data stratification. The term “developed independently” refers to a specific data element. For example, “The indemnity portion of lost time claims developed independently” represents the development of the indemnity portion of a claim separately using historical data for this particular type of claim. Developing claims using different data stratifications allows the Company to identify trends for a specific group of claims that would not necessarily be readily identifiable if the data were included with other types of claim information. For example, developing the medical portion of a claim separately may allow the Company to identify a medical inflation trend that may not have been evident if it had been included with indemnity claim information. The combination of the different data stratifications and standard actuarial methods, including the following, produce different actuarial indications for the Company to evaluate:

Incurred Loss Development Method. The incurred (case incurred) loss development method relies on the assumption that, at any given state of maturity, ultimate losses can be predicted by multiplying cumulative reported losses (paid losses plus case reserves) by a cumulative development factor. The validity of the results of this method depends on the stability of claim reporting and settlement rates, as well as the consistency of case reserve levels. Case reserves do not have to be adequately stated for this method to be effective; they only need to have a fairly consistent level of adequacy at all stages of maturity. “Age-to-age” loss development factors (“LDFs”) are calculated to measure the relative development of an accident year from one maturity point to the next.

Paid Loss Development Method. The paid loss development method relies on paid losses to estimate ultimate losses and is mechanically identical to the incurred loss development method described above. The paid method does not rely on case reserves or claim reporting patterns in making projections. The validity of the results from using a paid loss development approach can be affected by many conditions, such as internal claim department processing changes, legal changes or variations in a company’s mix of business from one year to the next. Also, since the percentage of losses paid for immature years is often low, development factors are more volatile. A small variation in the number of claims paid can have a leveraging effect that can lead to significant changes in estimated ultimate liability for losses and LAE. Therefore, ultimate values for immature accident years are often based on alternative estimation techniques.

Bornhuetter-Ferguson Methodology. The Bornhuetter-Ferguson expected loss projection method based on reported loss data relies on the assumption that remaining unreported losses are a function of the total expected ultimate losses rather than a function of the currently reported losses. The expected ultimate losses in this analysis are based on historical results, adjusted for known pricing changes and inflationary trends. The expected ultimate losses are multiplied by the unreported percentage to produce expected unreported losses. The unreported percentage is calculated as one minus the reciprocal of the selected cumulative incurred LDFs. Finally, the unreported losses are added to the current reported

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losses to produce ultimate losses. The Bornhuetter-Ferguson method is most useful as an alternative to other models for immature accident years. For these immature accident years, the amounts reported or paid may be small and unstable and therefore not predictive of future development. Therefore, future development is assumed to follow an expected pattern that is supported by more stable historical data or by emerging trends. This method is also useful when changing reporting patterns distort historical development of losses.

The Bornhuetter-Ferguson method can also be applied with paid losses.

In estimating ULAE reserves, the Company reviews past loss adjustment expenses in relation to paid claims and estimated future costs based on expected claims activity and duration. The sum of the Company’s net loss and ALAE reserve and ULAE reserves represents its total net reserve for unpaid losses and LAE.

In determining management’s best estimate, the Company considers the various accident year loss indications produced by the actuarial methods. Considering the results of the methods, the inherent strengths and weaknesses of each method as described above, as well as other statistical information such as ultimate loss ratios, ultimate loss to exposure ratios and average ultimate claim values, the Company determines and records its best estimate of unpaid losses and ALAE. Management believes its best estimate of recorded reserves for unpaid losses and LAE is representative of the inherent uncertainty surrounding reserving for a long-tail line of business such as workers’ compensation as well as the relative immature accident year historical experience of its workers’ compensation insurance segment, which completed its first full year of operations in 1998.

As of December 31, 2012, the Company’s best estimate of its ultimate liability for losses and LAE, net of amounts recoverable from reinsurers, for its workers’ compensation insurance segment was $89.2 million.

For each of the methods described above that are used to estimate reserves for losses and LAE, the estimated paid and incurred loss development factors are key assumptions. Loss development factors are estimated based on the Company’s historical paid and incurred loss development patterns, and an estimate of the “tail factor”, or a factor to account for development beyond the maturity of the historical data. In addition, for the Bornhuetter-Ferguson methods, a key assumption is an estimate of the expected loss ratio. The expected loss ratio is determined based on estimated historical loss ratios adjusted to reflect current underwriting and rate change activity. The assumptions used in these methods by the Company over time have reflected a consistent application of the Company’s estimating processes to emerging experience. The tail factors used in the calculation of loss development factors requires considerable judgment. Selecting representative tail factors requires substantially more judgment than the historical loss development factors. While loss development factors are based on the historical claim payment and reserving patterns of the Company over a period of time, tail factors are estimated based on loss development trends in more mature accident years and industry information, and therefore are estimated in the absence of direct historical loss development history.

Management believes that changes in tail factors are reasonably likely considering the impact that changing economic conditions and medical inflation may have on the loss and LAE estimation process. There are loss and LAE risk factors that affect workers’ compensation claims that can change over time and also cause the Company’s loss reserves to fluctuate. Some examples of these risk factors include, but are not limited to, the following:

• recovery time from the injury;

• degree of patient responsiveness to treatment;

• use of pharmaceutical drugs;

• type and effectiveness of medical treatments;

• frequency of visits to healthcare providers;

• changes in costs of medical treatments;

• availability of new medical treatments and equipment;

• types of healthcare providers used;

• availability of light duty for early return to work;

• attorney involvement;

• wage inflation in states that index benefits; and

• changes in administrative policies of second injury funds.

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Although many factors influence the actual cost of claims and the corresponding reserves for unpaid losses and LAE estimates, we do not measure and estimate values for all of these variables individually. This is due to the fact that many of the factors that are known to impact the cost of claims cannot be measured directly. In most instances, we rely on historical experience and tail factors to estimate values for the variables that are explicitly used in the unpaid loss and LAE analysis. For the most recent accident year, we rely on selecting an expected loss ratio to estimate the reserves for unpaid losses and LAE. In addition to the examples above that represent reasonably likely changes in our tail factor, another example of potential variability in our loss and LAE estimation process involves selecting an expected loss ratio for the most recent accident year. For example, if our expected loss ratio for the 2012 accident year were to increase by 5 percentage points, our reserves for unpaid losses and LAE as of December 31, 2012 would increase by $6.3 million, which would result in an after-tax reduction in our earnings of $4.1 million. Management believes that changes in the most recent year accident year loss ratio are reasonably likely due to variability in underwriting and rate changes. It is important to note that actual claims costs will vary from our estimate of ultimate claim costs, perhaps by substantial amounts, due to the inherent variability of the business written, the potentially significant claim settlement lags and the fact that not all events affecting future claim costs can be estimated.

In the event that our estimates of ultimate reserves for unpaid losses and LAE prove to be greater or less than the ultimate liability, our future earnings and financial position could be positively or negatively impacted. Future earnings would be reduced by the amount of any deficiencies in the year(s) in which the claims are paid or the reserves for unpaid losses and LAE are increased. For example, if we determined our reserves for unpaid losses and LAE, net of reinsurance, of $79.1 million as of December 31, 2012 to be 5% inadequate, this would result in an after-tax reduction in our earnings of approximately $2.6 million. This reduction could be realized in one year or multiple years, depending on when the deficiency is identified. The deficiency would also impact our financial position because our statutory surplus would be reduced by an amount equivalent to the reduction in net income. Any deficiency is typically recognized in the reserves for unpaid losses and LAE and, accordingly, it typically does not have a material effect on our liquidity because the claims have not been paid. Since the claims will typically be paid out over a multi-year period, we have generally been able to adjust our investments to match the anticipated future claim payments. Conversely, if our estimates of ultimate reserves for unpaid losses and LAE prove to be redundant, our future earnings and financial position would be improved.

The Company has utilized the following tail factors for the years ended December 31, 2012, 2011, and 2010:

	2012		2011		2010
Incurred loss development		1.020		1.020		1.020
Paid loss development		1.035		1.035		1.035

Following is a sensitivity analysis of the Company’s workers’ compensation reserves to reasonably likely changes in the tail factors used to project actual current losses to ultimate losses (dollars in thousands):

Change in Tail Factor Assumption	Increase (Decrease) in Net Reserves			Impact on Net Income			Percentage of Shareholders’ Equity
2 basis point increase	$	7,679		$	(4,992	)		-3.67	%
1 basis point increase	$	3,856		$	(2,506	)		-1.84	%
1 basis point decrease	$	(3,890	)	$	2,529			1.86	%
2 basis point decrease	$	(7,815	)	$	5,080			3.74	%

The estimates above rely on substantial judgment. There is inherent uncertainty in estimating reserves for unpaid losses and LAE. It is possible that the actual losses and LAE incurred may vary significantly from the Company’s estimates.

Segregated Portfolio Cell Reinsurance

The Company’s reserves for unpaid losses and LAE in its segregated portfolio cell reinsurance segment as of December 31, 2012 and 2011 are summarized below (in thousands):

	2012			2011
Case reserves	$	8,986		$	10,229
Case incurred development, IBNR and unallocated LAE reserves		15,537			12,931
Amount of discount		(1,226	)		(1,196	)
Net reserves before reinsurance recoverables		23,297			21,964
Reinsurance recoverables on unpaid losses and LAE		4,998			2,798
Reserves for unpaid losses and LAE	$	28,295		$	24,762

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The Company estimates and records reserves for its segregated portfolio cell reinsurance segment in the same manner as for its workers’ compensation insurance segment.

The reporting and paid loss development patterns in the segregated portfolio cell reinsurance segment are also consistent with that of the workers’ compensation insurance segment. Accordingly, the tail factors used to project actual current losses to ultimate losses for claims covered in the Company’s segregated portfolio cell reinsurance segment require considerable judgment. The difference between total revenue for the segregated portfolio cell reinsurance segment for each period and the sum of losses and LAE, acquisition and other underwriting expenses, other expenses, and policyholder dividend expense is accrued as a segregated portfolio dividend expense. Accordingly, any change in the reserve for unpaid losses and LAE is recorded to the segregated portfolio dividend payable/receivable account and would only impact the Company’s net income or shareholders’ equity if the Company were a segregated portfolio cell dividend participant.

“Other Than Temporary” Investment Impairments

Unrealized investment gains or losses on investments carried at estimated fair value, net of applicable income taxes, are reflected directly in shareholders’ equity as a component of accumulated other comprehensive income (loss) and, accordingly, have no effect on net income. When, in the opinion of management, a decline in the fair value of an investment below its cost or amortized cost is considered to be “other-than- temporary,” such investment is written down to its fair value at the balance sheet date. The amount written down is recorded as a realized loss in the consolidated statements of operations and comprehensive income (loss). Generally, the determination of other-than-temporary impairment includes, in addition to other relevant factors, a presumption that if the market value is below cost by a significant amount for a period of time, a write-down is necessary. Notwithstanding this presumption, the determination of other-than-temporary impairment requires judgment about future prospects for an investment and is therefore a matter of inherent uncertainty. For the years ended December 31, 2012, 2011 and 2010, the Company recorded other-than-temporary impairments, excluding impairments in the segregated portfolio cell reinsurance segment, of $127,000, $0 and $6,000, respectively. Other-than-temporary impairments in the segregated portfolio cell reinsurance segment totaled $0, $78,000 and $80,000 for the years ended December 31, 2012, 2011 and 2010, respectively. The Company generally applies the following standards in determining whether the decline in fair value of an investment is other-than-temporary:

Equity securities. An equity security is considered impaired when one of the following conditions exist: 1) an equity security’s market value is less than 80% of its cost for a continuous period of 6 months, 2) an equity security’s market value is less than 50% of its cost, regardless of the amount of time the security’s market value has been below cost, and 3) an equity security’s market value has been less than cost for a continuous period of 12 months or more, regardless of the magnitude of the decline in market value. Equity securities that are in an unrealized loss position, but do not meet the above quantitative thresholds are evaluated to determine if the decline in market value is other than temporary.

The Company recognized other-than-temporary impairments of $127,000 related to two equity securities for the year ended December 31, 2012. The impairments related to equity securities that had been in an unrealized loss position for more than 12 months. The Company did not recognize any other-than-temporary impairments related to its equity security portfolio for the years ended December 31, 2011 or 2010.

As of December 31, 2012, the Company held equity securities, excluding equity securities in the segregated portfolio cell reinsurance segment, with gross unrealized losses of $135,000, none of which were in an unrealized loss position for more than twelve months. The Company does not intend to sell the equity securities and it is not more likely than not that the Company will be required to sell the equity securities before recovery of their cost bases; therefore, management does not consider the equity securities to be other-than-temporarily impaired as of December 31, 2012. Adverse investment market conditions, or poor operating results of underlying investments, could result in impairment charges in the future.

Fixed income securities. A fixed income security is considered to be other-than-temporarily impaired when the security’s estimated fair value is less than its amortized cost basis and 1) the Company intends to sell the security, 2) it is more likely than not that the Company will be required to sell the security before recovery of the security’s amortized cost basis, or 3) the Company believes it will be unable to recover the entire amortized cost basis of the security (i.e., a credit loss has occurred). When the Company determines a credit loss has been incurred, but the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery of the security’s amortized cost basis, the portion of the other-than-temporary impairment that is credit related is recorded as a realized loss in the consolidated statements of operations and comprehensive income (loss), and the portion of the other-than-temporary impairment that is not credit related is included in other comprehensive income (loss). A fixed income security is reviewed for potential credit loss if any of the following situations occur:

• A review of the financial condition and prospects of the issuer indicates that the security should be evaluated;

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• Moody’s or Standard & Poor’s rate the security below investment grade; or

• The security has a market value below 80% of amortized cost due to deterioration in credit quality.

The Company did not recognize any other-than-temporary impairments related to its fixed income security portfolio in 2012 or 2011. The Company recognized an other-than-temporary impairment of $6,000 related to its fixed income security portfolio in 2010.

As of December 31, 2012, the Company held fixed income securities, excluding fixed income securities in the segregated portfolio cell reinsurance segment, with gross unrealized losses of $125,000, of which $3,000 were in an unrealized loss position for more than twelve months. Management has evaluated the unrealized losses related to those fixed income securities and determined that they are primarily due to a fluctuation in interest rates and not to credit issues of the issuer or the underlying assets in the case of asset-backed securities. The Company does not intend to sell the fixed income securities and it is not more likely than not that the Company will be required to sell the fixed income securities before recovery of their amortized cost bases, which may be maturity; therefore, management does not consider the fixed income securities to be other–than-temporarily impaired as of December 31, 2012. Adverse investment market conditions, or poor operating results of underlying investments, could result in impairment charges in the future.

Limited partnerships. A limited partnership investment is generally written down if the Company is unable to hold or otherwise intends to sell its interest in the limited partnership at a loss, or if management has received information that suggests the Company will be unable to recover its original investment in the limited partnership. The amount written down is recorded in the change in equity interest in limited partnerships in the consolidated statement of operations and comprehensive income (loss).

There were no write-offs or impairments related to the Company’s limited partnership investments in 2012 or 2010. During 2011, the Company wrote off its interest in the real estate limited partnership. The write off totaled $49,000 and was a result of the limited partnership being liquidated without any benefit to the Company.

Goodwill

In accordance with the requirements of ASC 350, Intangibles—Goodwill and Other, goodwill is not amortized but is tested for impairment at the reporting unit level, which is at the operating segment level or one level below an operating segment. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. Goodwill is required to be tested for impairment annually and between annual tests if events or circumstances change, such as adverse changes in the business climate, that would more likely than not reduce the fair value of the reporting unit below its carrying value.

Goodwill is assigned to one or more reporting units at the date of acquisition. The Company has allocated 100% of the goodwill recorded on its consolidated balance sheet as of September 30, 2012 to its workers’ compensation insurance segment.

The Company performs its annual goodwill impairment test as of September 30.

For the 2012 annual impairment test, the fair value of the workers’ compensation insurance segment was estimated using a discounted cash flow analysis, using management’s internal five-year forecast for the workers’ compensation insurance segment and a terminal value estimated using a long-term growth rate of 5.0% and a discount rate of 13.0%. Cash flows were adjusted, as necessary, to maintain adequate capital requirements.

The estimated fair value of the workers’ compensation insurance segment, based on the discounted cash flow analysis, exceeded its carrying value as of September 30, 2012; therefore, goodwill was considered not impaired, and the second step of the impairment test was not necessary.

In the event the operating results of the Company’s workers’ compensation insurance segment were to be adversely impacted by a significant loss of business or higher than expected losses and LAE, management’s internal forecast may need to be re-evaluated, which could result in an estimated fair value that is less than the carrying value of the workers’ compensation insurance segment and the need to recognize a goodwill impairment.

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Deferred Income Taxes

The temporary differences between the tax and book bases of assets and liabilities are recorded as deferred income taxes. Management evaluates the recoverability of the net deferred tax asset based on historical trends of generating taxable income or losses, as well as expectations of future taxable income or loss. As of December 31, 2012, the Company recorded a net deferred tax asset of $3.2 million. Management expects that the net deferred tax asset is fully recoverable. If this assumption were to change, any amount of the net deferred tax asset that the Company could not expect to recover would be provided for as an allowance and would be reflected as an increase in income tax expense in the period in which it was established.

Reinsurance Recoverables

Amounts recoverable from Company’s reinsurers are estimated in a manner consistent with the reserves for unpaid losses and LAE associated with the reinsured policy. Amounts paid for reinsurance contracts are expensed over the contract period during which insured events are covered by the reinsurance contracts. Reinsurance balances recoverable on paid and unpaid loss and LAE are reported separately as assets, instead of being netted with the appropriate liabilities, because reinsurance does not relieve the Company of its legal liability to its policyholders. Reinsurance balances recoverable are subject to credit risk associated with the particular reinsurer. Additionally, the same uncertainties associated with estimating unpaid losses and LAE affect the estimates for the ceded portion of these liabilities. The Company continually monitors the financial condition of its reinsurers and where necessary obtains collateral. As of December 31, 2012, the Company had reinsurance recoverables of $19.7 million.

Recent Accounting Pronouncements

ASU 2012-03

In August 2012, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2012-03, “Technical Amendments and Corrections to SEC Sections: Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin (“SAB”) No. 114, Technical Amendments Pursuant to SEC Release No. 33-9250, and Corrections Related to FASB ASU 2010-22” (“ASU 2012-03). This update amends various SEC paragraphs pursuant to the issuance of SAB No. 114. The adoption of ASU 2012-03 is not expected to have a material impact on the Company’s financial condition or results of operations.

Indefinite-Lived Intangible Asset Impairment Testing

In July 2012, the FASB issued ASU 2012-02, “Testing Indefinite-Lived Intangible Assets for Impairment (the revised standard)”. ASU 2012-02 does not change the existing guidance on when to test indefinite-lived intangible assets for impairment, which must be performed annually and between annual tests if events or circumstances indicate that it is more likely than not that the asset is impaired. ASU 2012-02 provides entities with an option to first perform a qualitative assessment to determine whether further impairment testing is necessary. The qualitative assessment is not required to be performed and an entity may proceed directly to the quantitative impairment test. Additionally, the qualitative assessment may be performed on all, some or none of an entity’s indefinite-lived intangible assets. If an entity performs the qualitative assessment and determines that it is not more likely than not that the asset is impaired, no further action is required. If an entity determines that it is more likely than not (that is, a likelihood of more than 50 percent) that the asset is impaired, the quantitative assessment must be performed to calculate the asset’s fair value and determine if the asset is impaired. ASU 2012-02 is effective for annual and interim indefinite-lived intangible asset impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted for calendar year-end public entities whose annual impairment test is performed in the third or fourth quarter. The Company adopted ASU 2012-02 effective September 30, 2012.

Presentation of Comprehensive Income

In June 2011, the FASB issued ASU 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”). ASU 2011-05 requires entities to present net income and comprehensive income in either a single continuous statement or in two separate, but consecutive, statements of net income and other comprehensive income. The option to present items of other comprehensive income in the statement of changes in equity was eliminated. ASU 2011-05 was effective for public entities as of the beginning of a fiscal year that began after December 15, 2011 (including interim periods) and is effective for nonpublic entities for fiscal years ending after December 15, 2012 and interim and annual periods thereafter. Early adoption was permitted and retrospective application is required. The Company adopted ASU 2011-05 effective January 1, 2012. The Company presents comprehensive income in the consolidated statement of operations and comprehensive income; therefore, the adoption of ASU 2011-05 did not change the Company’s presentation of comprehensive income.

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Fair Value Measurement and Disclosure Requirements

In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurements and Disclosures—Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS.” ASU 2011-04 clarifies the application of existing fair value measurement and disclosure requirements, changes certain principles related to measuring fair value, and requires additional disclosures about fair value measurements. ASU 2011-04 was effective for periods beginning after December 15, 2011. The Company adopted ASU 2011-04 effective January 1, 2012. The adoption of ASU 2011-04 did not affect the Company’s financial condition or results of operations.

Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts

In October 2010, the FASB issued ASU 2010-26, “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts” (“ASU 2010-26”). ASU 2010-26 provides specific types of costs that should be capitalized in connection with the acquisition or renewal of insurance contracts. Those costs include incremental direct costs of contract acquisition incurred in connection with independent third parties and certain costs related to activities performed by the insurer for the contract, including underwriting, policy issuance and processing, medical and inspection, and sales force contract selling. Under ASU 2010-26, costs incurred by an entity related to unsuccessful acquisition or renewal efforts must be charged to expense as incurred. ASU 2010-26 was effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011 and is to be applied prospectively. Retrospective application to all prior periods upon the date of adoption was permitted, but not required. The Company adopted ASU 2010-26 effective January 1, 2012 and applied it prospectively. As a result of adoption, the Company expensed certain underwriting salaries totaling approximately $2.4 million ($1.5 million, net of tax) for the year ended December 31, 2012 that would have been capitalized under the previous accounting guidance to give effect to unsuccessful acquisition or renewal activities. If the new accounting guidance had been adopted effective January 1, 2011, the Company would have recognized additional expense related to underwriting salaries totaling $2.9 million ($1.9 million, net of tax) for the year ended December 31, 2011.

YEAR ENDED DECEMBER 31, 2012 COMPARED TO YEAR ENDED DECEMBER 31, 2011

RESULTS OF OPERATIONS

The major components of consolidated revenue were as follows for the years ended December 31, 2012 and 2011 (in thousands):

	2012		2011
Net premiums written	$	169,958	$	142,121
Net premiums earned	$	159,614	$	132,173
Net investment income		3,882		3,698
Change in equity interest in limited partnerships		1,007		5
Net realized investment gains		3,246		1,654
Other revenue		319		425
Consolidated revenue	$	168,068	$	137,955

The increase in consolidated revenue from 2011 to 2012 primarily reflects the following:

• An increase in net premiums earned of 20.8%, reflecting new business growth, renewal rate increases and an increase in audit premium from customers;

• An increase in the equity interest in the Company’s limited partnership interests, primarily related to the multi-strategy fund of funds and structured financial opportunity fund; and

• An increase in net realized investment gains, primarily reflecting an increase in the estimated fair value of the convertible bond portfolio.

The components of consolidated net income, by segment, for the years ended December 31, 2012 and 2011 were as follows (in thousands):

	2012			2011
Workers’ compensation insurance	$	12,413		$	10,232
Segregated portfolio cell reinsurance		—			—
Corporate/other		(2,063	)		(2,878	)
Consolidated net income	$	10,350		$	7,354

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The increase in consolidated net income from 2011 to 2012 primarily reflects an increase in net premiums earned, equity interest in limited partnerships and net realized investment gains in the workers’ compensation insurance segment, partially offset by an increase in the workers’ compensation insurance combined ratio. The increase in the combined ratio primarily reflects the impact of adopting the new accounting policy for deferred acquisition costs, which increased the expense ratio by 1.9 percentage points in 2012.

WORKERS’ COMPENSATION INSURANCE

The following table represents the operations of the workers’ compensation insurance segment for the years ended December 31, 2012 and 2011 (in thousands).

	2012			2011
Revenue:
Direct premiums written	$	182,924		$	155,746
Reinsurance premiums assumed		3,144			2,047
Ceded premiums written (1)		(49,584	)		(45,779	)
Net premiums written		136,484			112,014
Change in unearned premiums		(8,985	)		(8,346	)
Net premiums earned		127,499			103,668
Net investment income		3,127			3,317
Change in equity interest in limited partnerships		872			(18	)
Net realized investment gains		3,314			1,360
Total revenue		134,812			108,327
Expenses:
Losses and LAE incurred		84,582			67,802
Acquisition and other underwriting expenses		10,768			7,035
Other expenses		21,185			16,844
Policyholder dividend expense		682			1,331
Total expenses		117,217			93,012
Income before income taxes		17,595			15,315
Income tax expense		5,182			5,083
Net income	$	12,413		$	10,232

(1) Ceded premiums written include premiums ceded to the segregated portfolio cell reinsurance segment of $37,826 and $33,994 for the years ended December 31, 2012 and 2011, respectively.

The workers’ compensation insurance ratios were as follows for the years ended December 31, 2012 and 2011:

	2012			2011
Loss and LAE ratio		66.3	%		65.4	%
Expense ratio		25.1	%		23.0	%
Policyholder dividend expense ratio		0.5	%		1.3	%
Combined ratio		91.9	%		89.7	%

Premiums

The increase in direct premiums written primarily reflects new business of $37.7 million, an increase in audit premium, average renewal rate increases of 3.7%, partially offset by a decrease in the renewal retention rate. Traditional and alternative market direct premiums written totaled $145.1 million and $37.8 million, respectively, for the year ended December 31, 2012. Audit premium, including the EBUB estimate, increased direct premiums written by $6.3 million in 2012, compared to $3.5 million in 2011. The traditional book of business recognized audit premium from customers of $4.3 million in 2012, compared to $2.3 million in 2011. The renewal retention rate decreased from 88.6% in 2011 to 83.5% in 2012, which primarily reflects the loss of seven accounts with total annual premiums of approximately $4.3 million in 2012.

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Net Investment Income