UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)
x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2007
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from               to

Commission file number: 001-32377

KMG AMERICA CORPORATION
(Exact Name of Registrant as Specified in Its Charter)

Virginia	20-1377270
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)

12600 Whitewater Drive, Suite 150, Minnetonka, Minnesota	55343
(Address of Registrant’s Principal Executive Offices)	(Zip Code)

Registrant’s telephone number, including area code: (952) 930-4800

Former name, former address and former fiscal year, if changed since last report:

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. x Yes      o No

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

Large accelerated filer o Accelerated filer x Non-accelerated filer o

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

As of August 3, 2007, the number of shares of Common Stock outstanding was 22,216,319.

TABLE OF CONTENTS

ITEM NO.			PAGE NO.
PART I. FINANCIAL INFORMATION			1
	ITEM 1. FINANCIAL STATEMENTS		1
		CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 2007 (UNAUDITED) AND DECEMBER 31, 2006	1
		CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) FOR THE THREE MONTHS ENDED JUNE 30, 2007 AND 2006 AND THE SIX MONTHS ENDED JUNE 30, 2007 AND 2006	3
		CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED) FOR THE SIX MONTHS ENDED JUNE 30, 2007 AND 2006	4
		NOTES TO CONSOLIDATED FINANCIAL STATEMENTS	5
	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		20
	ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		40
	ITEM 4. CONTROLS AND PROCEDURES		40
PART II. OTHER INFORMATION			40
	ITEM 1. LEGAL PROCEEDINGS		40
	ITEM 1A. RISK FACTORS		40
	ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS		40
	ITEM 6. EXHIBITS		41
SIGNATURES			42

i

PART I
FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

KMG AMERICA CORPORATION
CONSOLIDATED BALANCE SHEETS

	June 30, 2007		December 31, 2006
	(unaudited)
Assets
Investments:
Fixed maturity securities available for sale, at fair value (amortized cost of $573,883,218 and $531,477,537 as of June 30, 2007 and December 31, 2006, respectively)	$	550,635,804	$	520,624,942
Equity securities available for sale, at fair value (cost of $156,840 and $101,945 as of June 30, 2007 and December 31, 2006, respectively)		155,140		103,545
Mortgage loans		12,590,408		13,921,019
Policy loans		17,847,931		18,163,223
Other investments		5,798,598		5,523,232
Total investments		587,027,881		558,335,961
Cash and cash equivalents		26,796,650		21,744,137
Investment in subsidiary		1,083,000		—
Reinsurance balances recoverable		92,136,868		89,091,232
Accrued investment income		6,788,960		6,502,801
Real estate and equipment (net of accumulated depreciation of $4,788,866 and $3,652,073 as of June 30, 2007 and December 31, 2006, respectively)		16,208,206		15,068,506
Federal income tax recoverable		5,111,539		5,111,539
Deferred income tax asset		295,483		6,578,604
Amounts due from reinsurers		2,770,885		2,906,176
Deferred policy acquisition costs		36,044,022		28,453,929
Value of business acquired		69,143,463		70,766,211
Other assets		26,876,967		27,154,750
Total assets	$	870,283,924	$	831,713,846

1

KMG AMERICA CORPORATION
CONSOLIDATED BALANCE SHEETS

	June 30, 2007			December 31, 2006
	(unaudited)
Liabilities and shareholders’ equity
Liabilities:
Policy and contract liabilities:
Life and annuity reserves	$	248,957,703		$	252,658,190
Accident and health reserves		309,500,346			294,581,002
Policy and contract claims		27,198,420			14,530,782
Other policyholder liabilities		10,815,834			10,594,225
Total policy and contract liabilities		596,472,303			572,364,199
Accounts payable and accrued expenses		26,173,654			24,497,525
Taxes, other than federal income taxes		718,724			1,037,508
Federal income taxes accrued		188,160			523,889
Deferred income taxes		9,939,861			14,735,262
Liability for benefits for employees and agents		6,178,598			5,847,970
Funds held in suspense		3,752,378			4,832,579
Notes payable		14,000,000			14,000,000
Interest payable on note		25,550			50,350
Subordinated debt securities		36,083,000			—
Interest payable on subordinated debt		120,577			—
Other liabilities		1,593,946			1,773,077
Total liabilities		695,246,751			639,662,359
Shareholders’ equity:
Common Stock, par value $0.01 per share, 75,000,000 shares authorized and 22,216,319 and 22,211,589 shares issued and outstanding as of June 30, 2007 and December 31, 2006, respectively		222,163			222,116
Paid-in capital		189,899,520			189,150,959
Retained earnings		1,998,784			11,702,929
Accumulated other comprehensive loss		(17,083,294	)		(9,024,517	)
Total shareholders’ equity		175,037,173			192,051,487
Total liabilities and shareholders’ equity	$	870,283,924		$	831,713,846

See accompanying notes.

2

KMG AMERICA CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2007			2006			2007			2006
Revenue:
Insurance premiums	$	41,687,214		$	30,662,058		$	81,603,122		$	60,472,683
Net investment income		8,377,617			7,619,113			16,253,284			14,825,180
Commission and fee income		4,071,473			4,117,494			8,239,623			8,336,609
Realized investment gains (losses)		243,732			(115,044	)		190,824			96,064
Other income		1,193,565			922,347			2,252,633			1,908,880
Total revenues		55,573,601			43,205,968			108,539,486			85,639,416
Benefits and expenses:
Policyholder benefits		35,054,608			24,373,653			72,597,230			47,727,367
Insurance commissions, net of deferrals		4,021,202			2,923,991			8,173,646			5,905,276
General insurance expenses, net of deferrals		11,169,219			11,289,622			23,339,336			22,182,973
Insurance taxes, licenses and fees		1,860,532			1,292,320			3,475,548			2,807,372
Depreciation and amortization		764,139			630,494			1,469,286			1,271,359
Amortization of deferred policy acquisition costs and value of business acquired		1,108,572			1,155,242			3,189,253			2,333,343
Total benefits and expenses		53,978,272			41,665,322			112,244,299			82,227,690
Income (loss) before income taxes		1,595,329			1,540,646			(3,704,813	)		3,411,726
Provision for income taxes		(1,036,261	)		(523,612	)		(5,999,332	)		(1,158,495	)
Net income (loss)	$	559,068		$	1,017,034		$	(9,704,145	)	$	2,253,231
Net income per share:
Basic	$	0.03		$	0.05		$	(0.44	)	$	.10
Diluted	$	0.03		$	0.05		$	(0.44	)	$	.10
Weighted-average shares outstanding:
Basic		22,213,894			22,201,305			22,212,845			22,167,545
Diluted		22,213,894			22,217,635			22,212,845			22,197,249

See accompanying notes.

3

KMG AMERICA CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)

	Six Months Ended June 30, 2007			Six Months Ended June 30, 2006
Operating Expenses
Net (loss) income	$	(9,704,145	)	$	2,253,231
Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities:
Depreciation and amortization		2.376,117			2,271,834
Policy acquisition costs deferred		(9,156,598	)		(7,671,963	)
Amortization of deferred policy acquisition costs and value of business acquired		3,189,253			2,333,343
Realized investment losses (gains), net		(190,824	)		(96,064	)
Deferred income tax expense		5,827,061			1,158,495
Changes in operating assets and liabilities:
Investment in subsidiary		(1,083,000	)		—
Reinsurance balances recoverable		(3,045,636	)		(8,368,881	)
Accrued investment income		(286,159	)		(133,907	)
Other assets		277,783			(5,218,721	)
Amounts due from reinsurers		135,291			(2,024,758	)
Policy and contract liabilities		24,108,104			12,675,064
Accounts payable and accrued expenses		1,676,129			2,396,528
Interest payable		95,777			393,750
Stock-based compensation expense		748,609			628,013
Taxes, other than federal income taxes		(318,784	)		(247,359	)
Federal income taxes accrued		(335,729	)		—
Funds held in suspense		(1,080,201	)		(430,410	)
Liability for benefits for employees and agents		330,628			(427,691	)
Other liabilities		(179,131	)		(450	)
Net cash provided by (used in) operating activities		13,384,545			(509,946	)
Investing activities
Securities available for sale:
Sales		11,806,084			7,797,608
Maturities, calls and redemptions		13,889,921			18,739,103
Purchases		(69,480,446	)		(53,795,616	)
Repayments of mortgage loans		1,330,611			2,196,666
Decrease in policy loans, net		315,292			2,670,782
Purchases of real estate, property and equipment		(2,276,494	)		(2,735,270	)
Net cash (used in) investing activities		(44,415,032	)		(25,126,727	)
Financing activities
Issuance of subordinated debt securities		36,083,000			—
Net cash provided by (used in) financing activities		36,083,000			—
Net increase (decrease) in cash and cash equivalents		5,052,513			(25,636,673	)
Cash and cash equivalents at beginning of period		21,744,137			32,582,964
Cash and cash equivalents at end of period	$	26,796,650		$	6,946,291
Supplemental disclosures of cash flow information
Federal income taxes paid	$	508,000		$	—

See accompanying notes.

4

KMG AMERICA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Organization and Nature of Operations

          Unless the context requires otherwise, references to “we”, “us”, “our”, “KMG America” or the “Company” are intended to mean KMG America Corporation and its consolidated subsidiaries, including, without limitation, Kanawha Insurance Company (“Kanawha”). References to our “predecessor” mean Kanawha prior to it being acquired by KMG America.

          KMG America is a holding company incorporated under the laws of the Commonwealth of Virginia on January 21, 2004. KMG America commenced operations shortly before it completed its initial public offering of common stock on December 21, 2004, and its shares trade on the New York Stock Exchange under the symbol “KMA.” Concurrently with the completion of its initial public offering, KMG America completed its acquisition of Kanawha and its subsidiaries, which are KMG America’s primary operating subsidiaries and which underwrite and sell life and health insurance products.

          Kanawha, the primary operating subsidiary of KMG America, is licensed to issue life and accident and health insurance. Kanawha is domiciled in South Carolina. Kanawha has one wholly owned subsidiary, Kanawha HealthCare Solutions, Inc., a third-party administrator with operations in Lancaster and Greenville, South Carolina.

          The primary insurance products that the Company underwrites include: group and individual life insurance; group long term disability insurance; group and individual short term disability insurance; group and individual dental insurance; group and individual indemnity health insurance; group critical illness insurance and employer group excess risk insurance. The Company ceased actively underwriting new long-term care insurance policies after December 31, 2005. The Company intends to retain and actively manage the Company’s existing block of in force long-term care policies. The Company’s third-party administration and medical management businesses include a wide array of services with the primary emphasis on the offering of administrative service-only products.

          The Company’s sales historically have been primarily in the southeastern United States, predominantly in Florida, South Carolina and North Carolina, but are now expanding nationwide. Sales are made through an internal sales force, full-time agents, general agents and brokers. Under the Company’s current business strategy, the Company expects group lines of business to account for an increasing percentage of the Company’s premium revenues.

          On May 7, 2007, the Company publicly announced that it had retained Keefe, Bruyette & Woods, Inc., an investment banking firm, to advise management and the Board of Directors regarding strategic alternatives, including the possible sale or merger of the Company. The process is underway and advanced negotiations are occurring. There can be no assurance that this process will result in a sale or merger of the Company, or if a sale or merger is undertaken, the potential terms or timing of the transaction. The Company does not intend to publicly disclose updates or developments in its strategic alternatives process until such time as the Company enters into a definitive agreement with a third party in connection with a transaction or terminates the strategic alternatives process.

2. Significant Accounting Policies

          Basis of Presentation

          The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All significant intercompany accounts and transactions have been eliminated in consolidation. Operating results for the quarter ended June 30, 2007, are not necessarily indicative of the results that may be expected for the year ended December 31, 2007.

          The Company also submits financial statements to insurance industry regulatory authorities. Those financial statements are prepared on the basis of statutory accounting practices (“SAP”) and are significantly different from financial statements prepared in accordance with GAAP (see Note 4).

5

KMG AMERICA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

          Use of Estimates and Assumptions

          The presentation of the accompanying consolidated financial statements requires management to make estimates and assumptions that affect amounts reported in the consolidated financial statements and accompanying notes. Such estimates and assumptions could change in the future as more information becomes known, which could impact the amounts reported and disclosed herein.

          Cash and Cash Equivalents

          The Company includes with cash and cash equivalents its holdings of highly liquid investments with maturities of three months or less from the date of acquisition.

          Investments

          Statement of Financial Accounting Standards (“SFAS”) No. 115, Accounting for Certain Investments in Fixed Maturity and Equity Securities, requires that all fixed maturity and equity securities be classified into one of three categories—held to maturity, available-for-sale, or trading. The Company has no securities classified as held to maturity. Management determines the appropriate classification of fixed maturities at the time of purchase. Investments are reported on the following basis:

          Fixed maturities classified as available-for-sale are stated at fair value with unrealized gains and losses reported directly in shareholders’ equity as accumulated other comprehensive income. Fair values for fixed maturity securities are based on quoted market prices, where available. For fixed maturity securities that are not actively traded, fair values are estimated using values obtained from independent pricing services.

          Equity securities classified as available-for-sale are stated at fair value with unrealized gains and losses reported directly in shareholders’ equity as accumulated other comprehensive income.

          Assets supporting the deferred compensation plan are classified as trading and are included in other investments. Trading account assets are held for resale in anticipation of short-term market movements. Trading account assets, consisting of mutual funds, are stated at fair value. Gains and losses, both realized and unrealized, are included in realized gains and losses.

          Mortgage loans on real estate are stated at unpaid balances, net of allowances for unrecoverable amounts. Valuation allowances for mortgage loans are established when the Company determines it is probable that it will be unable to collect all amounts (both principal and interest) due according to the contractual terms of the loan agreement. Such allowances are based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, if foreclosure is probable, on the estimated fair value of the underlying real estate.

          Policy loans are stated at their unpaid balances.

          Interest on loans is generally recorded over the term of the loan based on the unpaid principal balance. Accrual of interest is discontinued when either principal or interest becomes 90 days past due or when, in management’s opinion, collection of such interest is doubtful. In addition, any previously accrued interest is reversed when the loan becomes 90 days past due.

          Other investments are stated at fair value, or the lower of cost or fair value, as appropriate.

          Amortization of premiums and accrual of discounts on investments in fixed maturity securities is reflected in earnings over the contractual terms of the investments in a manner that produces a constant effective yield. Realized gains and losses on dispositions of securities are determined by the specific-identification method.

          The Company regularly reviews its investment portfolio to identify securities that may have suffered impairments in value that will not be recovered, termed potentially distressed securities. In identifying potentially distressed securities, the Company first screens for all securities that have a fair value to cost or amortized cost ratio of less than 80%. Additionally, as part of this identification process, the Company utilizes the following information:

6

KMG AMERICA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

• length of time the fair value was below amortized cost;

• industry factors or conditions related to a geographic area negatively affecting the security;

• downgrades by a rating agency;

• past due interest or principal payments or other violation of covenants; and

• deterioration of the overall financial condition of the specific issuer.

          In analyzing its potentially distressed securities list for other-than-temporary impairments, the Company pays special attention to securities that have been on the list for a period greater than six months. The Company assumes that, absent reliable contradictory evidence, a security that is potentially distressed for a continuous period greater than twelve months has incurred an other-than-temporary impairment. Reliable contradictory evidence might include, among other factors, a liquidation analysis performed by the Company’s investment advisors or outside consultants, improving financial performance of the issuer, or valuation of underlying assets specifically pledged to support the credit.

          Should the Company conclude that the decline is other-than-temporary, the security is written down to fair value through a charge to realized investment gains and losses. The Company adjusts the amortized cost for securities that have experienced other-than-temporary impairments to reflect fair value at the time of the impairment. The Company considers factors that lead to an other-than-temporary impairment of a particular security in order to determine whether these conditions have impacted other similar securities.

          Real Estate and Equipment

          Company-occupied real estate, primarily buildings, is carried at cost less accumulated depreciation and are depreciated principally by the straight-line method over estimated useful lives generally ranging from 15 to 30 years. Equipment is stated at cost, less accumulated depreciation, and depreciated principally by the straight-line method over their estimated useful lives, generally 3 to 5 years.

          Expenditures for improvements are capitalized, and expenditures for maintenance and repairs are charged to operations as incurred. Upon sale or retirement, the cost and related accumulated depreciation and amortization are removed from the accounts and the resulting gain or loss, if any, is reflected in operations.

          Deferred Policy Acquisition Costs

          Acquisition costs incurred by the Company in the process of acquiring new business are deferred and amortized into income as discussed below. Costs deferred consist primarily of commissions and certain policy underwriting, issue and agency expenses that vary with and are primarily related to production of new business.

          For most insurance products, the amortization of deferred acquisition costs is recognized in proportion to the ratio of annual premium revenue to the total anticipated premium revenue, which gives effect to expected terminations. Deferred acquisition costs are amortized over the premium-paying period of the related policies. Anticipated premium revenue is determined using assumptions consistent with those utilized in the determination of liabilities for insurance reserves.

          Value of Business Acquired

          Value of business acquired is the value assigned to the insurance in force of acquired insurance companies or blocks of insurance business at the date of acquisition.

          The amortization of value of business acquired is generally recognized using amortization schedules established at the time of the acquisitions based upon expected revenue. The amortization is further impacted by actual-to-expected persistency adjustments which reflect our actual experience as it emerges over time relative to what we expected in the development of the amortization schedules.

7

KMG AMERICA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

          Impairment of Long-Lived Assets

          Long-lived assets include property and equipment, other intangible assets, systems development and other deferred costs and other assets. In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144”), the Company regularly evaluates whether events and circumstances have occurred which indicate that the carrying amount of long-lived assets may warrant revision or may not be recoverable. When factors indicate that long-lived assets should be evaluated for possible impairment, the Company uses an estimate of the future undiscounted net cash flows of the related business over the remaining life of the asset in measuring whether the carrying amount of the related asset is recoverable. To the extent these projections indicate that future undiscounted net cash flows are not sufficient to recover the carrying amounts of the related assets, the underlying assets are written down by charges to expense so that the carrying amount is equal to fair value, primarily determined based on future discounted cash flows. In the opinion of management, the Company’s long-lived assets are appropriately valued at June 30, 2007 and December 31, 2006.

          Benefit Reserves

          Insurance reserves for individual life insurance, individual accident and health insurance, group life insurance and group accident and health insurance are associated with earned premiums so as to recognize profits over the premium-paying period. This association is accomplished by recognizing the liabilities for insurance reserves on a net level premium method based on assumptions deemed appropriate at the date of issue as to future investment yield, mortality, morbidity, withdrawals and maintenance expenses, and including margins for adverse deviations. Interest assumptions are based on the Company’s experience. Mortality, morbidity and withdrawal assumptions are based on recognized actuarial tables or the Company’s experience, as appropriate. Life reserves are calculated using mean reserve factors. Accident and health reserves are calculated using mid-terminal reserve factors. Benefit reserves for investment products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include benefit claims incurred in the period in excess of related policy account balances.

          Benefit reserves as reported are shown on a GAAP purchase accounting basis (“PGAAP”). Prior to the quarter ending June 30, 2006, this conversion was based on an adjustment to benefit reserves developed on a historical GAAP basis. Effective June 30, 2006, a refinement in methodology was implemented whereby the benefit reserves are now being developed directly on a PGAAP basis. This seriatim factor approach was not implemented in prior quarters because of the significant amount of time it has taken to develop the complete set of reserve factors that was needed. The refinement of the methodology to use seriatim developed reserves had no material impact on income but did have an impact on the balance sheet on a segment by segment basis as of June 30, 2006.

          Loss recognition testing of the Company’s policy benefit reserves is performed annually. This testing involves a comparison of the Company’s actual net liability position (all liabilities less deferred acquisition costs (“DAC”) and value of business acquired (“VOBA”)) to the present value of future liabilities calculated using then-current assumptions. These assumptions are based on the Company’s best estimate of future experience. To the extent a premium deficiency exists, it would be recognized immediately by a charge to the statement of operations and a corresponding reduction in DAC or VOBA. Any additional deficiency would be recognized as a premium deficiency reserve. Historically, loss recognition testing has not resulted in an adjustment to DAC, VOBA or reserves. These adjustments would occur only if economic, mortality and/or morbidity conditions deviated in a significantly adverse fashion from the underlying assumptions.

          Claims and Claim Adjustment Expenses

          Claim reserves relating to short duration contracts generally are recorded when insured events occur. The liability is based on the expected ultimate cost of settling the claims. The claims and benefits payable reserves include: (1) case base reserves for known but unpaid claims as of the balance sheet date; (2) incurred but not reported (“IBNR”) reserves for claims where the insured event has occurred but has not been reported as of the balance sheet date; and (3) loss adjustment expense reserves for the expected handling costs of settling the claims. Case base reserves and the IBNR reserves are recorded at an amount equal to the net present value of the expected future claims payments. Factors considered when setting IBNR reserves include patterns in elapsed time from claim incidence to claim reporting, and elapsed time from claim reporting to claim payment. Claim reserves generally equal the Company’s estimate, at the end of the current reporting period, of the present value of the liability for future benefits and expenses to be paid on claims incurred as of that date. A claim reserve for a specific claim is

8

KMG AMERICA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

based on assumptions derived from historical experience as to claim duration, as well as the specific characteristics of the claimant such as benefits available under the policy, the benefit period, and the age and occupation of the claimant. Although considerable variability is inherent in such estimates, management believes that the reserves for claims and claim adjustment expenses are adequate. The estimates are continually reviewed and adjusted as necessary as experience develops or new information becomes known; such adjustments are included in current operations.

          Reinsurance

          Reinsurance premiums, benefits and reserves are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the insurance contracts. Benefit reserves and claim liabilities are reported gross of reinsured amounts. An estimated allowance for doubtful accounts is recorded on the basis of periodic evaluations of balance due from reinsurers, reinsurer solvency, Company experience and current economic conditions.

          Recognition of Revenue

          Premiums on life insurance products are reported as revenue when due unless received in advance of the due date. Premiums on accident and health insurance are reported as earned over the contract period. A reserve is provided for the portion of premiums written which relate to unexpired coverage terms.

          Revenue from annuity and interest sensitive products including universal life products includes charges for the cost of insurance, for initiation and administration of the policy and for surrender of the policy. Revenue from these products is recognized in the year assessed to the policyholder, except that any portion of an assessment, which relates to services to be provided in future years, is deferred and recognized over the period during which services are provided.

          Revenue from commission and fee income is recognized over the related contract periods.

          Realized Capital Gains (Losses)

          Realized capital gains and losses are reported in the income statement on a pretax basis in the period that the asset giving rise to the gain or loss is sold. Impairment writedowns are recorded when there has been a decline in value deemed other than temporary, in which case the write down for such impairments is charged to income.

          Recognition of Benefits

          Benefits related to traditional life and accident and health insurance products are recognized when incurred in a manner designed to match them with related premiums and spread income recognition over expected policy lives. For annuity and interest sensitive products including universal life products, benefits include interest credited to policyholders’ accounts, which is recognized as it accrues.

          Share-Based Compensation

          On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including stock options and restricted common stock based on estimated fair values. SFAS 123(R) supersedes the Company’s previous accounting for periods beginning in 2006.

          The Company had adopted the disclosure-only requirements of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), as amended by FASB Statement No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure (“SFAS 148”) through December 31, 2005. As permitted by the provisions of this Statement, the Predecessor accounted for stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and Related Interpretations (“APB No. 25”). Accordingly, the Company recognized no compensation expense for stock option awards to employees or directors when the option exercise price was not less than the market value of the stock at the date of award.

9

KMG AMERICA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

          The Company adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of the Company’s fiscal year 2006. The Company’s Consolidated Financial Statements as of December 31, 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method, the Company’s Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R).

          SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The Company has used a Black-Scholes option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s Consolidated Statement of Income.

          On November 10, 2005, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position No. FAS 123(R)-3 “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards.” The Company has elected to adopt the alternative transition method provided in the FASB Staff Position for calculating the tax effects of stock-based compensation pursuant to SFAS 123(R). The alternative transition method includes simplified methods to establish the beginning balance.

          Defined Benefit Retirement Plan

          In September 2006, the FASB issued SFAS No. 158, “Employers Accounting for Defined Benefit Pension and Other Postretirement Plans – An Amendment of FASB Statements No. 87, 88, 106, and 132R” (“SFAS No. 158”). SFAS No. 158 requires companies to (1) recognize as an asset or liability, the overfunded or underfunded status of defined pension and other postretirement benefit plans; (2) recognize changes in the funded status through other comprehensive income in the year in which the changes occur; (3) measure the funded status of defined pension and other postretirement benefit plans as of the date of the company’s fiscal year-end; and (4) provide enhanced disclosures. The provisions of SFAS No. 158 are effective for the Company’s year-ending December 31, 2006. The Company adopted SFAS No. 158 at December 31, 2006.

          Income Taxes

          Income taxes are computed using the liability method required by SFAS No. 109, Accounting for Income Taxes. Under this Statement, deferred tax assets and liabilities are determined based on the differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Recorded amounts are adjusted to reflect changes in income tax rates and other tax law provisions as they become enacted.

          Recently Issued Accounting Standards

          In February 2007, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“FAS No. 159”), which allows a company to make an irrevocable election, on specific election dates, to measure eligible items at fair value with unrealized gains and losses recognized in earnings at each subsequent reporting date. The election to measure an item at fair value may be determined on an instrument by instrument basis, with certain exceptions. If the fair value option is elected, any upfront costs and fees related to the item will be recognized in earnings as incurred. Items eligible for the fair value option include: certain recognized financial assets and liabilities; rights and obligations under certain insurance contracts that are not financial instruments; host financial instruments resulting from the separation of an embedded non financial derivative instrument from a non financial hybrid instrument; and certain commitments. FAS No. 159 is generally effective for fiscal years beginning after November 15, 2007.As of the effective date, the fair value option may be elected for certain eligible items that exist on that date. The effect of the first measurement to fair value shall be reported as a cumulative effect adjustment to the opening balance of retained earnings. The Company is currently evaluating the items to which the fair value option may be applied.

          In September 2006, the FASB issued FASB Statement No. 157, “Fair Value Measurements” (“FAS No. 157”). FAS No. 157 provides guidance for using fair value to measure assets and liabilities whenever other standards require (or permit) assets or liabilities to be measured at fair value. FAS No. 157 does not expand the use of fair value to any new circumstances. Under FAS No. 157, the FASB clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, FAS No. 157 establishes a fair value hierarchy that prioritizes the information used to develop such

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KMG AMERICA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. FAS No. 157 also requires separate disclosure of fair value measurements by level within the hierarchy and expanded disclosure of the effect on earnings for items measured using unobservable data. The provisions of FAS No. 157 are effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is in the process of determining the impact of adoption of FAS No. 157.

          In June 2006, FASB issued Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement 109.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted FIN 48 effective January 1, 2007 and has determined that there is no material impact on its financial statements upon adoption.

          In September 2005, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants (AcSEC) issued Statement of Position 05 -1 (SOP 05 -1), Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts. SOP 05 -1 provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in Statement of Financial Accounting Standards (SFAS) No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from Sale of Investments. SOP 05 -1 defines an internal replacement as a modification in product benefits, features, rights, or coverages that occur by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. SOP 05 -1 is effective for internal replacements occurring in fiscal years beginning after December 15, 2006 with earlier adoption encouraged. Retrospective application of SOP 05 -1 to previously issued financial statements is not permitted. The Company adopted SOP 05-1 effective January 1, 2007 and determined that there was no material financial impact on its financial statements upon adoption.

3. Investments

          Aggregate amortized cost, aggregate fair value and gross unrealized gains and losses of investments in fixed maturity and equity securities are summarized in the following table.

	AmortizedCost		Gross Unrealized Gains		Gross Unrealized Losses		FairValue
Available for sale securities at June 30, 2007:
Fixed maturity securities	$	573,883,218	$	562,346	$	23,809,760	$	550,635,804
Equity securities		156,840		—		1,700		155,140
Securities available for sale	$	574,040,058	$	562,346	$	23,811,460	$	550,790,944

4. Statutory Financial Information

          State insurance laws and regulations prescribe accounting practices for determining statutory net income and equity for insurance companies. In addition, state regulators may permit statutory accounting practices that differ from prescribed practices. The Company does not have any accounting practices that differ from prescribed statutory accounting practices.

          Under South Carolina insurance regulations, Kanawha is required to maintain minimum capital of $1.2 million and minimum surplus of $1.2 million. Additionally, Kanawha is restricted as to amounts that can be transferred in the form of dividends, loans, or advances. While the South Carolina Insurance Department acknowledges distinctions between ordinary and extraordinary dividends, their approval is required before any dividend payments can be made.

11

KMG AMERICA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

5.	Employee Benefits
	Defined Benefit Retirement Plan

          As of the dates indicated, the net periodic retirement benefit cost of the Company’s defined benefit pension plan for the quarters presented included the following components:

	Three Months Ended June 30,						Six Months Ended June 30,
	2007			2006			2007			2006
Components of net periodic benefit cost:
Service cost	$	—		$	47,778		$	—		$	95,556
Interest cost		240,000			232,510			480,000			465,020
Expected return on plan assets		(360,000	)		(309,641	)		(720,000	)		(619,282	)
Amortization of transition liability		—			362			—			724
Recognized net actuarial loss		50,000			52,646			100,000			105,292
Net periodic benefit cost	$	(70,000	)	$	23,655		$	(140,000	)	$	47,310
Curtailment Expense	$	—			—		$	—			120,170

          On January 31, 2006, the Company adopted two amendments to the defined benefit retirement plan that froze participation in the plan and froze accrual of any additional benefits under the plan. As of June 30, 2006, no new participants were allowed to enter the plan. Effective as of September 30, 2006, no additional benefits accrue under the plan with respect to service after that date. As a result, final average earnings will be determined as of September 30, 2006, for all future benefit payments, and will not be adjusted for future changes in employee compensation.

          The curtailment expense recognized as a result of the plan freeze was $120,170 for the six months ended June 30, 2006.

          Defined Contribution Plan

          The Company offers a 401(k) qualified savings plan for which substantially all employees and agents are eligible. Plan participants may contribute up to 15% of pretax annual compensation, which includes overtime, bonuses and commissions. Participants may also contribute amounts representing distributions from other qualified defined benefit or defined contribution plans. Until October 1, 2006, the Company contributed 25% of the first 6% of base compensation that a participant contributed to the Plan. The Company also could make an additional contribution up to 25% at its discretion.

          Effective as of October 1, 2006, the Company matches 100% of the first 3% of salary deferral contributions that a participant contributes to the plan and 50% of the next 2% of salary deferral contributions a participant contributes to the plan. Effective January 1, 2007, participants will be 100% vested in all matching contributions made by the Company to the plan on and after that date.

          Effective January 1, 2007, the Company began additional annual employer contributions to the 401(k) plan accounts of associates who: have at least five years of service (were hired before January 1, 2002); are at least age 45 on January 1, 2007; and have at least 1,000 hours of service in the calendar year for which the contribution is being made, and are actively employed on December 31 of that year. The contribution will be equal to the amount of the eligible associate’s earned salary and bonus in the calendar year for which the contribution is being made, multiplied by the percentage in the table below corresponding to that associate’s age as of January 1, 2007:

Age 45-49	1.5%
Age 50-54	2.75%
Age 55+	4.0%

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KMG AMERICA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

          The initial contribution will be made in January 2008, and annually thereafter. The contribution vests immediately after being made.

          Deferred Compensation Plan

          The Company has a non-qualified deferred compensation plan for senior management that allows the deferment of a portion of their compensation until their services with the Company have terminated. The plan includes deferred contributions, which were not elected by employees to be transferred to the 401(k) plan upon adoption of the 401(k) plan. The plan’s investments include mutual funds and are recorded in investments as held for trading. The corresponding deferred obligations to participants are recorded in other liabilities.

          KMG America 2004 Equity Incentive Plan

          The KMG America 2004 Equity Incentive Plan was established in 2004 and amended in 2006 with 2,827,500 shares of KMG America Common Stock reserved for issuance under the Plan. Through June 30, 2007, net of forfeitures, 144,678 shares of Common Stock have been granted which generally vest with respect to one-fourth of the shares granted on each of the first, second, third, and fourth anniversaries of the date of grant. To date, 52,742 shares of Common Stock granted are fully vested. Also, through June 30, 2007, net of forfeitures, options to purchase 1,860,925 shares of Common Stock have been issued which generally vest with respect to one-fourth of the shares subject to the option on each of the first, second, third and fourth anniversaries of the date of grant. With respect to options issued to one optionholder, they vest one-third on each of the first, second and third anniversaries of the date of grant, subject to earlier immediate vesting upon the termination of the optionholder’s employment with the Company, by the Company without cause, by him with good reason, upon a change in control of the Company and upon his receipt of a notice of non-renewal of his employment agreement, or upon his death or disability.

          The Company adopted SFAS 123(R) as of January 1, 2006. Below is the presentation of our employee and director stock options and common stock grants under the fair value method.

          Common Stock Grants

          The activity related to the common stock grants is set forth below:

	Common Stock Grants Outstanding					Weighted Average Grant Date Fair Value Per Share of Common Stock Grants Outstanding
	Nonvested			Vested		Nonvested		Vested
Outstanding as of December 31, 2006		114,042			25,906		8.29		8.45
Granted		—			6,669		—		6.56
Vested		(20,167	)		20,167		8.02		8.02
Forfeited		(1,939	)		—		8.36		—
Outstanding as of June 30, 2007		91,936			52,742		8.35		8.05

          Stock Options

          Black-Scholes option-pricing model assumptions used:

Average Risk-free Interest Rate	4.54	%
Expected Dividend Yield	—
Expected Volatility	20.0	%
Expected Life (years)	5

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KMG AMERICA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

          The activity related to the stock options is set forth below:

	Options Outstanding			Weighted Average Exercise Price		Aggregate Intrinsic Value		Weighted Average Remaining Life (in years)
Outstanding as of December 31, 2006		1,913,425			9.16
Granted		10,000			8.74
Exercised		—			—
Forfeited		(62,500	)		8.99
Outstanding as of June 30, 2007		1,860,925			9.17		4,554,565		7.99
Exercisable as of June 30, 2007		807,852			9.35		1,982,425		7.70

          The following table sets forth share-based compensation and the related tax benefit:

	Six Months Ended June 30, 2007
Total Share-Based Compensation
Included in loss before income taxes	$	748,609
Included in net loss, net of tax effects	$	486,596
Excess tax benefits related to options exercised	$	—
Excess tax benefits related to share-based compensation(1)	$	—

(1) Represents the tax benefit, recognized in additional paid-in-capital for stock options exercised.

          As of June 30, 2007, there was $2,702,976 of total unrecognized compensation cost related to nonvested share-based compensation arrangements.

6. Comprehensive Income (Loss)

          Total comprehensive income (loss) for the six months ended June 30, 2007 and 2006 was ($17,762,922) and $(11,759,484), respectively. The difference between comprehensive income and net income for these periods was unrealized investment gains (losses) of $(8,058,777) and $(14,012,715), respectively.

          Total comprehensive income (loss) for the three months ended June 30, 2007 and 2006 was $(7,987,949) and $(5,055,412), respectively. The difference between comprehensive income and net income for these periods was unrealized investment gains (losses) of $(8,547,017) and $(6,072,446), respectively.

On December 31, 2006, we adopted Financial FASB Statement of Financial Accounting Standards (“SFAS”) No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. Upon adoption, we recorded a $1,971,370 reduction in comprehensive income on our consolidated balance sheet as of December 31, 2006. However, the cumulative effect of the change in accounting, net of tax, should have been recorded as a separate component of accumulated other comprehensive income. As of December 31, 2006, we reported total comprehensive income of $3,189,482. With this revised presentation, total comprehensive income would have been $5,160,852 as of December 31, 2006. This revised presentation will be reflected in our Annual Report on Form 10-K as of December 31, 2007.

14

KMG AMERICA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7. Commitments and Contingencies

          The Company is occasionally named as a defendant in various legal actions arising principally from claims made under insurance policies and contracts. Those actions are considered by the Company in estimating the policy and contract liabilities and management believes adequate reserves have been established for such cases. Management believes that the resolution of those actions will not have a material effect on the Company’s financial position or results of operations.

          As previously disclosed by the Company, on May 4, 2007, the Company entered into a settlement agreement with ReliaStar Life Insurance Company and ReliaStar Life Insurance Company of New York (“ReliaStar”) to settle litigation ReliaStar brought against the Company, Kanawha, and the following officers of the Company: Kenneth U. Kuk; Paul F. Kraemer; Paul P. Moore; Thomas J. Gibb; Scott H. DeLong III; and Thomas D. Sass. The complaint and amended complaint filed by ReliaStar alleged claims of misappropriation of trade secrets, conversion, tortious interference with business and employment relationships, breach of fiduciary duties, breach of contract, unfair competition, interference with contractual relationships, civil conspiracy, fraudulent misrepresentation and civil theft. Pursuant to the settlement agreement, the Company made a cash payment of $825,000 to ReliaStar in settlement of all claims, ending the litigation. The insurance carrier for the Company’s primary directors and officers insurance policy previously informed the Company that it was willing to provide reimbursement for a portion of the amount paid by the Company in settlement of the litigation. The Company views the amount offered by the insurance carrier to be insufficient. Moreover, during the course of the litigation, the insurance carrier made various deductions from its reimbursements to the Company for the legal fees expended by the Company. The Company will make a good faith effort to reach an agreement with the insurance carrier relating to the insurance carrier’s contribution to the settlement and the insurance carrier’s payments for the legal fees incurred by the Company throughout the duration of the litigation. At the present time, it is unclear whether the Company will be able to reach a satisfactory arrangement with its primary directors and officers liability carrier. If it is not able to do so, the Company intends to pursue additional reimbursement from the insurance carrier under the insurance policy.

8. Debt and Other Obligations

          Wachovia Credit Agreement.

          On December 21, 2006, the Company entered into a credit agreement with Wachovia, which provides a $15.0 million unsecured revolving credit facility from which we borrowed $14.0 million to repay the five-year subordinated promissory note that was issued to fund a portion of the purchase price for the Kanawha acquisition. The remaining $1.0 million available under the credit facility may be used to finance the Company’s working capital, liquidity needs and general working requirements and those of its subsidiaries. Amounts outstanding under the credit agreement will bear interest at a rate calculated according to, at the Company’s option, a base rate or the LIBOR rate plus an applicable percentage. The applicable percentage is based on the A.M. Best financial strength rating of Kanawha, and ranges from 0.25% to 0.35% for base rate loans and from 1.25% to 1.35% for LIBOR rate loans. In the case of LIBOR rate loans, interest on amounts outstanding is payable at the end of the interest period, which can be one, two, three or six months, as selected by the Company in its notice of borrowing. Wachovia’s obligation to fund the credit agreement terminates, and all principal outstanding under the credit agreement is due and payable, no later than December 31, 2007. As of June 30, 2007, the $14.0 million outstanding under the credit agreement was a LIBOR rate plus applicable percentage loan with an interest rate of 6.57%.

          The credit agreement requires the Company to comply with certain covenants, including, among others, maintaining a maximum ratio of consolidated indebtedness to total capitalization, a minimum available dividend amount for Kanawha and a minimum A.M. Best financial strength rating of B++ for Kanawha. The Company must also comply with limitations on certain payments, additional debt obligations, dispositions of assets and its lines of business. The credit agreement also restricts the Company from creating or allowing certain liens on its assets and from making certain investments.

15

KMG AMERICA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

          Subordinated Debt Securities.

          On March 22, 2007, KMG America completed the issuance and sale in a private placement of $35,000,000 in aggregate principal amount of trust preferred securities (the “Trust Preferred Securities”) issued by the Company’s newly-formed subsidiary, KMG Capital Statutory Trust I, a Delaware statutory trust (the “Trust”). The Trust Preferred Securities will mature on March 15, 2037, may be called at par by the Company any time after March 15, 2012, and require quarterly distributions of interest by the Trust to the holder of the Trust Preferred Securities. Distributions are payable quarterly at a fixed interest rate equal to 8.02% per annum through March 15, 2012, and then will be payable at a floating interest rate equal to the 3-month London Interbank Offered Rate (“LIBOR”) plus 310 basis points per annum. The Trust simultaneously issued one of the Trust’s common securities (the “Common Securities”) to the Company for a purchase price of $1,083,000, which constitutes all of the issued and outstanding common securities of the Trust.

          The Trust used the proceeds from the sale of the Trust Preferred Securities together with the proceeds from the sale of the Common Securities to purchase $36,083,000 in aggregate principal amount of unsecured junior subordinated deferrable interest debt securities due March 15, 2037, issued by the Company (the “Junior Subordinated Debt”). The net proceeds to the Company from the sale of the Junior Subordinated Debt to the Trust will be used by the Company for general corporate purposes.

          The Junior Subordinated Debt was issued pursuant to an Indenture, dated March 22, 2007 (the “Indenture”), between the Company, as issuer, Wilmington Trust Company, as trustee, and the administrators named therein. The terms of the Junior Subordinated Debt are substantially the same as the terms of the Trust Preferred Securities. The interest payments on the Junior Subordinated Debt paid by the Company will be used by the Trust to pay the quarterly distributions to the holders of the Trust Preferred Securities. The Indenture permits the Company to redeem the Junior Subordinated Debt (and thus a like amount of the Trust Preferred Securities) on or after March 15, 2012. If the Company redeems any amount of the Junior Subordinated Debt, the Trust must redeem a like amount of the Trust Preferred Securities.

          The Trust was not consolidated based on the guidance issued by the FASB in Interpretation (“FIN”) No. 46(R), Consolidation of Variable Interest Entities, but rather is treated like an equity-method investment. Thus, the Company’s $1.1 million investment in the Trust is recorded as an Investment in subsidiary.

9. Federal Income Taxes

          The actual effective rate for the six months ended June 30, 2007 varies from the expected statutory rate of approximately 35% primarily as a result of the establishment of a $7.2 million valuation allowance to offset the portion of the deferred tax asset relating to the holding company. The decision by A.M. Best to change the outlook of our rating from stable to negative, and the resulting strategic options being considered, has created uncertainty about our ability and timing to generate taxable income at the holding company. Because of this uncertainty, the Company has deemed it appropriate to establish the valuation allowance. The Company will continue to evaluate tax planning strategies to utilize the operating losses prior to their expiration.

          The Company had no interest and penalties for the six months ended June 30, 2007 and no amounts were accrued. To the extent the Company incurred interest and penalties, such amounts would be recognized in provision for income taxes. For KMG America’s subsidiaries, tax years 2002 through 2006 are subject to examination by the Internal Revenue Service. There are no income tax examinations currently in process. The Company has no unrecognized tax positions at June 30, 2007 and expects no material change in its unrecognized tax positions within the next 12 months.

16

KMG AMERICA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

10. Business Segments

          The Company has five reportable segments that are differentiated by their respective methods of distribution and the nature of the related products: worksite insurance business, senior market insurance business, third party administration business, acquired business and corporate and other. Management makes decisions regarding the Company’s business based on these segment classifications. No segments have been aggregated other than including the marketing business in the corporate and other segment.

          The worksite insurance business provides life and health insurance products to employers and employees. The primary insurance products that the Company underwrites include: group and individual life insurance; group long term disability insurance; group and individual short term disability insurance; group and individual dental insurance; group and individual indemnity health insurance; group critical illness insurance and employer group excess risk insurance. This segment also includes business sold through the career agency distribution channel, which is a group of agents and managers that are employees of the Company or its subsidiaries.

          The senior market insurance business consists primarily of the Company’s in-force block of long-term care insurance policies that the Company actively manages, including the right to receive renewal premiums and liability for future claims. Effective January 1, 2006, the Company ceased actively underwriting long-term care insurance policies.

          The third party administration business provides fee-based administrative and managed care services to employers with self funded health care plans, insurance carriers, reinsurance companies and others.

          The acquired business represents closed blocks of life and health insurance business that have been acquired through reinsurance transactions over a period of years.

          The corporate and other segment includes investment income earned on the investment portfolio allocated to capital and surplus, as well as all realized capital gains and losses, which are not allocated by line of business. This segment also includes marketing allowances, commissions and related expenses pertaining to product sales for other insurance carriers, which are currently not material. In addition, this segment includes certain unallocated expenses, primarily costs associated with being a public company, deferred compensation, incentive compensation and stock based compensation, and other non-allocated items such as the costs associated with the litigation with ReliaStar.

          During the quarter ended June 30, 2006, the Company finalized the calculation of seriatim PGAAP reserve factors and implemented the use of such factors. While the implementation of seriatim PGAAP factors did not change total reserves of the Company, it did result in a reallocation of reserves among the worksite insurance, senior market insurance and acquired business segments. This reallocation was reflected in the second quarter results of the affected segments.

          The result of the reallocation of reserves between business segments was to strengthen reserves by $ 37.5 million in the senior market insurance business segment in the second quarter of 2006. This was offset by a reduction in reserves of $ 31.2 million in the acquired business segment and $ 6.3 million in the worksite segment in the second quarter of 2006. No material effect to overall policy reserves or to earnings resulted from the reallocation, but this reallocation of reserves between the business segments does impact the comparability of the quarter and year to date reported policyholder benefits and the resulting reported benefit ratios by segment.

17

KMG AMERICA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

          The following represents a summary of the Company’s statements of income and asset composition by reportable segment.

	Three Months Ended June 30,					Six Months Ended June 30,
	2007		2006			2007			2006
Worksite Insurance Business
Insurance premiums	$	30,706,642	$	19,326,163		$	59,900,946		$	37,832,719
Net investment income		2,174,360		1,763,532			4,225,126			3,358,540
Commissions and fees		—		—			—			—
Net realized gains		—		—			—			—
Other income		193,747		49,941			354,587			96,224
Total revenues		33,074,749		21,139,636			64,480,659			41,287,483
Policyholder benefits		24,494,203		7,405,312			52,007,482			21,000,147
Commissions		2,558,078		1,563,226			5,241,470			3,084,044
Expenses, taxes, fees and depreciation		4,769,710		4,460,388			9,570,279			8,684,010
Amortization of DAC and VOBA		1,083,159		525,981			2,697,746			1,304,183
Total benefits and expenses		32,905,150		13,954,907			69,516,977			34,072,384
Income (loss) before Federal income tax	$	169,599	$	7,184,729		$	(5,036,318	)	$	7,215,099
Total assets	$	187,638,359	$	163,926,424		$	187,638,359		$	163,926,424
Senior Market Insurance Business
Insurance premiums	$	11,082,822	$	10,705,500		$	21,861,110		$	21,380,120
Net investment income		2,826,936		1,565,634			5,530,895			2,977,247
Commissions and fees		—		—			—			—
Net realized gains		—		—			—			—
Other income		780,063		759,930			1,560,376			1,569,005
Total revenues		14,689,821		13,031,064			28,952,381			25,926,372
Policyholder benefits		8,736,603		46,762,345			16,489,080			55,297,567
Commissions		1,375,851		1,269,647			2,755,780			2,636,456
Expenses, taxes, fees and depreciation		814,877		733,915			1,546,631			1,499,074
Amortization of DAC and VOBA		273,294		503,996			599,951			976,110
Total benefits and expenses		11,200,625		49,269,903			21,391,442			60,409,207
Income (loss) before Federal income tax	$	3,489,196	$	(36,238,839	)	$	7,560,939		$	(34,482,835	)
Total assets	$	272,716,346	$	249,677,460		$	272,716,346		$	249,677,460
Third Party Administration Business
Insurance premiums	$	—	$	—		$	—			—
Net investment income		—		—			—			—
Commissions and fees		3,911,330		4,025,624			8,030,774			8,159,341
Net realized gains		—		—			—			—
Other income		—		—			—			—
Total revenues		3,911,330		4,025,624			8,030,774			8,159,341
Policyholder benefits		—		—			—			—
Commissions		—		—			—			—
Expenses, taxes, fees and depreciation		3,260,921		3,448,153			6,883,821			6,951,309
Amortization of DAC and VOBA		—		—			—			—
Total benefits and expenses		3,260,921		3,448,153			6,883,821			6,951,309
Income before Federal income tax		650,409	$	577,471		$	1,146,953		$	1,208,032
Total assets	$	9,514,510	$	10,141,646		$	9,514,510		$	10,141,646

18

KMG AMERICA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

	Three Months Ended June 30,						Six Months Ended June 30,
	2007			2006			2007			2006
Acquired Business
Insurance premiums	$	(102,249	)	$	630,395		$	(158,935	)	$	1,259,845
Net investment income		1,975,864			2,106,105			3,985,320			4,086,761
Commissions and fees		—			—			—			—
Net realized gains		—			—			—			—
Other income		21,689			23,221			37,911			39,022
Total revenues		1,895,304			2,759,721			3,864,296			5,385,628
Policyholder benefits		1,823,802			(29,794,003	)		4,100,667			(28,570,346	)
Commissions		87,273			91,118			176,396			184,776
Expenses, taxes, fees and depreciation		592,088			593,502			1,188,431			1,201,476
Amortization of DAC and VOBA		(247,881	)		125,265			(108,443	)		53,050
Total benefits and expenses		2,255,282			(28,984,118	)		5,357,051			(27,131,044	)
(Loss) income before Federal income tax	$	(359,978	)	$	31,743,839		$	(1,492,755	)	$	32,516,672
Total assets	$	158,195,046		$	164,916,856		$	158,195,046		$	164,916,856
Corporate and Other
Insurance premiums	$	—		$	—		$	—		$	—
Net investment income		1,400,456			2,183,841			2,511,943			4,402,631
Commissions and fees		160,144			91,871			208,849			177,268
Net realized gains		243,732			(115,044	)		190,824			96,064
Other income		198,066			89,255			299,759			204,629
Total revenues		2,002,398			2,249,923			3,211,375			4,880,592
Policyholder benefits		—			—			—			—
Commissions		—			—			—			—
Expenses, taxes, fees and depreciation		4,356,295			3,976,478			9,095,007			7,925,835
Amortization of DAC and VOBA		—			—			—			—
Total benefits and expenses		4,356,295			3,976,478			9,095,007			7,925,835
(Loss) before Federal income tax	$	(2,353,897	)	$	(1,726,555	)	$	(5,883,632	)	$	(3,045,243	)
Total assets	$	242,219,663		$	206,034,361		$	242,219,663		$	206,034,361
Total Company
Insurance premiums	$	41,687,214		$	30,662,058		$	81,603,122			60,472,683
Net investment income		8,377,617			7,619,113			16,253,284			14,825,180
Commissions and fees		4,071,473			4,117,494			8,239,623			8,336,609
Net realized gains		243,732			(115,044	)		190,824			96,064
Other income		1,193,565			922,347			2,252,633			1,908,880
Total revenues		55,573,601			43,205,968			108,539,486			85,639,416
Policyholder benefits		35,054,608			24,373,653			72,597,230			47,727,367
Commissions		4,021,202			2,923,991			8,173,646			5,905,276
Expenses, taxes, fees and depreciation		13,793,890			13,212,436			28,284,170			26,261,704
Amortization of DAC and VOBA		1,108,572			1,155,242			3,189,253			2,333,343
Total benefits and expenses		53,978,272			41,665,322			112,244,299			82,227,690
Income (loss) before Federal income tax		1,595,329		$	1,540,646		$	(3,704,813	)	$	3,411,726
Total assets	$	870,283,924		$	794,696,747		$	870,283,924		$	764,696,747

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

          KMG America is a holding company incorporated under the laws of the Commonwealth of Virginia on January 21, 2004. We commenced our operations shortly before we completed our initial public offering of common stock on December 21, 2004, and our shares trade on the New York Stock Exchange under the symbol “KMA.” Concurrently with the completion of our initial public offering, we completed our acquisition of Kanawha and its subsidiaries, which are our primary operating subsidiaries and which underwrite and sell life and health insurance products.

          For GAAP accounting purposes, Kanawha is treated as KMG America’s predecessor entity and is referred to herein as our “predecessor.” For financial reporting purposes, we have treated the acquisition as if it closed on December 31, 2004, rather than the actual closing date of December 21, 2004, as the effects of the acquisition for the period from December 21, 2004, through December 31, 2004, were not material. Accordingly, in the following discussion any financial information as of any date prior to, or for any period ending on or prior to, December 31, 2004, is reported on a historical basis without GAAP purchase accounting adjustments reflecting the acquisition, and any financial information as of any date on or after, or for any period ending after, December 31, 2004, reflects GAAP purchase accounting adjustments made as of December 31, 2004, reflecting the acquisition.

          Worksite insurance business. Our worksite insurance business is a provider of life and health insurance products to employers and their employees. Our predecessor’s marketing and sales efforts were primarily in the southeastern United States, predominately in Florida, South Carolina and North Carolina. Since acquiring our predecessor, we have begun to implement our business strategy to market our products nationwide. The primary insurance products that we underwrite include: group and individual life insurance; group long term disability insurance; group and individual short term disability insurance; group and individual dental insurance; group and individual indemnity health insurance; group critical illness insurance and employer group excess risk insurance. For the six months ended June 30, 2007, our worksite insurance business produced premiums, commissions and fees, excluding intercompany payments, of $59.9 million, which accounted for 66.5% of our premiums, commissions and fees, excluding intercompany payments in that period. Our business strategy is to operate our existing worksite insurance business efficiently while developing a new worksite marketing and distribution organization that targets larger employer groups nationwide with an expanded variety of life and health insurance products which have added a new set of employer-paid life insurance, disability and health products to our existing voluntary products. Since December 2004, we have opened sales offices hosting regional sales managers in Boston, Massachusetts and Irvine, California, a Los Angeles suburb and we have opened regional sales offices in Tampa, Florida; Chicago, Illinois; Morristown, New Jersey; Atlanta, Georgia; Dallas, Texas; Kansas City, Missouri; Cleveland, Ohio; Philadelphia, Pennsylvania; New Orleans, Louisiana; San Diego and San Francisco, California; Phoenix, Arizona; Denver, Colorado; and Minneapolis, Minnesota. We will base future expansion of our sales organization on developing market trends and our profit margins. The costs associated with any expansion of our sales organization will be recognized before we recognize revenues resulting from new sales activity. Consequently, we expect negative cash flow and operating losses in the short term.

          Senior market insurance business. Our senior market insurance business has been a provider in the southeastern United States of individual insurance products tailored to the needs of older individuals. The primary insurance product included in this business is long-term care insurance that we underwrote. For the six months ended June 30, 2007, our senior market insurance business produced premiums, commissions and fees, excluding intercompany payments, of $21.9 million, which accounted for 24.3% of our premiums, commissions and fees, excluding intercompany payments, in that period.

          Effective January 1, 2006, we ceased actively underwriting long-term care insurance policies. Significant factors that contributed to our decision to cease actively underwriting long-term care insurance policies include, among others: (1) sales for this business were significantly lower than originally projected; and (2) the lack of strategic fit between the underwriting and distribution of long-term care products and our current strategy of focusing on worksite marketing of life and health insurance products. We intend to retain and actively manage the

20

existing block of in-force long-term care insurance policies (including the right to receive future premiums and the liability for future claims).

          Third-party administration business. Our third-party administration business provides a wide range of insurance product administration, claims handling, eligibility administration, call center and support services. This business primarily administers the insurance plans offered by our worksite insurance business and senior market insurance business. Our third-party administration business also provides administrative and managed care services to third parties, such as employers with self-funded health care plans, other insurance carriers, reinsurers and managed care plans. For the six months ended June 30, 2007, our third-party administration business produced commissions and fees, excluding intercompany payments, of $8.0 million, which accounted for 8.9% of our premiums, commissions and fees, excluding intercompany payments, in that period. Our strategy is to grow this business as it administers the increasing volume of policies and products that we anticipate will be sold by the worksite insurance business as we attempt to grow that business. In addition, as our national worksite marketing business develops, we intend to opportunistically market our third-party administration services to self-insured plans, stop loss insurers, pharmacy benefit organizations, managed care service providers, other insurance carriers and reinsurers nationwide. It is expected that any incremental costs associated with this expanded marketing will be modest and will be funded out of the operations of our third-party administration business.

          In addition, we have retained our predecessor’s closed block of life and health insurance business reported in the acquired business segment and the investment and marketing activities reported in the corporate and other segment. While acquisitions of books of business from other insurance carriers is not one of our principal growth strategies, we will consider making acquisitions on an opportunistic basis if we can complete the acquisitions on favorable financial terms that we expect to be generally accretive to earnings per share and return on equity while maintaining our financial strength ratings.

          We expect to realize earnings from our investment portfolio. Insurance companies in both the life and health and property and casualty insurance industries earn profits on the investment float, which reflects the investment income earned on the premiums paid to the insurer between the time of receipt and the time benefits are paid-out under the policy. Volatility in the capital markets, changes in interest rates and changes in economic conditions can all impact the amount of earnings that we will realize from our investment portfolio.

Financial Strength Ratings Outlook

          Kanawha has an A.M. Best financial strength rating of A- (excellent). Recently, A.M. Best changed its outlook for Kanawha’s rating from stable to negative. Also, S&P recently lowered the financial strength rating for Kanawha to BBB (good), with a positive ratings outlook. Rating agencies review their ratings periodically and Kanawha’s current ratings may not be maintained in the future.

          If Kanawha’s ratings are reduced from their current levels by A.M. Best or S&P, or as recently occurred with A.M. Best, are placed under surveillance or review with possible negative implications, Kanawha’s competitive position in the insurance industry would likely suffer and it would likely lose customers. Since A.M. Best changed Kanawha’s rating outlook from stable to negative, we have not been precluded from bidding on group cases, although we have lost some cases we expected to be awarded. If Kanawha’s financial strength ratings are reduced, the negative impact may be more pronounced. Our cost of borrowing would likely increase, our sales and earnings would likely decrease and our results of operations and financial condition would likely be materially adversely affected. For example, a minimum A.M. Best rating of “A-” is generally required to participate in the group life and disability and excess risk insurance markets. If Kanawha’s A.M. Best rating of A- is reduced, we likely will be precluded from participating in those markets, which are key to our growth and financial strength.

          Potential stop loss claims volatility and the adverse effect it may have on our results of operations could induce A.M. Best or S&P to downgrade Kanawha’s financial strength rating.

          See “Item 1A. Risk Factors – The financial strength of Kanawha, our insurance subsidiary, is rated by A.M. Best and S&P, and a decline in these ratings would likely negatively affect our standing in the insurance industry, cause our sales and earnings to decrease and our results of operations and financial condition would likely be materially adversely affected”.

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Current Year Developments

          After a comprehensive review of its stop loss book of business, the Company recognized a $6 million charge in the first quarter of 2007 for increased claims and reserves that reflects recent experience on stop loss cases. The Company began writing annually renewable stop loss insurance in mid-2005, and initially relied on pricing assumptions, a common industry practice relative to new books of stop loss business, to establish expected loss ratios due to a lack of credible actual claim experience. As a contrast, companies with mature books of stop loss business typically establish claim reserves as a function of experience studies of its business. Because actual claims on stop loss cases typically are not fully reported until after the end of the policy period, it is a common practice to increase or decrease claims reserves once the actual claims experience becomes known.

          As experience emerged, the Company recognized additional claims and reserves reflecting the recent adverse claims experience. The Company also decided to increase claims assumptions on business prospectively, reflecting a more conservative estimate of future claims on this business. The Company’s experience has been that it takes four quarters after a case has been written before a clear picture becomes apparent regarding claims for that case. While some of the unfavorable claims data began to emerge late in the fourth quarter of 2006 and guided our reserving at year-end, new more meaningful data came to the Company’s attention late in the first quarter of this year after the year-end books were closed and earnings reported. As a result of the new data the Company has concluded that it would be prudent to increase the estimated loss ratios on newer cases for claims before credible claims experience has developed on this business. As a result of these actions, the Company believes its June 30, 2007 claim reserves on stop loss business adequately reflect both the development of recent experience and the Company’s more conservative outlook on loss experience related to current premiums.

          In order to address the imbalance in its overall new sales mix, which has a disproportionate concentration of stop loss business, the Company has restructured the sales incentive compensation plan for its sales organization with increased incentives for sales of core group life/disability and voluntary benefit products. Additionally, the Company is limiting new sales of stop loss by means of pricing new business at a higher expected profit margin and a requirement that sales of stop loss be packaged with other products.

          The Company has also established a $7.2 million valuation allowance as a non-cash charge to offset the portion of the deferred tax asset that was generated by net operating losses at the holding company. The decision by A.M. Best to change the outlook of our rating from stable to negative, and the resulting strategic options being considered, has created uncertainty about our ability and timing to generate taxable income at the holding company. Because of this uncertainty, the Company deemed it appropriate to establish the valuation allowance. The Company intends to continue to evaluate tax planning strategies to utilize the operating losses prior to their expiration.

Strategic Alternatives

          On May 7, 2007, the Company publicly announced that it had retained Keefe, Bruyette & Woods, Inc., an investment banking firm, to advise management and the Board of Directors regarding strategic alternatives, including the possible sale or merger of the Company. The process is underway and advanced negotiations are occurring. There can be no assurance that this process will result in a sale or merger of the Company, or if a sale or merger is undertaken, the potential terms or timing of the transaction. The Company does not intend to publicly disclose updates or developments in its strategic alternatives process until such time as the Company enters into a definitive agreement with a third party in connection with a transaction or terminates the strategic alternatives process.

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          Results of Operations

          Consolidated Overview

          The following table presents consolidated financial information for the quarters ended June 30, 2007 and June 30, 2006 for KMG America.

	Three Months Ended June 30,						Six Months Ended June 30,
	2007			2006			2007			2006
	(000’s omitted)
Revenues:
Insurance premiums	$	41,687		$	30,662		$	81,603		$	60,473
Net investment income		8,378			7,619			16,253			14,825
Commission and fees		4,071			4,118			8,240			8,336
Net realized gains (losses)		244			(115	)		191			96
Other income		1,194			922			2,252			1,909
Total revenues		55,574			43,206			108,539			85,639
Benefits and expenses:
Policyholder benefits		35,055			24,374			72,597			47,728
Commissions		4,021			2,924			8,174			5,905
General expenses		11,169			11,290			23,339			22,183
Taxes, licenses and fees		1,861			1,292			3,476			2,807
Depreciation and amortization		764			630			1,469			1,271
Amortization of DAC and VOBA		1,109			1,155			3,189			2,333
Total benefits and expenses		53,979			41,665			112,244			82,227
Income before income taxes		1,595			1,541			(3,705	)		3,412
Provision for income taxes		(1,036	)		(524	)		(5,999	)		(1,159	)
Net income	$	559		$	1,017		$	(9,704	)	$	2,253
Benefits to premiums ratio(1)		84.1	%		79.5	%		89.0	%		78.9	%

(1) The benefits to premiums ratio is equal to policyholder benefits (equal to incurred claims plus increases in policyholder active life reserves) divided by insurance premiums.

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          Consolidated Results of Operations by Business Segment

          The following represents a summary of the Company’s statements of income and asset composition by reportable segment.

	Three Months Ended June 30,					Six Months Ended June 30,
	2007		2006			2007			2006
Worksite Insurance Business
Insurance premiums	$	30,706,642	$	19,326,163		$	59,900,946		$	37,832,719
Net investment income		2,174,360		1,763,532			4,225,126			3,358,540
Commissions and fees		—		—			—			—
Net realized gains		—		—			—			—
Other income		193,747		49,941			354,587			96,224
Total revenues		33,074,749		21,139,636			64,480,659			41,287,483
Policyholder benefits		24,494,203		7,405,312			52,007,482			21,000,147
Commissions		2,558,078		1,563,226			5,241,470			3,084,044
Expenses, taxes, fees and depreciation		4,769,710		4,460,388			9,570,279			8,684,010
Amortization of DAC and VOBA		1,083,159		525,981			2,697,746			1,304,183
Total benefits and expenses		32,905,150		13,954,907			69,516,977			34,072,384
Income (loss) before Federal income tax	$	169,599	$	7,184,729		$	(5,036,318	)	$	7,215,099
Total assets	$	187,638,359	$	163,926,424		$	187,638,359		$	163,926,424
Senior Market Insurance Business
Insurance premiums	$	11,082,822	$	10,705,500		$	21,861,110		$	21,380,120
Net investment income		2,826,936		1,565,634			5,530,895			2,977,247
Commissions and fees		—		—			—			—
Net realized gains		—		—			—			—
Other income		780,063		759,930			1,560,376			1,569,005
Total revenues		14,689,821		13,031,064			28,952,381			25,926,372
Policyholder benefits		8,736,603		46,762,345			16,489,080			55,297,567
Commissions		1,375,851		1,269,647			2,755,780			2,636,456
Expenses, taxes, fees and depreciation		814,877		733,915			1,546,631			1,499,074
Amortization of DAC and VOBA		273,294		503,996			599,951			976,110
Total benefits and expenses		11,200,625		49,269,903			21,391,442			60,409,207
Income (loss) before Federal income tax	$	3,489,196	$	(36,238,839	)	$	7,560,939		$	(34,482,835	)
Total assets	$	272,716,346	$	249,677,460		$	272,716,346		$	249,677,460
Third Party Administration Business
Insurance premiums	$	—	$	—		$	—			—
Net investment income		—		—			—			—
Commissions and fees		3,911,330		4,025,624			8,030,774			8,159,341
Net realized gains		—		—			—			—
Other income		—		—			—			—
Total revenues		3,911,330		4,025,624			8,030,774			8,159,341
Policyholder benefits		—		—			—			—
Commissions		—		—			—			—
Expenses, taxes, fees and depreciation		3,260,921		3,448,153			6,883,821			6,951,309
Amortization of DAC and VOBA		—		—			—			—
Total benefits and expenses		3,260,921		3,448,153			6,883,821			6,951,309
Income before Federal income tax		650,409	$	577,471		$	1,146,953		$	1,208,032
Total assets	$	9,514,510	$	10,141,646		$	9,514,510		$	10,141,646

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	Three Months Ended June 30,						Six Months Ended June 30,
	2007			2006			2007			2006
Acquired Business
Insurance premiums	$	(102,249	)	$	630,395		$	(158,935	)	$	1,259,845
Net investment income		1,975,864			2,106,105			3,985,320			4,086,761
Commissions and fees		—			—			—			—
Net realized gains		—			—			—			—
Other income		21,689			23,221			37,911			39,022
Total revenues		1,895,304			2,759,721			3,864,296			5,385,628
Policyholder benefits		1,823,802			(29,794,003	)		4,100,667			(28,570,346	)
Commissions		87,273			91,118			176,396			184,776
Expenses, taxes, fees and depreciation		592,088			593,502			1,188,431			1,201,476
Amortization of DAC and VOBA		(247,881	)		125,265			(108,443	)		53,050
Total benefits and expenses		2,255,282			(28,984,118	)		5,357,051			(27,131,044	)
(Loss) income before Federal income tax	$	(359,978	)	$	31,743,839		$	(1,492,755	)	$	32,516,672
Total assets	$	158,195,046		$	164,916,856		$	158,195,046		$	164,916,856
Corporate and Other
Insurance premiums	$	—		$	—		$	—		$	—
Net investment income		1,400,456			2,183,841			2,511,943			4,402,631
Commissions and fees		160,144			91,871			208,849			177,268
Net realized gains		243,732			(115,044	)		190,824			96,064
Other income		198,066			89,255			299,759			204,629
Total revenues		2,002,398			2,249,923			3,211,375			4,880,592
Policyholder benefits		—			—			—			—
Commissions		—			—			—			—
Expenses, taxes, fees and depreciation		4,356,295			3,976,478			9,095,007			7,925,835
Amortization of DAC and VOBA		—			—			—			—
Total benefits and expenses		4,356,295			3,976,478			9,095,007			7,925,835
(Loss) before Federal income tax	$	(2,353,897	)	$	(1,726,555	)	$	(5,883,632	)	$	(3,045,243	)
Total assets	$	242,219,663		$	206,034,361		$	242,219,663		$	206,034,361
Total Company
Insurance premiums	$	41,687,214		$	30,662,058		$	81,603,122			60,472,683
Net investment income		8,377,617			7,619,113			16,253,284			14,825,180
Commissions and fees		4,071,473			4,117,494			8,239,623			8,336,609
Net realized gains		243,732			(115,044	)		190,824			96,064
Other income		1,193,565			922,347			2,252,633			1,908,880
Total revenues		55,573,601			43,205,968			108,539,486			85,639,416
Policyholder benefits		35,054,608			24,373,653			72,597,230			47,727,367
Commissions		4,021,202			2,923,991			8,173,646			5,905,276
Expenses, taxes, fees and depreciation		13,793,890			13,212,436			28,284,170			26,261,704
Amortization of DAC and VOBA		1,108,572			1,155,242			3,189,253			2,333,343
Total benefits and expenses		53,978,272			41,665,322			112,244,299			82,227,690
Income (loss) before Federal income tax		1,595,329		$	1,540,646		$	(3,704,813	)	$	3,411,726
Total assets	$	870,283,924		$	794,696,747		$	870,283,924		$	764,696,747

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Six Months Ended June 30, 2007 Compared to Six Months Ended June 30, 2006

Financial Results Overview

          Net income for the six months ended June 30, 2007, decreased $12.0 million, or 521.7%, to a $9.7 million net loss compared to net income of $2.3 million for the six months ended June 30, 2006. The decrease in net income was primarily due to $6 million of reserve strengthening in the stop loss book of business which will be discussed in the policyholder benefits analysis below as well as the establishment of a deferred tax valuation allowance of $7.2 million which will be discussed in the provision for income taxes analysis below. Other factors include increases in premiums and net investment income, offset by increases in policyholder benefits, commissions and general expenses, all of which are described in greater detail below.

Revenues

          Total revenues for the six months ended June 30, 2007, increased $22.9 million, or 26.8%, to $108.5 million from total revenues of $85.6 million for the six months ended June 30, 2006. The primary factors causing the increase are explained below under the captions “—Premiums,” “—Net Investment Income,” “—Commission and Fee Income,” “—Realized Investment Gains and Losses” and “—Other Income.”

Premiums

The following table presents the distribution of premiums by type and business segment (dollars in millions).

	For the six months ended June 30, 2007												For the six months ended June 30, 2006											Increase (decrease)
	Worksite			Senior			Acquired			Total			Worksite			Senior			Acquired		Total			Worksite			Senior			Acquired			Total
Direct
New	$	40.8		$	0.1		$	—		$	40.9		$	19.9		$	0.5		$	—	$	20.4		$	20.9		$	(0.4	)	$	—		$	20.5
Renewal		23.5			28.8			—			52.3			22.6			28.0			—		50.6			0.9			0.8			—			1.7
Total		64.3			28.9			—			93.2			42.5			28.5			—		71.0			21.8			0.4			—			22.2
Assumed
New		—			—			—			—			—			—			—		—			—			—			—			—
Renewal		1.0			—			0.1			1.1			—			—			1.3		1.3			1.0			—			(1.2	)		(0.2	)
Total		1.0			—			0.1			1.1			—			—			1.3		1.3			1.0			—			(1.2	)		(0.2	)
Ceded
New		(4.7	)		—			—			(4.7	)		(4.1	)		(0.3	)		—		(4.4	)		(0.6	)		0.3			—			(0.3	)
Renewal		(0.7	)		(7.0	)		(0.3	)		(8.0	)		(0.6	)		(6.8	)		—		(7.4	)		(0.1	)		(0.2	)		(0.3	)		(0.6	)
Total		(5.4	)		(7.0	)		(0.3	)		(12.7	)		(4.7	)		(7.1	)		—		(11.8	)		(0.7	)		0.1			(0.3	)		(0.9	)
Net
New		36.1			0.1			—			36.2			15.8			0.2			—		16.0			20.3			(0.1	)		—			20.2
Renewal		23.8			21.8			(0.2	)		45.4			22.0			21.2			1.3		44.5			1.8			0.6			(1.5	)		0.9
Total	$	59.9		$	21.9		$	(0.2	)	$	81.6		$	37.8		$	21.4		$	1.3	$	60.5		$	22.1		$	0.5		$	(1.5	)	$	21.1

          Worksite net new premiums increased $20.3 million, or 128.5%, to $36.1 million for the six months ended June 30, 2007, from $15.8 million for the six months ended June 30, 2006, due to increased sales volumes. The primary driver of this increase was new stop loss premium generated by the new KMG America sales force, which represents $28.5 million of direct new premiums, offset by $3.5 million of ceded new premiums. In order to address the imbalance in its overall new sales mix, which has a disproportionate concentration of stop loss business, the Company has restructured the sales incentive compensation plan for its sales organization with increased incentives for sales of core group life/disability and voluntary benefit products. Additionally, the Company is limiting new sales of stop loss by means of pricing new business at a higher expected profit margin and a requirement that sales of stop loss be packaged with other products. Net renewal premiums increased $1.8 million or 8.2% as a result of the assumption of a block of voluntary term life insurance and universal life insurance policies from Columbian Life Insurance Company and Columbian Mutual Life Insurance Company.

          Senior market net new premiums, composed of long term care policies, decreased $0.1 million, or 50.0%, to $0.1 million for the six months ended June 30, 2007, from $0.2 million for the six months ended June 30, 2006 due to decreased sales volumes as the Company ceased actively underwriting new long term care policies after December 31, 2005.Net renewal premiums increased 2.8% to $21.8 million, representing premiums from the insurance in force created by prior year sales.

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          Acquired business premiums decreased $1.5 million, or 115.4%, to $(0.2) million for the six months ended June 30, 2007, from $1.3 million for the six months ended June 30, 2006. We have not acquired any blocks of business since 1999 and a significant portion of the decline is a result of policy lapses. In the second quarter of 2007, an estimated refund due to a reinsurance carrier of $0.3 million was accrued in relation to possible adjustments needed for previously settled billings. In addition, experience refunds are generated on certain reinsurance treaties that reduce both premiums and policyholder benefits equally. The experience refunds increased to $4.9 million for the six months ended June 30, 2007, from $4.3 million for the six months ended June 30, 2006.

Net Investment Income

          Net investment income increased $1.5 million, or 10.1%, to $16.3 million for the six months ended June 30, 2007, from $14.8 million for the six months ended June 30, 2006. Net investment income is primarily affected by changes in levels of invested assets and interest rates. The increase in investment income for the six months ended June 30, 2007, occurred primarily as a result of an additional $35.0 million of cash and invested assets generated through the issuance of junior subordinated debt, as described in Note 8. Generally, an increase in invested assets is due to retention of premiums to establish policy reserves for the payment of future policyholder benefits.

          Net investment income is allocated to our various business segments on a pro rata basis based on the invested assets attributed to the business segment. Assets attributed to the senior market insurance segment continue to increase as a result of policy reserve increases in this segment, while assets attributed to the acquired segment continue to decline as this business lapses. There were no other significant asset shifts in the business segments.

Commission and Fee Income

          Commission and fee income decreased $0.1 million, or 1.2%, to $8.2 million for the six months ended June 30, 2007, from $8.3 million for the six months ended June 30, 2006. Most of the commission and fee income was from administrative fees relating to third-party administration, and the volume of business in force is relatively flat compared to 2006 levels.

Realized Investment Gains and Losses

          Realized investment gains and losses occur as a result of the sale or impairment of investments. The net realized investment gain for the six months ended June 30, 2007, increased by $0.1 million to $0.2 million, from $0.1 million for the six months ended June 30, 2006, due primarily to marking to market investments held in the Company’s trading account. These investments represent the assets purchased to support the deferred compensation liability of the Company, and realized gains and/or losses are directly offset with increases and/or decreases in compensation expenses. Realized investment gains and losses are allocated entirely to the corporate and other business segment.

Other Income

          Other income increased $0.4 million, or 21.1%, to $2.3 million for the six months ended June 30, 2007, from $1.9 million for the six months ended June 30, 2006, reflecting increased administrative fees for the issuance of universal life products, increased commission and expense allowances from reinsurance companies generated from an increase in renewal ceded premiums, and a payment received as part of WorldCom’s settlement with former bond holders.

Benefits and Expenses

          Total benefits and expenses increased $30.0 million, or 36.5%, to $112.2 million for the six months ended June 30, 2007, from $82.2 million for the six months ended June 30, 2006. The primary factors causing this increase are explained below under the captions “—Policyholder Benefits,” “—Insurance Commissions,” “—General Insurance Expenses,” “—Insurance Taxes, Licenses and Fees,” and “—Amortization of DAC and VOBA.”

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Policyholder Benefits

          Benefit reserves as reported are shown after conversion to a GAAP purchase accounting basis. Prior to the quarter ending June 30, 2006, this conversion was based on an adjustment to benefit reserves developed on a historical GAAP basis. Effective June 30, 2006, a change in methodology was implemented whereby the benefit reserves began to be developed directly on a purchase GAAP basis. The change to seriatim developed reserves had no material impact on income but does have an impact on the balance sheet on a segment by segment basis. This balance sheet impact is further discussed in Note 10 (Business Segments).

          Policyholder benefits increased $24.9 million, or 52.2%, to $72.6 million for the six months ended June 30, 2007, from $47.7 million for the six months ended June 30, 2006. This produced a benefits to premium ratio of 89.0% for the six months ended June 30, 2007, compared to 78.9% for the six months ended June 30, 2006.

          Worksite marketing policyholder benefits increased $31.0 million, or 147.6%, to $52.0 million for the six months ended June 30, 2007, from $21.0 million for the six months ended June 30, 2006. This produced benefits to premium ratios of 86.8% for the six months ended June 30, 2007, compared to 55.5% for the six months ended June 30, 2006. The ratio in 2006 was deflated due to the conversion to Purchase GAAP seriatim reserve factors from the aggregate method, which resulted in decreased benefits of $6.3 million. The six months ended June 30, 2006 benefits to premium ratio adjusted would be 72.0% without the reserve conversion impact.

          In the first quarter of 2007, after a comprehensive review of its stop loss book of business, the Company recognized a $6 million charge for increased claims and reserves that reflects recent experience on stop loss cases. The Company began writing annually renewable stop loss in mid-2005, and initially relied on pricing assumptions, a common industry practice relative to new books of stop loss business, to establish expected loss ratios due to lack of credible actual claim experience. As a contrast, companies with mature books of stop loss business typically establish claim reserves as a function of experience studies of its business. Because actual claims on stop loss cases typically are not fully reported until after the end of the policy period, it is a common practice to increase or decrease claims reserves once the actual claims experience becomes known. As experience has emerged, the Company has recognized additional claims and reserves reflecting the recent adverse claims experience. The Company also decided to increase claims assumptions on business prospectively, reflecting a more conservative estimate of future claims on this business. The Company’s experience has been that it takes four quarters after a case has been written before a clear picture becomes apparent regarding claims for that case. As a result of the new data the Company has concluded that it would be prudent to increase the estimated loss ratios on newer cases for claims before credible claims experience has developed on this business. As a result of these actions, the Company believes its current claim reserves on stop loss business adequately reflect both the development of recent experience and the Company’s more conservative outlook on loss experience related to current premiums.

          In order to address the imbalance in its overall new sales mix, which has a disproportionate concentration of stop loss business, the Company has restructured the sales incentive compensation plan for its sales organization with increased incentives for sales of core group life/disability and voluntary benefit products. Additionally, the Company is limiting new sales of stop loss by means of more conservative pricing and a requirement that sales of stop loss be packaged with other products.

          Senior market policyholder benefits decreased $38.8 million, or 70.2%, to $16.5 million for the six months ended June 30, 2007, from $55.3 million for the six months ended June 30, 2006. This produced benefits to premium ratios of 75.3% for the six months ended June 30, 2007, compared to 258.6% for the six months ended June 30, 2006. The benefits to premium ratio decreased primarily as a result of the 2006 conversion to Purchase GAAP seriatim reserve factors from the aggregate method, which resulted in increased benefits of $37.5 million. The six months ended June 30, 2006 benefits to premium ratio adjusted would be 83.3% without the reserve conversion impact. The first six months of 2006 had some large increases in open claims that have not been repeated in the first six months of 2007, which accounts for the improved benefits ratio.

          Acquired business policyholder benefits increased $32.7 million, to $4.1 million for the six months ended June 30, 2007, from $(28.6) million for the six months ended June 30, 2006. Benefits to premium ratios do not provide meaningful information in this segment without first adjusting for certain routine items that have no impact

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on net income but have significant impact on the benefit ratios Experience refunds are generated on certain reinsurance treaties that reduce both premiums and policyholder benefits equally. The experience refunds increased to $4.9 million for the six months ended June 30, 2007, from $4.3 million for the six months ended June 30, 2006. In addition, the 2006 conversion to Purchase GAAP seriatim reserve factors from the aggregate method resulted in decreased benefits of $31.2 million. Also, in the second quarter of 2007, an estimated refund due to our reinsurance carrier of $0.3 million was accrued in relation to possible adjustments needed for previously settled billings. Excluding the effects of these items, the comparable benefit ratios are 177.8% for the six months ended June 30, 2007 and 167.8% for the six months ended June 30, 2006. These benefits to premium ratios are affected by large portions of the acquired business that are no longer premium paying with substantial reserves and investment income on reserves.

Insurance Commissions

          Commission expenses increased $2.3 million, or 39.0%, to $8.2 million for the six months ended June 30, 2007, from $5.9 million for the six months ended June 30, 2006. This increase consists of normal increases related to increased renewal premiums, in addition to an increase in first year commissions that were not deferred, a large portion of which relates to the increased sales of stop loss products.

General Insurance Expenses

          General insurance expenses increased $1.1 million, or 4.9%, to $23.3 million for the six months ended June 30, 2007, from $22.2 million for the six months ended June 30, 2006. The increased expenses for the six months ended June 30, 2007 are primarily attributable to a $0.8 million litigation settlement expenses and interest on the junior subordinated debt of $0.8, offset somewhat by a $0.6 million decrease in legal expenses related to the litigation.

          Overhead expenses that are not directly associated with a particular business segment are allocated to the various business segments on a pro rata basis based on different factors, such as headcount, policy count, number of policies issued, premiums and other relevant factors.

Insurance Taxes, Licenses and Fees

          Insurance taxes, licenses and fees increased $0.7 million, or 25.0%, to $3.5 million for the six months ended June 30, 2007, from $2.8 million for the six months ended June 30, 2006. Employment taxes related to additional staffing represents approximately half of the increase, and additional premium taxes due to increased premiums represents the other half of the increase.

Amortization of DAC and VOBA

          First year commissions and general insurance expenses associated with the acquisition of new business are deferred and amortized over the premium-paying period of the related policies. The total deferrals of policy acquisition costs were $9.2 million and $7.7 million for the six months ended June 30, 2007 and 2006, respectively. The increase in deferrals was primarily due to the increase in net new premiums and the associated increase in commissions and expenses in the worksite segment.

          The amortization of deferred acquisition costs (“DAC”) and the value of business acquired (“VOBA”) increased $0.9 million, or 39.1%, to $3.2 million for the six months ended June 30, 2007, from $2.3 million for the six months ended June 30, 2006, reflecting the increased deferrals described above. The DAC balance at June 30, 2007 has increased $14.8 million over the balance at June 30, 2006, which accounts for a large part of the increase in amortization expense.

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Provision for Income Taxes

          Total income taxes may differ from the amount computed by applying the federal corporate tax rate of 35% due to tax-advantaged investments and net operating loss carry forwards available. The effective income tax rates for the six months ended June 30, 2007 and 2006 were 161.9 % and 33.9%, respectively. The variation in these rates is due to a valuation allowance of $7.2 million that has been established.

          Under SFAS No. 109, management must provide a valuation allowance for any deferred tax amounts that it believes are uncertain to be realized. The decision by A.M. Best to change the outlook of our rating from stable to negative, and the resulting strategic options being considered, has created uncertainty about our ability and timing to generate taxable income at the holding company. Because of this uncertainty, the Company deemed it appropriate to establish a valuation allowance of $7.2 million which represents the portion of the deferred tax asset that was generated by net operating losses at the holding company.

Three Months Ended June 30, 2007 Compared to Three Months Ended June 30, 2006

Financial Results Overview

          Net income for the three months ended June 30, 2007, decreased $0.4 million, or 40.0%, to $0.6 million from net income of $1.0 million for the three months ended June 30, 2006. The decrease in net income was primarily due to increases in premiums and net investment income, which were more than offset by increases in policyholder benefits, general expenses and federal income taxes, all of which are described in greater detail below.

Revenues

          Total revenues for the three months ended June 30, 2007, increased $12.4 million, or 28.7%, to $55.6 million from total revenues of $43.2 million for the three months ended June 30, 2006. The primary factors causing the increase are explained below under the captions “—Premiums,” “—Net Investment Income,” “—Commission and Fee Income,” “—Realized Investment Gains and Losses” and “—Other Income.”

Premiums

The following table presents the distribution of premiums by type and business segment (dollars in millions).

	For the three months ended June 30, 2007												For the three months ended June 30, 2006												Increase (decrease)
	Worksite			Senior			Acquired			Total			Worksite			Senior			Acquired			Total			Worksite			Senior			Acquired			Total
Direct
New	$	21.1		$	0.1		$	—		$	21.2		$	10.5		$	0.2		$	—		$	10.7		$	10.6		$	(0.1	)	$	—		$	10.5
Renewal		11.8			14.5			—			26.3			11.3			14.1			—			25.4			0.5			0.4			—			0.9
Total		32.9			14.6			—			47.5			21.8			14.3			—			36.1			11.1			0.3			—			11.4
Assumed
New		0.1			—			—			0.1			—			—			—			—			0.1			—			—			0.1
Renewal		0.6			—			0.2			0.8			—			—			0.7			0.7			0.6			—			(0.5	)		0.1
Total		0.7			—			0.2			0.9			—			—			0.7			0.7			0.7			—			(0.5	)		0.2
Ceded
New		(2.5	)		—			—			(2.5	)		(2.2	)		(0.1	)		—			(2.3	)		(0.3	)		0.1			—			(0.2	)
Renewal		(0.4	)		(3.5	)		(0.3	)		(4.2	)		(0.3	)		(3.5	)		(0.1	)		(3.9	)		(0.1	)		—			(0.2	)		(0.3	)
Total		(2.9	)		(3.5	)		(0.3	)		(6.7	)		(2.5	)		(3.6	)		(0.1	)		(6.2	)		(0.4	)		0.1			(0.2	)		(0.5	)
Net
New		18.7			0.1			—			18.8			8.3			0.1			—			8.4			10.4			—			—			10.4
Renewal		12.0			11.0			(0.1	)		22.9			11.0			10.6			0.6			22.2			1.0			0.4			(0.7	)		0.7
Total	$	30.7		$	11.1		$	(0.1	)	$	41.7		$	19.3		$	10.7		$	0.6		$	30.6		$	11.4		$	0.4		$	(0.7	)	$	11.1

          Worksite net new premiums increased $10.4 million, or 125.3%, to $18.7 million for the three months ended June 30, 2007, from $8.3 million for the three months ended June 30, 2006, due to increased sales volumes. The primary driver of this increase was new stop loss premium generated by the new KMG America sales force, which represents $14.6 million of direct new premiums, offset by $1.7 million of ceded new premiums. In order to address the imbalance in its overall new sales mix, which has a disproportionate concentration of stop loss business,

30

the Company has restructured the sales incentive compensation plan for its sales organization with increased incentives for sales of core group life/disability and voluntary benefit products. Additionally, the Company is limiting new sales of stop loss by means of pricing new business at a higher expected profit margin and a requirement that sales of stop loss be packaged with other products. Net renewal premiums increased $1.0 million or 9.1% as a result of the assumption of a block of voluntary term life insurance and universal life insurance policies from Columbian Life Insurance Company and Columbian Mutual Life Insurance Company.

          Senior market net new premiums, composed of long term care policies, remained unchanged at $0.1 million for the three months ended June 30, 2007, and 2006, respectively. The Company ceased actively underwriting new long term care policies after December 31, 2005.Net renewal premiums increased 3.8% to $11.0 million, representing premiums from the insurance in force created by prior year sales.

          Acquired business premiums decreased $0.7 million, or 116.7%, to $(0.1) million for the three months ended June 30, 2007, from $0.6 million for the three months ended June 30, 2006. We have not acquired any blocks of business since 1999 and a significant portion of the decline is a result of policy lapses. In the current quarter, an estimated refund due to a reinsurance carrier of $0.3 million was accrued in relation to possible adjustments needed for previously settled billings. In addition, experience refunds are generated on certain reinsurance treaties that reduce both premiums and policyholder benefits equally. The experience refunds increased to $2.3 million for the three months ended June 30, 2007, from $2.0 million for the three months ended June 30, 2006.

Net Investment Income

          Net investment income increased $0.8 million, or 10.5%, to $8.4 million for the three months ended June 30, 2007, from $7.6 million for the three months ended June 30, 2006. Net investment income is primarily affected by changes in levels of invested assets and interest rates. The increase in investment income for the three months ended June 30, 2007, occurred primarily as a result of an additional $35.0 million of cash and invested assets generated through the issuance of junior subordinated debt, as described in Note 8. Generally, an increase in invested assets is due to retention of premiums to establish policy reserves for the payment of future policyholder benefits.

          Net investment income is allocated to our various business segments on a pro rata basis based on the invested assets attributed to the business segment. Assets attributed to the senior market insurance segment continue to increase as a result of policy reserve increases in this segment, while assets attributed to the acquired segment continue to decline as this business lapses. There were no other significant asset shifts in the business segments.

Commission and Fee Income

          Commission and fee income remained constant at $4.1 million for the three months ended June 30, 2007 and 2006, respectively. Most of the commission and fee income was from administrative fees relating to third-party administration, and the volume of business in force is relatively flat compared to 2006 levels.

Realized Investment Gains and Losses

          Realized investment gains and losses occur as a result of the sale or impairment of investments. The net realized investment gain for the three months ended June 30, 2007, increased by $0.3 million to $0.2 million, from $(0.1) million for the three months ended June 30, 2006, due primarily to marking to market investments held in the Company’s trading account. These investments represent the assets purchased to support the deferred compensation liability of the Company, and realized gains and/or losses are directly offset with increases and/or decreases in compensation expenses. Realized investment gains and losses are allocated entirely to the corporate and other business segment.

Other Income

          Other income increased $0.3 million, or 33.3%, to $1.2 million for the three months ended June 30, 2007, from $0.9 million for the three months ended June 30, 2006, reflecting increased administrative fees for the issuance

31

of universal life products, increased commission and expense allowances from reinsurance companies generated from an increase in renewal ceded premiums, and a payment received as part of WorldCom’s settlement with former bond holders.

Benefits and Expenses

          Total benefits and expenses increased $12.3 million, or 29.5%, to $54.0 million for the three months ended June 30, 2007, from $41.7 million for the three months ended June 30, 2006. The primary factors causing this increase are explained below under the captions “—Policyholder Benefits,” “—Insurance Commissions,” “—General Insurance Expenses,” “—Insurance Taxes, Licenses and Fees,” and “—Amortization of DAC and VOBA.”

Policyholder Benefits

          Benefit reserves as reported are shown after conversion to a GAAP purchase accounting basis. Prior to the quarter ending June 30, 2006, this conversion was based on an adjustment to benefit reserves developed on a historical GAAP basis. Effective June 30, 2006, a change in methodology was implemented whereby the benefit reserves began to be developed directly on a purchase GAAP basis. The change to seriatim developed reserves had no material impact on income but does have an impact on the balance sheet on a segment by segment basis. This balance sheet impact is further discussed in Note 10 (Business Segments).

          Policyholder benefits increased $10.7 million, or 43.9%, to $35.1 million for the three months ended June 30, 2007, from $24.4 million for the three months ended June 30, 2006. This produced a benefits to premium ratio of 84.1% for the three months ended June 30, 2007, compared to 79.5% for the three months ended June 30, 2006.

          Worksite marketing policyholder benefits increased $17.1 million, or 231.1%, to $24.5 million for the three months ended June 30, 2007, from $7.4 million for the three months ended June 30, 2006. This produced benefits to premium ratios of 79.8% for the three months ended June 30, 2007, compared to 38.3% for the three months ended June 30, 2006. The ratio in 2006 was deflated due to the conversion to Purchase GAAP seriatim reserve factors from the aggregate method, which resulted in decreased benefits of $6.3 million. The three months ended June 30, 2006 benefits to premium ratio adjusted would be 70.7% without the reserve conversion impact.

          The Company began writing annually renewable stop loss business in mid-2005, and initially relied on pricing assumptions, a common industry practice relative to new books of stop loss business, to establish expected loss ratios due to lack of credible actual claim experience. As a contrast, companies with mature books of stop loss business typically establish claim reserves as a function of experience studies of its business. Because actual claims on stop loss cases typically are not fully reported until after the end of the policy period, it is a common practice to increase or decrease claims reserves once the actual claims experience becomes known. As experience has emerged, the Company has recognized additional claims and reserves reflecting the recent adverse claims experience. The Company also decided to increase claims assumptions on business prospectively, reflecting a more conservative estimate of future claims on this business. The Company’s experience has been that it takes four quarters after a case has been written before a clear picture becomes apparent regarding claims for that case. As a result of the new data the Company has concluded that it would be prudent to increase the estimated loss ratios on newer cases for claims before credible claims experience has developed on this business. As a result of these actions, the Company believes its current claim reserves on stop loss business adequately reflect both the development of recent experience and the Company’s more conservative outlook on loss experience related to current premiums.

          In order to address the imbalance in its overall new sales mix, which has a disproportionate concentration of stop loss business, the Company has restructured the sales incentive compensation plan for its sales organization with increased incentives for sales of core group life/disability and voluntary benefit products. Additionally, the Company is limiting new sales of stop loss by means of more conservative pricing and a requirement that sales of stop loss be packaged with other products.

          Senior market policyholder benefits decreased $38.1 million, or 81.4%, to $8.7 million for the three months ended June 30, 2007, from $46.8 million for the three months ended June 30, 2006. This produced benefits to

32

premium ratios of 78.8% for the three months ended June 30, 2007, compared to 436.8% for the three months ended June 30, 2006. The benefits to premium ratio decreased primarily as a result of the 2006 conversion to Purchase GAAP seriatim reserve factors from the aggregate method, which resulted in increased benefits of $37.5 million. The three months ended June 30, 2006 benefits to premium ratio adjusted would be 86.6% without the reserve conversion impact. The second quarter of 2006 had some large increases in open claims that have not been repeated in the second quarter of 2007, which accounts for the improved benefits ratio.

          Acquired business policyholder benefits increased $31.6 million, to $1.8 million for the three months ended June 30, 2007, from $(29.8) million for the three months ended June 30, 2006. Benefits to premium ratios do not provide meaningful information in this segment without first adjusting for certain routine items that have no impact on net income but have significant impact on the benefit ratios. Experience refunds are generated on certain reinsurance treaties that reduce both premiums and policyholder benefits equally. The experience refunds increased to $2.3 million for the three months ended June 30, 2007, from $2.0 million for the three months ended June 30, 2006. In addition, the 2006 conversion to Purchase GAAP seriatim reserve factors from the aggregate method resulted in decreased benefits of $31.2 million. Also, in the second quarter of 2007, an estimated refund due to our reinsurance carrier of $0.3 million was accrued in relation to possible adjustments needed for previously settled billings. Excluding the effects of these items, the comparable benefit ratios are 186.8% for the three months ended June 30, 2007 and 174.9% for the three months ended June 30, 2006. These benefits to premium ratios are affected by large portions of the acquired business that are no longer premium paying with substantial reserves and investment income on reserves.

Insurance Commissions

          Commission expenses increased $1.1 million, or 37.9%, to $4.0 million for the three months ended June 30, 2007, from $2.9 million for the three months ended June 30, 2006. This increase consists of normal increases related to increased renewal premiums, in addition to an increase in first year commissions that were not deferred, a large portion of which relates to the increased sales of stop loss products.

General Insurance Expenses

          General insurance expenses decreased $0.1 million, or 1.0%, to $11.2 million for the three months ended June 30, 2007, from $11.3 million for the three months ended June 30, 2006. Increases were created by interest on the junior subordinated debt of $0.7, offset somewhat by a $0.4 million decrease in legal expenses related to litigation.

          Overhead expenses that are not directly associated with a particular business segment are allocated to the various business segments on a pro rata basis based on different factors, such as headcount, policy count, number of policies issued, premiums and other relevant factors.

Insurance Taxes, Licenses and Fees

          Insurance taxes, licenses and fees increased $0.6 million, or 46.2%, to $1.9 million for the three months ended June 30, 2007, from $1.3 million for the three months ended June 30, 2006. Employment taxes and additional premium taxes due to increased premiums account for the increase.

Amortization of DAC and VOBA

          First year commissions and general insurance expenses associated with the acquisition of new business are deferred and amortized over the premium-paying period of the related policies. The total deferrals of policy acquisition costs were $4.9 million and $3.9 million for the three months ended June 30, 2007 and 2006, respectively. The increase in deferrals was primarily due to the increase in net new premiums and the associated increase in commissions and expenses in the worksite segment.

          The amortization of deferred acquisition costs (“DAC”) and the value of business acquired (“VOBA”) remained constant at $1.1 million for the three months ended June 30, 2007 and 2006, respectively.

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Provision for Income Taxes

          Total income taxes may differ from the amount computed by applying the federal corporate tax rate of 35% due to tax-advantaged investments and net operating loss carry forwards available. The effective income tax rates for the three months ended June 30, 2007 and 2006 were 65.0 % and 34.0%, respectively. The variation in these rates is due to a valuation allowance of $0.4 million that has been established during the current quarter.

Under SFAS No. 109, management must provide a valuation allowance for any deferred tax amounts that it believes are uncertain to be realized. The decision by A.M. Best to change the outlook of our rating from stable to negative, and the resulting strategic options being considered, has created uncertainty about our ability and timing to generate taxable income at the holding company. Because of this uncertainty, the Company deemed it appropriate to establish a valuation allowance of $0.4 million which represents the portion of the deferred tax asset that was generated by net operating losses at the holding company during the current quarter.

          Liquidity and Capital Resources

          KMG America is a holding company and had minimal operations of its own prior to the completion of its initial public offering and the Kanawha acquisition. KMG America’s assets consist primarily of the capital stock of Kanawha and its non-insurance subsidiary. Accordingly, KMG America’s cash flows depend upon the availability of dividends and other statutorily permissible payments, such as payments under tax allocation agreements and under management agreements, from Kanawha. Kanawha’s ability to pay dividends and to make other payments is limited primarily by applicable laws and regulations of South Carolina, the state in which Kanawha is domiciled, which subjects insurance operations to significant regulatory restrictions. These laws and regulations require, among other things, that Kanawha, KMG America’s insurance subsidiary, maintain minimum solvency requirements and limit the amount of dividends it can pay to the holding company. Solvency regulations, capital requirements, types of insurance offered and rating agency status are some of the factors used in determining the amount of capital available for dividends. In general, South Carolina will permit annual dividends from insurance operations equal to the greater of (1) the most recent calendar year’s statutory net income or (2) 10% of total capital and surplus of the insurance operations at the end of the previous calendar year, provided that the dividend payment does not exceed earned surplus, in which case further limitations apply. While the South Carolina Insurance Department acknowledges distinctions between ordinary and extraordinary dividends, their approval is required before any dividend payments can be made.

          If KMG America is able to successfully execute its business plan and accelerate Kanawha’s earnings growth in its insurance operations, KMG America expects that the maximum allowable dividend from Kanawha to the holding company will increase at an accelerated rate year-over-year. If the ability of Kanawha to pay dividends or make other payments to KMG America is materially restricted by regulatory requirements, it could adversely affect KMG America’s ability to pay any dividends on its common stock and/or service its debt and pay its other corporate expenses.

          The primary sources of funds for KMG America’s subsidiaries consist of insurance premiums and other considerations, fees and commissions collected, proceeds from the sales and maturity of investments and investment income. Cash is primarily used to pay insurance claims, agent commissions, operating expenses, product surrenders and withdrawals and taxes. KMG America generally invests its subsidiaries’ excess funds in order to generate income. The primary use of dividends and other distributions from subsidiaries to KMG America will be to pay certain expenses of the holding company. We currently have no intention of paying dividends to our shareholders and will reinvest cash flows from operations into our businesses for the foreseeable future.

          On March 22, 2007, KMG America completed the issuance and sale in a private placement of $35,000,000 in aggregate principal amount of trust preferred securities (the “Trust Preferred Securities”) issued by the Company’s newly-formed subsidiary, KMG Capital Statutory Trust I, a Delaware statutory trust (the “Trust”). The Trust Preferred Securities will mature on March 15, 2037, may be called at par by the Company any time after March 15, 2012, and require quarterly distributions of interest by the Trust to the holder of the Trust Preferred Securities. Distributions are payable quarterly at a fixed interest rate equal to 8.02% per annum through March 15, 2012, and then will be payable at a floating interest rate equal to the 3-month London Interbank Offered Rate (“LIBOR”) plus 310 basis points per annum. The Trust simultaneously issued one of the Trust’s common securities

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(the “Common Securities”) to the Company for a purchase price of $1,083,000, which constitutes all of the issued and outstanding common securities of the Trust.

          The Trust used the proceeds from the sale of the Trust Preferred Securities together with the proceeds from the sale of the Common Securities to purchase $36,083,000 in aggregate principal amount of unsecured junior subordinated deferrable interest debt securities due March 15, 2037, issued by the Company (the “Junior Subordinated Debt”). The net proceeds to the Company from the sale of the Junior Subordinated Debt to the Trust will be used by the Company for general corporate purposes.

          The Junior Subordinated Debt was issued pursuant to an Indenture, dated March 22, 2007 (the “Indenture”), between the Company, as issuer, Wilmington Trust Company, as trustee, and the administrators named therein. The terms of the Junior Subordinated Debt are substantially the same as the terms of the Trust Preferred Securities. The interest payments on the Junior Subordinated Debt paid by the Company will be used by the Trust to pay the quarterly distributions to the holders of the Trust Preferred Securities. The Indenture permits the Company to redeem the Junior Subordinated Debt (and thus a like amount of the Trust Preferred Securities) on or after March 15, 2012. If the Company redeems any amount of the Junior Subordinated Debt, the Trust must redeem a like amount of the Trust Preferred Securities.

          On December 21, 2006, the Company entered into a credit agreement with Wachovia, which provides a $15.0 million unsecured revolving credit facility from which we borrowed $14.0 million to repay the five-year subordinated promissory note that was issued to fund a portion of the purchase price for the Kanawha acquisition. The remaining $1.0 million available under the credit facility may be used to finance the Company’s working capital, liquidity needs and general working requirements and those of its subsidiaries. Amounts outstanding under the credit agreement will bear interest at a rate calculated according to, at the Company’s option, a base rate or the LIBOR rate plus an applicable percentage. The applicable percentage is based on the A.M. Best financial strength rating of Kanawha, and ranges from 0.25% to 0.35% for base rate loans and from 1.25% to 1.35% for LIBOR rate loans. In the case of LIBOR rate loans, interest on amounts outstanding is payable at the end of the interest period, which can be one, two, three or six months, as selected by the Company in its notice of borrowing. Wachovia’s obligation to fund the credit agreement terminates, and all principal outstanding under the credit agreement is due and payable, no later than December 31, 2007. As of June 30, 2007, the $14.0 million outstanding under the credit agreement was a LIBOR rate plus applicable percentage loan with an interest rate of 6.57%.

          The credit agreement requires the Company to comply with certain covenants, including, among others, maintaining a maximum ratio of consolidated indebtedness to total capitalization, a minimum available dividend amount for Kanawha and a minimum A.M. Best financial strength rating of B++ for Kanawha. The Company must also comply with limitations on certain payments, additional debt obligations, dispositions of assets and its lines of business. The credit agreement also restricts the Company from creating or allowing certain liens on its assets and from making certain investments.

          While our primary focus is organic growth of our existing businesses by expanding our product and marketing capabilities, we do evaluate opportunities to grow through strategic alliances and acquisitions of blocks of business and/or companies that are compatible with our core businesses. If such opportunities arise we may make significant capital expenditures or acquisitions in 2007 or subsequent years. However, our primary focus is on significantly expanding outlays relating to marketing and sales activities over the next several years including outlays required to continue to build a national sales organization, which is a key component of our strategy. These outlays will include expenses such as salaries and cash incentive compensation, employee benefits, occupancy and information technology expenses of additional sales personnel, advertising and marketing costs, consulting and recruiting. The execution of our business plan will require additional outlays associated with the development of a national insurance company including home office expenses for executive management and additional financial, actuarial and underwriting personnel, infrastructure development and back-office expenses, as well as costs associated with our being a public company.

          We anticipate that these costs will be offset over time by increased sales production resulting from hiring additional sales personnel and increased cross-selling, as well as efficiencies resulting from greater scale.

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          On May 7, 2007, the Company publicly announced that it had retained Keefe, Bruyette & Woods, Inc., an investment banking firm, to advise management and the Board of Directors regarding strategic alternatives, including the possible sale or merger of the Company. The process is underway and advanced negotiations are occurring. There can be no assurance that this process will result in a sale or merger of the Company, or if a sale or merger is undertaken, the potential terms or timing of the transaction. The Company does not intend to publicly disclose updates or developments in its strategic alternatives process until such time as the Company enters into a definitive agreement with a third party in connection with a transaction or terminates the strategic alternatives process.

          Analysis of Change in Financial Condition and Cash Flows

          The nature of the life insurance business is that premiums are collected and invested and will be used for the payment of claims when they arise, and policy reserve liabilities are established in anticipation of these future claims. As a result, the change in financial condition directly corresponds to the cash flows and they are discussed here in tandem.

          We monitor cash flows at both the consolidated and subsidiary levels. Cash flow forecasts at the consolidated and subsidiary levels are provided on a monthly basis, and we use trend and variance analyses to project future cash needs, making adjustments to the forecasts when needed.

The table below shows the Company’s net cash flows in the indicated periods (dollars in thousands):

Net cash provided by (used in)	Six Months Ended June 30, 2007			Six Months Ended June 30, 2006
Operating activities	$	13,384.5		$	(509.9	)
Investing activities		(44,415.0	)		(25,126.7	)
Financing activities		36,083.0			—
Net change in cash	$	5,052.5		$	(25,636.6	)

          Cash Flows for the Six Months Ended June 30, 2007 and 2006. In the table shown above, increases in net cash provided by operating activities generally result from collected premiums while decreases in net cash flow provided by investing activities generally are a result of the investment of collected premiums. Policy and contract liabilities increase when premiums collected are retained to establish policy reserves. The portions of these liabilities that are reinsured by reinsurance companies are reflected in reinsurance balances recoverable.

          As a function of our third party administration business, we manage insurance funds for our clients. These funds are held in suspense accounts pending appropriate disposition, and the balances held in suspense vary on a day-to-day basis as insurance funds are received and applied by us.

          Other changes in cash flows for the six months ended June 30, 2007 and June 30, 2006, are as follows:

We held approximately $21.7 million in cash and cash equivalents at December 31, 2006, primarily consisting of investments in short term commercial paper. We also had $36.1 million net cash provided from financing activities as the result of the issuance of subordinated debt securities discussed previously in the Liquidity and Capital Resources section. We invested a significant portion of these funds in longer term securities, resulting in the net cash outflow from investing activities of $44.4 million for the six months ended June 30, 2007. This produced a corresponding increase in invested assets.

          Other assets decreased by $0.3 million in the six months ended June 30, 2007 primarily as a result of fluctuations in claims reimbursements due from self funded Administrative Services Only (“ASO”) clients. These claims are not actually disbursed until receipt of these funds, so there is nothing at risk with these assets, and fluctuations from day to day are typical.

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          Accounts payable and accrued expenses increased $1.7 million in the six months ended June 30, 2007, compared to a decrease of $2.4 million in the six months ended June 30, 2006 due to fluctuations in our reinsurance settlements payable.

          Federal income tax recoverable remained constant from the December 31, 2006 balance. The deferred tax asset decreased by $6.3 million and the deferred tax liability decreased by $4.8 million. The combination of these items resulted in a net decrease in tax assets of $1.5 million, inclusive of an increase of $4.3 million related to the change in fair market value of invested assets. Exclusive of the change relating to the increase in fair market value, the net deferred tax asset decreased by $5.9 million, which consists of tax credits on current year losses offset by the $7.2 valuation allowance discussed in the provision for income taxes section of this document.

          Investments

          The following table summarizes the unrealized gains and losses in our investment portfolio as of June 30, 2007.

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Available for sale securities at June 30, 2007:
U.S. Treasuries	$	7,799,687	$	—	$	260,686	$	7,539,001
U.S. Government Agencies		19,472,446		—		577,154		18,895,292
States and Political Subdivisions		13,384,428		28,397		510,012		12,902,813
Foreign Bonds		38,383,380		47,014		1,983,500		36,446,894
Corporate Bonds		240,776,982		374,188		11,888,471		229,262,699
Mortgage/Asset-Backed Securities		224,655,208		102,120		7,398,159		217,359,169
Preferred Stocks—Redeemable		29,411,087		10,627		1,191,778		28,229,936
Subtotal, Fixed Maturity Securities	$	573,883,218	$	562,346	$	23,809,760	$	550,635,804
Equity Securities		156,840		—		1,700		155,140
Securities Available For Sale	$	574,040,058	$	562,346	$	23,811,460	$	550,790,944

          We regularly monitor our investment portfolio to ensure that investments that may be other than temporarily impaired are identified in a timely fashion and properly valued and that any impairment is charged against earnings in the proper period. Our investment portfolio is managed by external asset management firms, with the exception of certain invested assets that are managed internally. Our methodology used to identify potential impairments requires judgment by us in conjunction with our investment managers.

          Changes in individual security values are monitored on a monthly basis in order to identify potential problem credits. In addition, pursuant to our impairment testing process, each month the portfolio holdings are reviewed with additional screening for securities whose market price is equal to 80% or less of their original purchase price. Management then makes an assessment as to which, if any, of these securities is other than temporarily impaired. Assessment factors include, but are not limited to, the financial condition and rating of the issuer, any collateral held and the length of time the market value of the security has been below cost. Each month the watch list is distributed to our investment committee and the outside investment managers, and discussions are held as needed in order to make any impairment decisions. Each quarter any security deemed to have been other than temporarily impaired is written down to its then current market value, with the amount of the write-down reflected in the statement of income for that quarter. Previously impaired issues are also monitored monthly, with additional write-downs taken quarterly if necessary.

          The substantial majority of our unrealized losses at June 30, 2007, can be attributed to increases in interest rates that caused the value of the fixed income securities in our investment portfolio to decrease.

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	Number of Issues		Aggregate Unrealized Loss		Aggregate Estimated Fair Value
			(in thousands)
Securities at a loss for 12 months or less		226	$	9,006.1		234,269.5
Securities at a loss for more than 12 months		327	$	14,805.4		266,724.9

          Management has reviewed these securities which either have been in an unrealized loss position for more than twelve months or have significant unrealized loss relative to cost and have concluded that these securities have not experienced any other than temporary impairment. Factors considered in making this evaluation included issue specific drivers of the decrease in price, near term prospects of the issuer, the length of time and degree of volatility of the depressed value, and the financial condition of the industry. Based on this review, no unrealized losses were considered to be other than temporary during the six months ended June 30, 2007.

          As a result of purchase accounting adjustments as required in connection with our acquisition of Kanawha as of December 31, 2004, the mark to market adjustments to the investment portfolio occurred at a time when very low market interest rates prevailed. Therefore, as interest rates rise, we would expect substantial unrealized investment losses. Due to the long range nature of our liabilities, the majority of these interest related unrealized losses are not expected to materialize into realized losses, and therefore should not have an adverse effect on our operations.

          Reserves

          The following table presents insurance policy benefit and contract-related liabilities information as of the dates indicated, by reserve type:

	As of June 30, 2007		As of December 31, 2006
	(dollars in thousands)
Life and annuity reserves	$	248,957.7	$	252,658.2
Accident and health reserves		309,500.4		294,581.0
Policy and contract claims		27,198.4		14,530.8
Other policyholder liabilities		10,815.8		10,594.2
Total policy liabilities	$	596,472.3	$	572,364.2

          Life and annuity reserves decreased by $3.7 million, or 1.5%, to $249.0 million as of June 30, 2007, from $252.7 million as of December 31, 2006. A large portion of the life and annuity reserves relates to acquired blocks of business that are lapsing at a steady pace because no new blocks of business have been acquired since 1999, and therefore represents a significant portion of the decrease in reserves for the six months ended June 30, 2007. Accident and health reserves increased by $14.9 million, or 5.1%, to $309.5 million as of June 30, 2007 from $294.6 million as of December 31, 2006. These reserve increases are consistent with growth in the underlying business, with the majority of the reserve growth being accumulated from long-term care renewal premiums received. Policy and contract claims, which represent liabilities for actual claims incurred, increased by $12.7 million, or 87.6%, to $27.2 million as of June 30, 2007 from $14.5 million as of December 31, 2006. This primarily represents the significant increase in new premiums in the stop loss book of business, combined with higher anticipated claims described below.

          After a comprehensive review of its stop loss book of business, the Company recognized a $6 million charge in the first quarter of 2007 for increased claims and reserves that reflects recent experience on stop loss cases. The Company began writing annually renewable stop loss insurance in mid-2005, and initially relied on pricing assumptions, a common industry practice relative to new books of stop loss business, to establish expected loss ratios due to a lack of credible actual claim experience. As a contrast, companies with mature books of stop loss business typically establish claim reserves as a function of experience studies of its business. Because actual claims

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on stop loss cases typically are not fully reported until after the end of the policy period, it is a common practice to increase or decrease claims reserves once the actual claims experience becomes known.

          As experience emerged, the Company recognized additional claims and reserves reflecting the recent adverse claims experience. The Company also decided to increase claims assumptions on business prospectively, reflecting a more conservative estimate of future claims on this business. The Company’s experience has been that it takes four quarters after a case has been written before a clear picture becomes apparent regarding claims for that case. While some of the unfavorable claims data began to emerge late in the fourth quarter of 2006 and guided our reserving at year-end, new more meaningful data came to the Company’s attention late in the first quarter of this year after the year-end books were closed and earnings reported. As a result of the new data the Company has concluded that it would be prudent to increase the estimated loss ratios on newer cases for claims before credible claims experience has developed on this business. As a result of these actions, the Company believes its June 30, 2007 claim reserves on stop loss business adequately reflect both the development of recent experience and the Company’s more conservative outlook on loss experience related to current premiums.

          Other policyholder liabilities, which are comprised primarily of dividend accumulations and advance premiums, increased by $0.2 million, or 1.9%, to $10.8 million as of June 30, 2007 from $10.6 million as of December 31, 2006.

          The following table sets forth reinsurance recoverables by category as of the dated indicated:

	As of June 30, 2007		As of December 31, 2006
	(dollars in thousands)
Ceded future policyholder benefits and expense	$	88,485.0	$	86,296.1
Ceded claims and benefits payable		3,651.9		2,795.1
Reinsurance recoverables	$	92,136.9	$	89,091.2

          Reinsurance recoverables increased by $3.0 million, or 3.4%, to $92.1 million as of June 30, 2007, from $89.1 million as of December 31, 2006. The increase in the recoverable balance is attributable to underlying business growth, specifically the growth in long-term care and excess risk business reinsured.

          Critical Accounting Policies and Estimates

          Our consolidated financial statements and certain disclosures made in this report have been prepared in accordance with GAAP and require us to make estimates and assumptions that affect reporting amounts of assets and liabilities and contingent assets and contingent liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The estimates most susceptible to material changes due to significant judgment (identified as the “critical accounting policies”) are those used in determining investment impairments, the reserves for future policy benefits and claims, deferred acquisition costs and value of business acquired, and the provision for income taxes. The results of these estimates are critical because they affect our profitability and may affect key indicators used to measure our performance. These estimates have a material effect on our results of operations and financial condition. For more information about our critical accounting policies, please refer to our discussion of critical accounting policies in our Annual Report on Form 10-K for the year ended December 31, 2006.

          Forward-Looking Statements

          Forward-looking statements in the foregoing Management’s Discussion and Analysis of Financial Condition and Results of Operations include statements that are identified by the use of words or phrases including, but not limited to, the following: “will likely result”, “expected to”, “will continue”, “is anticipated”, “estimated”, “project”, “believe”, “expect” and words or phrases of similar import. Changes in the following important factors, among others, could cause our actual results to differ materially from those expressed in any such forward-looking statements: the results of the strategic alternatives review process that the Company is presently conducting; competitive products and pricing; fluctuations in demand; possible recessionary trends in the United States

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economy; governmental policies and regulations; interest rates; risks disclosed in Part I Item 1A to Annual Report of Form 10-K for the year ended December 31, 2006 and in Part II Item 1A to our Quarterly Report on From 10-Q for the quarter ended March 31, 2007; and other risks that are detailed from time to time in reports we file with the Securities and Exchange Commission. We undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

          There are no material changes to the disclosure on this matter made in our Annual Report on Form 10-K for the year ended December 31, 2006.

ITEM 4. CONTROLS AND PROCEDURES

          We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of June 30, 2007. Based upon that evaluation, our management, including our Chief Executive Officer and our Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of June 30, 2007. There was no change in our internal control over financial reporting during the quarter ended June 30, 2007, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II
OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

          The disclosure made in Note 7, Commitments and Contingencies, of the Notes to Consolidated Financial Statements included in this report, which discusses certain legal proceedings in which we are involved, is incorporated herein by reference.

ITEM 1A. RISK FACTORS

          As of June 30, 2007, there have been no material changes in the risk factors of the Company as previously disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006, and subsequently updated in the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2007.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

          At the annual meeting of the shareholders on May 3, 2007, the shareholders voted upon nominees for election to the Board of Directors as Class III directors to serve three year terms expiring at the 2010 annual meeting of shareholders. Each of the two nominees was elected. The following is a summary of the votes cast:

	Number of Shares For	Number of Shares Withheld
Kenneth U. Kuk	19,730,179	1,370,792
John H. Flittie	19,108,427	1,992,544

          There were no abstentions or broker non-votes.

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ITEM 6. EXHIBITS

(a)	Exhibits:
31.01	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.02	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.01	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.02	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

          Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	KMG AMERICA CORPORATION
	(Registrant)
Date: August 9, 2007	By:	/s/ Scott H. DeLong III
		Name: Scott H. DeLong III
		Title: Senior Vice President & Chief Financial Officer
		(Principal Financial Officer)
Date: August 9, 2007	By:	/s/ Robert E. Matthews
		Name: Robert E. Matthews
		Title: Executive Vice President, Chief Financial Officer & Treasurer of Kanawha Insurance Company
		(Principal Accounting Officer)

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