The accompanying consolidated financial statements include the accounts of SeaBright and its wholly owned subsidiaries, SBIC, PointSure, and PMCS (collectively, the “Company”). All significant intercompany transactions among these affiliated entities have been eliminated in consolidation.

The consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and include amounts based on the best estimates and judgments of management. Such estimates and judgments could change in the future as more information becomes known, which could impact the amounts reported and disclosed herein.

In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 280, Segment Reporting, the Company considers an operating segment to be any component of its business whose operating results are regularly reviewed by the Company’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance. Currently, the Company has one operating segment, workers’ compensation insurance and related services.

Investment securities are classified as available-for-sale and are carried at fair value. The estimated fair value of investments in available-for-sale securities is generally based on quoted market prices for securities traded in the public marketplace. If a quoted market price is not available, fair value is generally estimated using quoted market prices for similar securities.

The Company regularly reviews its investment portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of its investments. A number of criteria are considered during this process including, but not limited to: whether the Company intends to sell the security; the current fair value as compared to amortized cost or cost, as appropriate, of the security; the length of time the security’s fair value has been below amortized cost or cost; the likelihood that the Company will be required to sell the security before recovery of its cost basis; objective information supporting recovery in a reasonable period of time; specific credit issues related to the issuer; and current economic conditions.

For debt securities that are considered other-than-temporarily impaired (“OTTI”) and that the Company does not intend to sell and more likely than not would not be required to sell prior to recovery of the amortized cost basis, the Company recognizes OTTI losses in accordance with the provisions of the ASC Topic 325, Investments - Other. The amount of the OTTI loss is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between a security’s amortized cost basis and the present value of expected future cash flows discounted at the security’s effective interest rate. The amount due to all other factors is recognized in other comprehensive income.

In general, the Company reviews all securities that are impaired by 5% or more at the end of the period. For securities with no stated maturity date, the review focuses on securities that were impaired by 20% or more at the end of the period or had been impaired 10% or more continuously for six months or longer as of the end of the period. The Company also analyzes the entire portfolio for other factors that might indicate a risk of impairment, including credit ratings, liquidity of the issuer and interest rates. Other-than-temporary impairment losses result in a permanent reduction of the carrying amount of the underlying investment. Significant changes in the factors considered when evaluating investments for impairment losses could result in a significant change in impairment losses reported in the consolidated financial statements.

Mortgage-backed securities represent participating interests in pools of first mortgage loans originated and serviced by the issuers of securities. These securities are carried at fair value. Premiums and discounts are amortized using a method that approximates the level yield method over the remaining period to contractual maturity, adjusted for anticipated prepayments. To the extent that the estimated lives of such securities change as a result of changes in prepayment rates, the adjustment is also included in net investment income. Prepayment assumptions used for mortgage-backed and asset-backed securities were obtained from an external securities information service and are consistent with the current interest rate and economic environment.

Although no impairment losses were recognized over the value of the Company’s investment portfolio in 2011, it is possible that the Company could recognize future impairment losses on some securities it owned at December 31, 2011 if future events, information or the passage of time result in a determination that a decline in value is other-than-temporary.

Cash and cash equivalents, which consist primarily of amounts deposited in banks and financial institutions, and all highly liquid investments with maturities of 90 days or less when purchased, are stated at cost. Cash in excess of daily requirements is invested in short-term, highly liquid bank funds and are deemed to be cash equivalents for purposes of the consolidated balance sheets and statements of cash flows.

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

Deferred premiums receivable consist of the unbilled portion of total policy premiums. For a typical policy, the entire premium is recorded as deferred premium receivable at inception and is billed over the policy period according to the terms of the policy. Premiums receivable consist of amounts that have been billed to policyholders. The allowance for doubtful accounts, which represents the Company’s best estimate of the amount of uncollectible premium in the Company’s existing premiums receivable balance, is based on historical account write-offs and takes into consideration the current economic environment. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

Acquisition costs related to premiums written are deferred and amortized over the periods in which the premiums are earned. Such acquisition costs vary with and are primarily related to the acquisition of insurance contracts and include commissions, premium taxes, and certain underwriting and policy issuance costs. Deferred policy acquisition costs are limited to amounts recoverable from unearned premiums and anticipated investment income.

Furniture and equipment are recorded at cost and depreciated using the straight-line method over their estimated useful lives, which range from three to five years. Leasehold improvements are depreciated on a straight-line basis over periods ranging from approximately two to seven years, which is the shorter of their estimated useful lives or the remaining term of the respective lease. Depreciation expense totaled $1.5 million, $1.7 million and $1.9 million for the years ended December 31, 2011, 2010, and 2009, respectively.

Goodwill balances are reviewed for impairment at least annually or more frequently if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying value. A reporting unit is defined as an operating segment or one level below an operating segment.

The goodwill impairment test follows a three step process. The first step consists of consideration of various qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of the reporting unit in question is less than its carrying amount. If such a determination is not reached, then performance of further impairment testing is not necessary.

In the second step (if necessary), the fair value of a reporting unit is compared to its carrying value. If the carrying value of a reporting unit exceeds its fair value, the third step of the impairment test is performed for purposes of measuring the impairment. In the third step, the fair value of the reporting unit is allocated to all of the assets and liabilities of the reporting unit to determine an implied goodwill value. If the carrying amount of the reporting unit goodwill exceeds the implied goodwill value, an impairment loss would be recognized in an amount equal to that excess, and the charge could have a material adverse effect on the Company’s results of operations and financial position.

Management’s determination of the fair value of each reporting unit incorporates multiple inputs including various qualitative considerations, discounted cash flow calculations and, as appropriate, the level of the Company’s own share price and assumptions that market participants would make in valuing the reporting unit. Other assumptions include levels of economic capital, future business growth, earnings projections, assets under management and the discount rate utilized.

Premiums for primary and reinsured risks are included in revenue over the life of the contract in proportion to the amount of insurance protection provided (i.e., ratably over the policy period). The portion of the premium that is applicable to the unexpired period of a policy in-force is not included in revenue but is deferred and recorded as unearned premium in the liability section of the balance sheet. Deferred premiums represent the unbilled portion of annual premiums.

Earned premiums on retrospectively rated policies are based on the Company’s estimate of loss experience as of the measurement date. Loss experience includes known losses specifically identifiable to a retrospective policy as well as provisions for future development of known losses and for losses incurred but not yet reported. Future loss development is projected using actuarial loss development factors, assumptions and methodologies that are consistent with how the Company projects losses in general. For retrospectively rated policies, the governing contractual minimum and maximum premiums are established at policy inception and are made a part of the insurance contract. While the typical retrospectively rated policy has five annual adjustment or measurement periods, premium adjustments continue until mutual agreement to cease future adjustments is reached with the policyholder.

The Company estimates the amount of premiums that have been earned but are unbilled at the end of the period by analyzing historical earned premium adjustments made at final audit and applying an adjustment percentage against premiums earned for the period. Final audit adjustments may result in increasing or decreasing the estimated premium earned and billed to date. Included in deferred premiums at December 31, 2011, 2010 and 2009 and premiums earned for the years then ended were accruals for earned but unbilled premiums of $0.3 million, ($0.6) million, and ($0.1) million, respectively.

Unpaid loss and loss adjustment expense represents an estimate of the ultimate net cost of all unpaid losses incurred through the specified period. Loss adjustment expenses are estimates of unpaid expenses to be incurred in settlement of the claims included in the liability for unpaid losses. These liabilities, which anticipate salvage and subrogation recoveries and are presented gross of amounts recoverable from reinsurers, include estimates of future trends in claim severity and frequency and other factors that could vary as the losses are ultimately settled. Liabilities for unpaid loss and loss adjustment expenses are not discounted to account for the time value of money.

In light of the Company’s short operating history, and uncertainties concerning the effects of legislative reform specifically as it relates to the Company’s California workers compensation class of business, actuarial techniques are applied that use the historical experience of the Company and the Company’s predecessor as well as industry information in the analysis of unpaid loss and loss adjustment expense. These techniques consider, among other factors:

Although it is not possible to measure the degree of variability inherent in such estimates, management believes that the liability for unpaid loss and loss adjustment expense is reasonable. The estimates are reviewed periodically and any necessary adjustments are included in the results of operations of the period in which the adjustment is determined.

The Company protects itself from excessive losses by reinsuring certain levels of risk in various areas of exposure with nonaffiliated reinsurers. Regardless of type, reinsurance does not legally discharge the ceding insurer from primary liability for the full amount due under the reinsured policies. Reinsurance premiums, commissions, expense reimbursements and reserves related to ceded business are accounted for on a basis consistent with the accounting for the original policies issued and the terms of reinsurance contracts. Amounts are shown net in the statements of operations and comprehensive income (loss). Premiums ceded to other companies are reported as a reduction of premiums written and earned. Reinsurance recoverables are determined based on the terms and conditions of the reinsurance contracts.

Balances due from reinsurers on unpaid loss and loss adjustment expenses, including an estimate of such recoverables related to reserves for IBNR losses, are reported as assets and are included in reinsurance recoverables even though amounts due on unpaid loss and loss adjustment expenses are not recoverable from the reinsurer until such losses are paid. The Company monitors the financial condition of its reinsurers and does not believe that it is currently exposed to any material credit risk through its reinsurance treaties because most of its reinsurance is recoverable from large, well-capitalized reinsurance companies. Historically, no amounts from reinsurers have been written-off as uncollectible.

The unpaid loss and loss adjustment expense subject to the adverse development cover with LMC is calculated on a quarterly basis using generally accepted actuarial methodologies for estimating unpaid loss and loss adjustment expense liabilities, including incurred loss and paid loss development methods. The minimum amount that must be maintained in the trust account is equal to the greater of (a) $1.6 million or (b) 102% of the then existing quarterly estimate of LMC’s total obligations under the adverse development cover. Amounts recoverable in excess of acquired reserves at September 30, 2003 are recorded gross in unpaid loss and loss adjustment expense in accordance with ASC Topic 805, Business Combinations, with a corresponding amount receivable from the seller.

The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the income statement in the period that includes the enactment date.

In assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. This analysis requires the Company to make various estimates and assumptions, including the scheduled reversal of deferred tax liabilities, the consideration of operating versus capital items, projected future taxable income and the effect of tax planning strategies. Based on this analysis, the Company may be required to establish a valuation allowance to reduce the deferred tax assets to the amounts more likely than not to be realized. As of December 31, 2011 and 2010, the Company had no valuation allowance against its deferred tax assets.

FASB ASC Topic 740, Income Taxes, prescribes a recognition threshold and measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on the derecognition of previously recorded benefits and their classification, as well as the proper recording of interest and penalties, accounting in interim periods, disclosures and transition. As of December 31, 2011 and 2010, the Company had no unrecognized tax benefits. The Company’s policy is to recognize interest and penalties on unrecognized tax benefits as an element of income tax expense (benefit) in the consolidated statements of operations and comprehensive income (loss).

The effect of including shares issuable upon the exercise of outstanding stock options and the vesting of nonvested restricted stock is antidilutive for the years ended December 31, 2011 and 2010. Therefore, such shares have been excluded from the calculation of diluted weighted average shares outstanding. The numbers of such shares excluded for the years ended December 31, 2011 and 2010 were approximately 615,000 and 577,000, respectively.

In October 2010, the FASB issued Accounting Standards Update (“ASU”) 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. This ASU allows insurance entities to defer costs related to the acquisition of new or renewal insurance contracts that are (1) incremental direct costs of the contract transaction (i.e., would not have occurred without the contract transaction), (2) a portion of an employee's compensation and fringe benefits related to certain activities for successful contract acquisitions, or (3) direct-response advertising costs as defined in ASC Subtopic 340-20, Other Assets and Deferred Costs - Capitalized Advertising Costs. All other costs related to the acquisition of new or renewal insurance contracts are required to be expensed as incurred. This ASU is effective for interim and annual periods beginning after December 15, 2011 with either prospective or retrospective application permitted. The Company will adopt this guidance retrospectively effective January 1, 2012. The Company currently estimates that adoption will reduce its December 31, 2011 retained earnings (the period immediately prior to adoption) by approximately $4.5 million, net of taxes.

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, to provide largely identical guidance about fair value measurement and disclosure requirements. The new standards do not extend the use of fair value but, rather, provide guidance about how fair value should be applied where it already is required or permitted under International Financial Reporting Standards (“IFRS”) or U.S. GAAP. The new guidance is effective for interim and annual reporting periods beginning after December 15, 2011. Early adoption is not permitted. The adoption of ASU 2011-04 is not expected to have a material effect on the Company’s consolidated financial condition and results of operations.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, to increase the prominence of other comprehensive income in the financial statements. An entity will have the option to present the components of net income and comprehensive income in either one or two consecutive financial statements. The new guidance is effective for interim and annual reporting periods beginning after December 15, 2011, with earlier adoption permitted. The Company adopted this guidance retrospectively effective September 30, 2011. The adoption of ASU 2011-05 did not have a material effect on the Company’s consolidated financial condition or results of operations.

In September 2011, the FASB issued ASU 2011-08, Intangibles—Goodwill and Other (Topic 350): Testing Goodwill for Impairment, to simplify the current two-step goodwill impairment test required under Topic 350. Under this update, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If such a determination is not reached, then performance of further impairment testing is not necessary. The new guidance is effective for annual and interim goodwill tests performed for fiscal years beginning after December 15, 2011. However, early adoption is permitted. The Company adopted ASU 2011-08 in the fourth quarter of 2011, which did not have a material effect on the Company’s consolidated financial condition or results of operations.